Thoughts on small cap value tilt with TDF?

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KidnetusDeletus
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Thoughts on small cap value tilt with TDF?

Post by KidnetusDeletus »

My Roth IRA is pretty simple, I have a Vanguard target date retirement fund making up 80% of it while I have 20% of it in VIOV.

Ive been debating if small cap value premiums still exist or if it even matters regardless because it is still small cap and smaller company's having more room to grow than big company's is not going to change because everyone realizes that so I may as well just keep the value tilt?

Any thoughts from those more experienced are appreciated as this is my first post.

Netus. :beer
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TimeIsYourFriend
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Re: Thoughts on small cap value tilt with TDF?

Post by TimeIsYourFriend »

No one knows if the small cap value premium will persist like it has in the past. Even when it was working it could underperform the market for over a decade or two. Maybe in 2050 we’ll have an idea. You need to stick with it to find out.
"Time is your friend; impulse is your enemy." - John C. Bogle
jaMichael
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Re: Thoughts on small cap value tilt with TDF?

Post by jaMichael »

In Chapter Two of Four Pillars of Investing, Bill Bernstein explains why he thinks the value premium still exists (he’s less sanguine about the size premium). He concludes:

“Value stocks—the shares of companies selling for low multiples of earnings, dividends, sales, and book value—have historically had higher returns than the market. Both behavioral and risk-based reasons explain this. For the past two decades, this has not been true. This is likely because the prices of growth stocks have been bid up to unreasonable values, and the superior historical returns of value stocks seem likely to return. This assertion comes minus any guarantee. Value stocks may also be a good inflation hedge.”

No one knows, but you are in good company. FWIW, I’m 10% AVUV.

[Some would suggest that you avoid a TDF in Roth because bonds are usually better in a tax deferred account like a traditional IRA or traditional 401(k).]
BitTooAggressive
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Re: Thoughts on small cap value tilt with TDF?

Post by BitTooAggressive »

KidnetusDeletus wrote: Sat Feb 10, 2024 12:37 am My Roth IRA is pretty simple, I have a Vanguard target date retirement fund making up 80% of it while I have 20% of it in VIOV.

Ive been debating if small cap value premiums still exist or if it even matters regardless because it is still small cap and smaller company's having more room to grow than big company's is not going to change because everyone realizes that so I may as well just keep the value tilt?

Any thoughts from those more experienced are appreciated as this is my first post.

Netus. :beer
Here you go.

https://www.paulmerriman.com/two-funds-for-life
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nisiprius
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Re: Thoughts on small cap value tilt with TDF?

Post by nisiprius »

I think it says something that there are no target-date funds with a built-in meaningful small-cap value tilt, not even Dimension Fund Advisors' (DFA).

DFA is the fund company with Fama and French on the investment research committee. I think it's fair to say they popularized and proselytized for factor investing, requiring advisors to accept DFA training as a condition for offering their funds. The target-date funds are advised by another Novel laureate, Robert Merton, their Resident Scientist. (Could there be different schools of thought among the Nobelists of DFA?)

Dimensional 2060 Target Dt Rtr Inc Instl DRILX

Image

Fund companies are willing to put all sorts of things into target-date funds that might be unfamiliar to the average 401(k) participant. Commodities, "Intrinsic Opportunities Fund," "Emerging Markets Debt Local Currency Fund" in Fidelity's, direct real estate in TIAA-CREF Lifecycle 2055 fund, etc.

But a small-cap value tilt? Apparently not.

This can be interpreted various ways, but a reasonable one is that a small-cap value tilt, assuming it really is beneficial, adds a kind of risk that most 401(k) investors cannot tolerate, and demands a depth of conviction and patience which most 401(k) participants do not have.
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bonesly
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Re: Thoughts on small cap value tilt with TDF?

Post by bonesly »

KidnetusDeletus wrote: Sat Feb 10, 2024 12:37 am Ive been debating if small cap value premiums still exist or if it even matters regardless because it is still small cap and smaller company's having more room to grow than big company's is not going to change because everyone realizes that so I may as well just keep the value tilt?
Small and value were identified as statistically significant factors in a linear regression analysis studied and published by Fama and French in their 3-Factor Model paper. You can see Small Cap Value (SCV) outperforms Total Stock Market (TSM) from 2000-present in Portfolio Visualizer using the Vanguard institutional share classes for comparison. However, simply using the ETF share classes of the same Vanguard funds is a different time-window from 2005-present that doesn't show that SCV outperformance as noted HERE.

Also, research conclusions are subject to change as further analysis is conducted, significant findings are verified, and proceedings are peer-reviewed and published.

Fama & Miller published a 5-Factor Asset Pricing Model in 2013, suggesting perhaps that 3-Factors was inadequate. "A five-factor model directed at capturing the size, value, profitability, and investment patterns in average stock returns performs better than the three-factor model of Fama and French (FF 1993)."

Fama & French published a Data & Rules Corrections for the Original 3 Factors just in 2023, suggesting the prior research was flawed in some way. "We describe the effects of data corrections and rule changes on returns to the market factor, Rm-Rf, the size factor, SMB (small minus big), and the value minus growth factor, HML (high minus low book-to-market equity) in the Fama-French Data Library."

The original research did win a Nobel Prize, but that doesn't mean the average investor can simply buy a SCV fund and beat TSM year-after-year. As jaMichael said, it can take decades to realize those gains. I also have concerns about "statistically honest data assessment" or the lack thereof in the analysis the Finance Theorists are conducting. If a proportion of the total data set was not withheld to assess prediction accuracy for data "unknown to the model" (i.e., not used to for fitting the factor coefficients), then over-fitting is a real problem that improves the model's accuracy for only the data set that was fit, but degrades the model's ability to predict similar but different data sets (e.g., future data). Edit in red per comment from nisiprius below.

The 5-Factor model suggests the small & value factors are still significant (the premium still exists), but it might be hard to realize any advantage depending on your time-frame.
Last edited by bonesly on Sat Feb 10, 2024 8:26 pm, edited 1 time in total.
yolointopants
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Re: Thoughts on small cap value tilt with TDF?

Post by yolointopants »

KidnetusDeletus wrote: Sat Feb 10, 2024 12:37 am My Roth IRA is pretty simple, I have a Vanguard target date retirement fund making up 80% of it while I have 20% of it in VIOV.

Ive been debating if small cap value premiums still exist or if it even matters regardless because it is still small cap and smaller company's having more room to grow than big company's is not going to change because everyone realizes that so I may as well just keep the value tilt?

Any thoughts from those more experienced are appreciated as this is my first post.

Netus. :beer
About 35% of my money is in small/mid+value. I don't think it still is a thing. But I'd like if it did. I still plod along, hoping it does. I've read the expected out of sample value premium is at best .3-.5% net of fees. So it's not much relative to the suffering you must endure. I've also seen it will take at least 50 years of underperformance to prove the premium is gone. I'll probably be dead by then, or at least eating mechanical soft food with better things to fuss about.
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Re: Thoughts on small cap value tilt with TDF?

Post by nisiprius »

bonesly wrote: Sat Feb 10, 2024 12:03 pm...The original research did win a Nobel Prize...
It did not.

Eugene Fama won a Nobel Prize, but it was not for the three-factor paper. And coauthor Kenneth French has not won a Nobel prize. The prize was awarded to Fama, not for the factor work, but for his large body of work on the efficient market hypothesis.

The capsule description by the Nobel organization says:
For many of us, the rise and fall of stock prices symbolizes economic development. In the 1960s, Eugene Fama demonstrated that stock price movements are impossible to predict in the short-term and that new information affects prices almost immediately, which means that the market is efficient. The impact of Fama's results has extended beyond the field of research. For example, Fama's results influenced the development of index funds.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
BackToSchoolDad
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Re: Thoughts on small cap value tilt with TDF?

Post by BackToSchoolDad »

If you're committed to it, 10-20% won't make a huge difference but can help based on past research, if you believe that. There's a whole book on the strategy, Two Funds for Life, that I believe you can get for free now.

I have a tdf and 10% each in US SCV and EM LCV in my 457 to push my domestic/international spread closer to world market cap and to skew the account more towards equities and value. In my Roth I'm 90% world equities (VT) and 10% SCV to give a slight home bias.

Just make sure you're buying a good, low cost fund and even if SCV doesn't pan out you won't lose a lot to fees. if anything, I like the idea of getting away from the top heavy nature of cap weighed funds, I've got a contrarian streak.
Lviotto
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Re: Thoughts on small cap value tilt with TDF?

Post by Lviotto »

To echo what many others have said, I think devoting a small percentage to small cap value is very reasonable. 2 Funds for life is available for free on line. The recs present in it provide a pretty substantial tilt to SCV, a bit too much for my taste. In my 401k, I devote 90% to a TDF and 10% to a SCV fund. I think this is reasonable to catch any potential increased returns that may come from SCV (and the fact that SCV remains undervalued, see page 18: https://corporate.vanguard.com/content/ ... o_2024.pdf ) but avoid too much index tracking error which would cause one to deviate from their plan, probably at the worst time.
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grabiner
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Re: Thoughts on small cap value tilt with TDF?

Post by grabiner »

Target-date funds are intended to be your whole portfolio, so that you get the simplicity of not needing to manage things yourself. Thus it doesn't make sense to use a target-date fund and then add a bias away from the market portfolio to small-cap value; you'll have to rebalance on your own anyway. If you do believe in overweighting small-cap value, you should choose your own allocation with individual funds for whatever asset classes you have.

Also, you write, "My Roth IRA is pretty simple"; you should view everything as one portfolio. It is reasonable to hold target-date funds in both a Roth IRA and a 401(k), or in neither.
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BackToSchoolDad
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Re: Thoughts on small cap value tilt with TDF?

Post by BackToSchoolDad »

grabiner wrote: Sun Feb 11, 2024 10:56 am Target-date funds are intended to be your whole portfolio, so that you get the simplicity of not needing to manage things yourself. Thus it doesn't make sense to use a target-date fund and then add a bias away from the market portfolio to small-cap value; you'll have to rebalance on your own anyway. If you do believe in overweighting small-cap value, you should choose your own allocation with individual funds for whatever asset classes you have.

Also, you write, "My Roth IRA is pretty simple"; you should view everything as one portfolio. It is reasonable to hold target-date funds in both a Roth IRA and a 401(k), or in neither.
It's still much simpler to manage a two fund portfolio of TDF and SCV than a fully bespoke portfolio. He can just rebalance with contributions if things get too out of wack.

Using the two fund approach also still gives all the benefits of a TDF like the glide path and internal rebalancing. And he doesn't have to make nearly as many allocation decisions. Just pick a good tdf and then a good SCV fund.
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