Small cap tilt

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BWildt
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Small cap tilt

Post by BWildt » Thu Sep 13, 2018 7:13 pm

I realize this is probably the millionth small cap discussion on this forum, but I just wanted to see how many of you Bogleheads have a tilt towards small cap, whether it be a small cap index or small cap value. As for me, I'm not sure I completely buy the evidence that there is a small cap "premium", though I admit I could most certainly be wrong on that.

My Roth IRA contains two funds: Vanguard Total Stock Market Index and Vanguard Total International Stock Market Index. I'm debating whether I should add a third fund, which would either be Vanguard Small Cap Index or Vanguard Small Cap Value Index.

I would appreciate any insight, and if there are links for/against small caps arguments, I would appreciate it.

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David Jay
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Re: Small cap tilt

Post by David Jay » Thu Sep 13, 2018 7:22 pm

The premium for small cap is not as clear the premium for value. I have a modest tilt to Small Cap Value, about 15% of my stock allocation.
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livesoft
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Re: Small cap tilt

Post by livesoft » Thu Sep 13, 2018 7:25 pm

Still tilted to small cap and to value. I own VBR, IJS, VSS, DLS, DGS. Plus I own the opposite of that: MTUM.

Those go with the other equity funds in the portfolio like Total US Stock Market, Total International Stock Market Index and their close cousins.

No special insights except that over a couple of decades of doing this, I have found that one cannot just buy small-cap value and expect it to work its magic all by itself. One has to buy more of it when it drops a lot in a single day. And one has to sell some after it goes back up. Otherwise, I think you just never harvest the value of small-cap value and never plant at the right time either.
Last edited by livesoft on Thu Sep 13, 2018 7:35 pm, edited 1 time in total.
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benway
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Re: Small cap tilt

Post by benway » Thu Sep 13, 2018 7:30 pm

I do not. However, I have thought about it and researched it.

Thesaints
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Re: Small cap tilt

Post by Thesaints » Thu Sep 13, 2018 7:34 pm

David Jay wrote:
Thu Sep 13, 2018 7:22 pm
The premium for small cap is not as clear the premium for value.
Yet it is a lot easier to understand.

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Taylor Larimore
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Re: Small cap tilt

Post by Taylor Larimore » Thu Sep 13, 2018 7:37 pm

BWildt wrote:
Thu Sep 13, 2018 7:13 pm
I realize this is probably the millionth small cap discussion on this forum, but I just wanted to see how many of you Bogleheads have a tilt towards small cap, whether it be a small cap index or small cap value. As for me, I'm not sure I completely buy the evidence that there is a small cap "premium", though I admit I could most certainly be wrong on that.

My Roth IRA contains two funds: Vanguard Total Stock Market Index and Vanguard Total International Stock Market Index. I'm debating whether I should add a third fund, which would either be Vanguard Small Cap Index or Vanguard Small Cap Value Index.

I would appreciate any insight, and if there are links for/against small caps arguments, I would appreciate it.
BWildt:

Vanguard Total Stock Market Index Fund ALREADY holds the market weight in small-cap and small-cap value stocks.

Strive for simplicity--not complexity.

Read my "Simplicity" link below.

Best wishes.
Taylor
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HEDGEFUNDIE
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Re: Small cap tilt

Post by HEDGEFUNDIE » Thu Sep 13, 2018 7:39 pm

Half of my US equities are small cap (IJR), and 2/3 of my international equities are small cap (ISCF).

I guess you could say I have conviction...

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whodidntante
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Re: Small cap tilt

Post by whodidntante » Thu Sep 13, 2018 7:39 pm

If you're looking to diversify from a concentration in the market factor, the Vanguard Multi-factor ETF VFMF is a new fund but all indications are that it is very well constructed. That's what I would do if it wouldn't trigger an avalanche of capital gains taxes for me. I wouldn't tilt to size only, at least not domestically. I just think there are better options available.
Last edited by whodidntante on Thu Sep 13, 2018 7:40 pm, edited 1 time in total.

Elysium
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Re: Small cap tilt

Post by Elysium » Thu Sep 13, 2018 7:40 pm

Small caps are riskier than large caps, so there has to be a premium, otherwise why would anyone lend their capital. Also, small value has even more risk, since they are distressed companies with limited access to capital, so even more risk premium. That said, no guarantees of returns, at least not within your investment timeframe. The longer the investment timeframe, better chance to capture any premium.

Personally, I have invested in small caps and value, actually at this time more like small value and mid value / mid caps. I don't think of it like a tilt or anything, as I am not very strict about total market investing or anything like many people. I keep a fairly sizeable allocation to small / mid caps like 15% or so of total portfolio, and I have no problem going 20%. Large caps are like another 25% to 30%. I don't worry about tracking error, because I look at them each as individual components and if S&P 500 returned 20% in a year and Small Value returned only 12% I won't complain, and this is true even if it was negative, now if they continue to be negative after 10 years of investing in them then I may start questioning the strategy. That hasn't happened so far, and hopefully will not.
Last edited by Elysium on Thu Sep 13, 2018 7:45 pm, edited 2 times in total.

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grabiner
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Re: Small cap tilt

Post by grabiner » Thu Sep 13, 2018 7:42 pm

I have overweighted small cap, value, and emerging markets for years. I prefer to increase the risk of my portfolio by holding riskier stocks (exposure to different risk factors in addition to the market), rather than holding more stock. Thus, in 2007-2009, while my portfolio was 90% stock, it declined by the same 60% as a typical 100%-stock portfolio. (And since I rebalanced near the market bottom, it recovered just as fast as well.)
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jalbert
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Re: Small cap tilt

Post by jalbert » Thu Sep 13, 2018 7:46 pm

Nobody can predict the future. The size or value premium may overperform with a vengeance after I’m dead, but underperform until then, and still satisfy that they still exist. If you believe in mean reversion, value may be a better bet than size right now.
Last edited by jalbert on Thu Sep 13, 2018 10:27 pm, edited 2 times in total.
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Alexa9
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Re: Small cap tilt

Post by Alexa9 » Thu Sep 13, 2018 7:47 pm

Yes Market Weight is a large cap tilt IMO (75% large caps). See my photo >>>>>

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nisiprius
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Re: Small cap tilt

Post by nisiprius » Fri Sep 14, 2018 11:02 am

I don't use a small-cap tilt.

The original paper (Banz 1981) that called attention to a small firm effect, now called the size factor, was based on a flawed data. When the data is corrected, the magnitude of the effect decreases. The effect is acknowledged by factor advocates to be one of the less strong factors. Factor advocates will not say that the size factor is discredited, but are now increasingly using phrases like "rescuing" or "resurrecting" or "not dead." They are now moving on to new factors, and emphasizing it only as having synergy with other factors when combined in specific ways, and "screened" in various ways.

There has been a tendency to overemphasize the higher return from small-caps, while underemphasizing the higher risk. When you look at risk-adjusted return, any difference is greatly reduced. Meanwhile, small-caps have not had such a low correlation large-caps as to have constituted a powerful diversifier.

Even the idea of a higher return can be challenged. One issue is that the higher return is completely attributable to one single time period of nine years: 1975-1983. A small-cap investor obtained no benefit from any holding period that didn't include those years. So (as is often the) this presents a conundrum: do we invest in small-caps in the hope that a second such period will recur during the period we are holding them? Or do we shrug it off as fluke that can't be counted on recurring?

If you assume that small-caps don't have higher risk-adjusted reward and don't have low correlation, then their most interesting use would be as a long-only substitute for leveraged stocks. This is not very interesting if you were not planning to leverage stocks in the first place.

Larry Swedroe has put forward some interesting ideas about using a smaller allocation of small-cap value stocks in lieu of a larger allocation to the total market. It's based oughly, on the idea that if you only have an X% allocation, even if they go to zero you can't lose more than X% of your portfolio, so, other things being equal, a smaller allocation to small-cap value has less "tail risk" than a larger allocation to the total market.

Another question that needs to be examined is that mid-caps have been pretty similar in behavior to small-caps. The division isn't so much between large-caps and small-caps, it's more between large-caps and not-large-caps. So someone who is interested in having a small-cap tilt ought to consider a mid-cap tilt, too.
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ruralavalon
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Re: Small cap tilt

Post by ruralavalon » Fri Sep 14, 2018 11:40 am

We use a small-cap value tilt, about 25% of domestic stocks in Vanguard Small-cap Value Index Fund Admiral Shares (VSIAX) and the rest in Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX).
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GammaPoint
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Re: Small cap tilt

Post by GammaPoint » Fri Sep 14, 2018 12:10 pm

I have some tilt to small cap, both domestically and internationally (VB and VSS, as well as VBR).
grabiner wrote:
Thu Sep 13, 2018 7:42 pm
I have overweighted small cap, value, and emerging markets for years.
Grabiner, how much do you overweight EM and with what justification? I overweight EM too actually but was curious about your % and technical/qualitative reasoning behind it (since EM is not a factor like size or value).

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Re: Small cap tilt

Post by CRTR » Fri Sep 14, 2018 1:04 pm

OK, I'm pretty sure I'm in the minority on this board (except for Larry Swedroe) but I've been VERY WELL served by having an extreme small cap tilt for the past 21 years. In fact, the equity portion of my portfolio has outperformed the classic Boglehead simple approach (TSM/TISM) on both an absolute and risk-adjusted basis with only a tiny bit higher volatility. Of course, I'm not going to say the next 20 years will repeat my experience but most rolling 20 year periods over the past 90 years have. By disclosure, it was not "my portfolio" . . . I simply followed recommendations of a friend in the industry (she worked for DFA and was one of the original architects of Schwab index funds). I invested in the following funds since 1998. I used contributions to rebalance:

25% VSMAX, Vanguard Small Cap,
25% BRSIX Bridgeway Micro Cap,
25% VINEX, Vanguard International Explorer,
25% VGSLX, Vanguard REIT

Here is my original post: viewtopic.php?f=1&t=229450&p=3566643#p3566643

Ironically, my advisor friend is NOT a fan of a tilting towards small caps -- even though she worked for DFA. In fact, she is in favor of general market wide diversification with one caveat: reduce exposure to so-called MEGA CAPS. She feels tilting away from that segment of the market will increase returns in the long run and reduce exposure in bubbles. As for small cap vs mid cap, she says the data is not there: they're equivalent.

I realize there are a number of things in my portfolio that will cause fits among many members of this board but the end result speaks for itself. To be clear, I am NOT arguing this is the best vehicle for everyone . . . just one example. If you can look past the 'religion' part of investing, it does satisfy the most important requirements: low costs, diversification, simplicity. Whatever you end up choosing, if it satisfies those requirements AND you stick with it, you'll be fine!

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vineviz
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Re: Small cap tilt

Post by vineviz » Fri Sep 14, 2018 1:18 pm

nisiprius wrote:
Fri Sep 14, 2018 11:02 am
Even the idea of a higher return can be challenged. One issue is that the higher return is completely attributable to one single time period of nine years: 1975-1983. A small-cap investor obtained no benefit from any holding period that didn't include those years.
If I only had a dollar for every time this falsehood got trotted out . . . .
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Jack FFR1846
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Re: Small cap tilt

Post by Jack FFR1846 » Fri Sep 14, 2018 1:23 pm

I watched a recent Bogle interview where he explained how SCV is only one of the latest trends where it looks like it's outperforming, everyone buys, the price of entry exceeds the outperformance, and we're back to no advantage.

I'll sit on my haystack and watch the trendy stuff blow by. No tilt here.
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grabiner
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Re: Small cap tilt

Post by grabiner » Fri Sep 14, 2018 7:06 pm

GammaPoint wrote:
Fri Sep 14, 2018 12:10 pm
I have some tilt to small cap, both domestically and internationally (VB and VSS, as well as VBR).
grabiner wrote:
Thu Sep 13, 2018 7:42 pm
I have overweighted small cap, value, and emerging markets for years.
Grabiner, how much do you overweight EM and with what justification? I overweight EM too actually but was curious about your % and technical/qualitative reasoning behind it (since EM is not a factor like size or value).
I overweight emerging markets because they are less correlated with the rest of my portfolio. They happen to be riskier as well, which increases my portfolio risk for a given stock allocation, but I can set my stock allocation freely to get a desired risk level.

I would split my foreign stock 50/50 between developed and emerging markets if the costs were equal. However, the costs are not equal; it is not just the 0.07% expense difference, but the higher percentage of non-qualified dividends. Therefore, my target allocation is 3/8 developed large, 1/4 emerging large, 1/4 developed small, 1/8 emerging small. (I don't hold emerging small separately at all because the ETFs are too expensive, but I hold the small-caps in Emerging Markets Index and the emerging markets in FTSE All-World Ex-US Small-Cap.)
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GammaPoint
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Re: Small cap tilt

Post by GammaPoint » Fri Sep 14, 2018 7:43 pm

grabiner wrote:
Fri Sep 14, 2018 7:06 pm
I overweight emerging markets because they are less correlated with the rest of my portfolio. They happen to be riskier as well, which increases my portfolio risk for a given stock allocation, but I can set my stock allocation freely to get a desired risk level.

I would split my foreign stock 50/50 between developed and emerging markets if the costs were equal. However, the costs are not equal; it is not just the 0.07% expense difference, but the higher percentage of non-qualified dividends. Therefore, my target allocation is 3/8 developed large, 1/4 emerging large, 1/4 developed small, 1/8 emerging small. (I don't hold emerging small separately at all because the ETFs are too expensive, but I hold the small-caps in Emerging Markets Index and the emerging markets in FTSE All-World Ex-US Small-Cap.)
Makes sense. Thanks, grabiner. My emerging small is also in VSS, with additional holdings in VWO and FDNE (well, and VXUS).

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Re: Small cap tilt

Post by MotoTrojan » Fri Sep 14, 2018 7:53 pm

Jack FFR1846 wrote:
Fri Sep 14, 2018 1:23 pm
I watched a recent Bogle interview where he explained how SCV is only one of the latest trends where it looks like it's outperforming, everyone buys, the price of entry exceeds the outperformance, and we're back to no advantage.

I'll sit on my haystack and watch the trendy stuff blow by. No tilt here.
Been proven wrong on here before. Dig around.

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nisiprius
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Re: Small cap tilt

Post by nisiprius » Fri Sep 14, 2018 8:35 pm

vineviz wrote:
Fri Sep 14, 2018 1:18 pm
nisiprius wrote:
Fri Sep 14, 2018 11:02 am
Even the idea of a higher return can be challenged. One issue is that the higher return is completely attributable to one single time period of nine years: 1975-1983. A small-cap investor obtained no benefit from any holding period that didn't include those years.
If I only had a dollar for every time this falsehood got trotted out . . . .
I should not have said "any holding period that didn't include those years" because obviously there were some during which small-caps did do better--as well as some when large-caps did better. The rest of it is straight out of Jeremy Siegel, Stocks for the Long Run 5/E, 2014, p. 178, figure 12-1.

Image

And a quick glance at table C-1 and C-2 from the Ibbotson 2010 Classic Yearbook verifies it:

1926-1974, large-caps, 8.4%; small-caps 9.1%;
1984-2009, large-caps 10.4%; small-caps 9.8%;

Calculating,
1926-2009 with 1975-1983 excluded, large-caps 9.09%, small-caps 9.34%.

1975-1983, large-caps 15.8%; small-caps 35.3%.

Why do you say "falsehood?"
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vineviz
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Re: Small cap tilt

Post by vineviz » Sat Sep 15, 2018 8:17 am

nisiprius wrote:
Fri Sep 14, 2018 8:35 pm

Why do you say "falsehood?"
Because what you said is not true.

It is sent true when Siegel wrote it and it hasn’t been true since then.

We’ve debunked it more times than I can count: do we need to do it again?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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DG99999
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Re: Small cap tilt

Post by DG99999 » Sat Sep 15, 2018 11:45 am

nisiprius wrote:
Fri Sep 14, 2018 8:35 pm
vineviz wrote:
Fri Sep 14, 2018 1:18 pm
nisiprius wrote:
Fri Sep 14, 2018 11:02 am
Even the idea of a higher return can be challenged. One issue is that the higher return is completely attributable to one single time period of nine years: 1975-1983. A small-cap investor obtained no benefit from any holding period that didn't include those years.
If I only had a dollar for every time this falsehood got trotted out . . . .
I should not have said "any holding period that didn't include those years" because obviously there were some during which small-caps did do better--as well as some when large-caps did better. The rest of it is straight out of Jeremy Siegel, Stocks for the Long Run 5/E, 2014, p. 178, figure 12-1.

Image

And a quick glance at table C-1 and C-2 from the Ibbotson 2010 Classic Yearbook verifies it:

1926-1974, large-caps, 8.4%; small-caps 9.1%;
1984-2009, large-caps 10.4%; small-caps 9.8%;

Calculating,
1926-2009 with 1975-1983 excluded, large-caps 9.09%, small-caps 9.34%.

1975-1983, large-caps 15.8%; small-caps 35.3%.

Why do you say "falsehood?"
Nisiprius, Thank you for succinctly presenting date we can use to understand/evaluate your proposition. I do not find other arguments that are based on a poster's memory and recollection to be useful when reading through a thread (and "data-less", vague references can not be helpful to new readers, who clearly have not seen the history).
I am not a financial professional. My posts are only my opinion on the topic. You need to do your own due diligence and consult with a professional when addressing your financial questions.

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vineviz
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Re: Small cap tilt

Post by vineviz » Sat Sep 15, 2018 12:50 pm

DG99999 wrote:
Sat Sep 15, 2018 11:45 am
I do not find other arguments that are based on a poster's memory and recollection to be useful when reading through a thread (and "data-less", vague references can not be helpful to new readers, who clearly have not seen the history).
Surely you can understand how cumbersome (and annoying) it would be to present the entire body of evidence anew every time people trotted out the "except for 1975-1983" myth?

But I take your point: data speaks louder than vague references.

It's not true that small stocks had no outperformance relative to large stocks prior to 1975. Here's their performance from 1930 to 1974.

Image

Furthermore, small stocks outperformed large stocks pretty much from the moment Siegel made his initial assertion in 1990 until the present.

Image

Small stocks had an especially robust period of performance from 1974 to 1983, it's true, and then an especially poor period of performance from 1984 to 1999. The logic behind the notion that we gain any useful insight from ignoring the good years but including the bad years escapes me.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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