Let me get this straight about SCV & factor diversification

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freddie
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Re: Let me get this straight about SCV & factor diversificat

Post by freddie »

lee1026 wrote:I was basing it on the ETFs.

VTV (Vanguard value) have had a mean return of 8.08 with std dev of 15.17 in the last 10 years. (It is new enough that 15 year returns weren't available.) That compares unfavorably to the S&P 500 at 8.38 return and 14.69 std dev.

VB (Vanguard small) have a sharpe ratio of 0.55, barely edging out the S&P at 0.52. This is also for the last 10 years because the fund isn't all that old.

All data is from morningstar.
Using the mutual fund version and looking at 15 year performance you see 5.63 to 4.6. Now 15 years is about as meaningless as 10 (I am 99% confidant that 20 years would go back to the S&P 500). You are pretty much just seeing which style was more in favor. The big problem with value (and to some extent small) is that all of the gains come during brief periods of time. For example using portfolio visualizers data set
1972-2013
LV = 11.77
LB = 10.21

Thats a nice 1.5% out performance. But lets say you miss those first 11 years
1982-2013
LV = 11.53
LB = 11.70

I would call the difference noise. You can debate if the Large value premium is gone or if it is just resting for a while before posting a 10 year outperformance stretch that will justify it.
lee1026
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Re: Let me get this straight about SCV & factor diversificat

Post by lee1026 »

I think using anything older than the early 90s is cheating. Fama-French was published in the 90s, and any data from before it being published is in sample data, and only data after it can be considered out-of-sample. Going back to 92, which is the inception for the vanguard value fund, have the value fund winning by a tiny margin vs the total stock market index fund - it won by a single basis point.

I believe the academic dataset have value winning by a lot more than a single basis point over this time period!
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

lee the problem as I have pointed out is that Vanguard funds are not really valuey or growthy, just slight loadings on the factors
So look at DFA LV fund since inception (so out of FF sample) 3/93-6/14 returned 10.58 and S&P returned 9.35 and FF large returned 9.53, and the indices have no expenses. Sure looks like a large value premium to me in last 20 years
Move forward to 5 years, to starting 3/98 and you get DFA LV 7.98 and S&P 5.83 and FF large 6.26
Same thing, large value realized premium

Now look at M* last 15 years DFALVX 7.98 S&P 500 4.6 and VIVAX 4.6

Golf investor
IMO I think can make that claim because we have international value data going back to 1975 for EAFE value for example and 81 for small value and that is long enough IMO through many cycles

YDNAL
Well all I'll say is that basically the entire academic community now discusses things in terms of factor exposures. If you want to continue to define things the way you see that's fine. But doesn't mean other ways are incorrect. You make even think so but that doesn't make you correct. When looking at portfolios that is all that you see. What loadings are on factors
Larry
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Re: Let me get this straight about SCV & factor diversificat

Post by lee1026 »

That is why I said there is actually two risks - whether the factor will perform, and whether the fund that you select will behave anything like the factor. Presumably if the Vanguard fund performed better than the DFA fund, people would point to the vanguard fund instead to prove the point that these factors work.
golfvestor
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Re: Let me get this straight about SCV & factor diversificat

Post by golfvestor »

larryswedroe wrote: Golf investor
IMO I think can make that claim because we have international value data going back to 1975 for EAFE value for example and 81 for small value and that is long enough IMO through many cycles

Larry
Larry,

Back to 81 gives us only 34 years of data. There have been periods in the US as long as 36 years(1927-1962) where the Sharpe ratios of large growth and small value were almost identical. It would be odd to declare that 34 years is enough data for international, but insufficient for the US.
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

Clearly_Irrational » Fri Sep 05, 2014 12:34 pm wrote:
YDNAL wrote:To "diversify" the coins in our pocket, one chooses to have three 25¢ coins, a couple of 10¢ coins, and one 5¢ coin - ALL very different coins, ALL very differently valued at my local grocery store. We can call that TSM for all practical purposes. :)
The person choosing the have only 1¢ coins (that would be SCV) in his/her pocket is NOT "diversifying" the coins.
Whether you believe in a multi-factor model or not, that just seems like a poor analogy. How do coins possibly relate to fuuture returns?
You are right, coins have nothing to do with that.

The problem with your "poor" observation is that I'm discussing the misuse of the word "diversification" - and not discussing beliefs or expectation of hoped-for future return.
freddie » Fri Sep 05, 2014 6:08 pm wrote:Why buy TSM when you could have some portfolio that gives you 11s in all the boxes which would give you much better Morningstar valuation box diversifications?:) The argument for VBR instead of TSM is that 1.02-.62-.41 is more diversified than 1-0-.03. You can decide if you believe that or not.
See above.

Thus, I don't "have to decide" anything.
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

larryswedroe » Fri Sep 05, 2014 10:16 pm wrote:YDNAL
Well all I'll say is that basically the entire academic community now discusses things in terms of factor exposures. If you want to continue to define things the way you see that's fine. But doesn't mean other ways are incorrect. You make even think so but that doesn't make you correct. When looking at portfolios that is all that you see. What loadings are on factors
Larry
Excellent!

Not a single mention of "diversification." A misuse of widely-used and accepted "definitions" comes across as an attempt to sell something. As I have quoted twice in recent days, you have addressed this same issue, and confirmed "wanting everyone to think of diversification differently," to the extent IMO that the original poster in this thread misused it 5 times in the original post alone.
In one sense, that is a true statement [that the Larry Portfolio is not well diversified]. The “LP” does limit the stock holdings in both the U.S. and developed international markets to small value stocks, and in emerging markets to value stocks. That means there are no U.S. and international developed-market holdings of small-cap, midcap and large-cap growth companies, and no holding of midcap and large-cap value companies. And in emerging markets, there are no growth stocks, just value stocks.

To address whether the LP is well diversified, investors should think about diversification in a different way than they are probably used to. The conventional way of thinking about how well a portfolio is diversified is to think in terms of the number and weighting of individual stocks, asset classes and geographic regions. We want you to also think about diversification in terms of exposure to the factors that determine the risk and return of a portfolio.
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

golf investor
Well you have to decide how long is enough. When you have 87 years of US data supported by the evidence totally out of sample exists in the rest of the world, virtually everywhere we look and the factors not only exist in stocks, but other asset classes like commodities and interest rates and currencies, but also in very similar size of the premiums, then IMO you have enough persistence to have a strong conviction. Now you certainly can feel otherwise. But you might be paying a steep price for that skepticism in light of the evidence and the statistical significance of them as well

Now as to your point about Sharpe ratios for that period. Makes mistake of looking at things in isolation again. I don't understand why people keep doing it when Markowitz won Nobel Prize for showing that's wrong.
Now look at it the right way,
27-62 60% LG and 40% 5 year Treasury returns 8.3% and SD of 14.7 and worst year -23.4, Now just 33% SV and 67% 5 year returned 8.4 with SD of 14.0 and worst year of 19.2

Hope this is helpful
Larry
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Ydnal
IMO the only one misusing anything is you by insisting that there is only one way to think about diversification, when in fact the most if not all of the academic community I believe would disagree with you and not me.
None so blind as those who will not see, comes to mind


Larry
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Re: Let me get this straight about SCV & factor diversificat

Post by dbr »

YDNAL wrote: Excellent!

Not a single mention of "diversification." A misuse of widely-used and accepted "definitions" comes across as an attempt to sell something. As I have quoted twice in recent days, you have addressed this same issue, and confirmed "wanting everyone to think of diversification differently," to the extent IMO that the original poster in this thread misused it 5 times in the original post alone.
In one sense, that is a true statement [that the Larry Portfolio is not well diversified]. The “LP” does limit the stock holdings in both the U.S. and developed international markets to small value stocks, and in emerging markets to value stocks. That means there are no U.S. and international developed-market holdings of small-cap, midcap and large-cap growth companies, and no holding of midcap and large-cap value companies. And in emerging markets, there are no growth stocks, just value stocks.

To address whether the LP is well diversified, investors should think about diversification in a different way than they are probably used to. The conventional way of thinking about how well a portfolio is diversified is to think in terms of the number and weighting of individual stocks, asset classes and geographic regions. We want you to also think about diversification in terms of exposure to the factors that determine the risk and return of a portfolio.
Yep, the station where I get off the train is where we have change the meaning of a well understood word when all we have to do is just say what we mean in plain language. What is it that causes the financial advising community to be unable to explain an idea without using buzz words and jargon? {emphasis added to quote above] The actual damage is that this causes all kinds of misunderstanding. This subject is technical enough and open to enough genuine questions that it does not need additional confusion.

I would have to review the original papers in detail, but I have the impression from reading once upon a time that the only use of the word diversification in the originals was to invoke the assumption that all portfolios are always diversified in the sense of not having any diversifiable risk caused by looking only at a very small number of individual holdings, which would mess up the data analysis. I could be wrong. Use of the term "risk factor" is a little dicey also as it leaves a discussion not completely resolved to this day why the FF factors are "risks," but the issue is at least supported by the well accepted principle that in investing if you get more return it must be you are taking more risk. The professional community has not been confused by it, but there have been discussions here that the method of analysis in the FF model is regression analysis and not what is known in statistics as factor analysis. The word factor is not illegitimate, however, as items which are multiplied together are called factors. However I think in mathematics the variables on which a regression is performed are called terms and the constants that multiply them are called coefficients. One hardly need mention the degree to which "alpha" and "beta" have become buzz words. But sticking to letters from the Roman alphabet rather than using the Greek alphabet would undermine a whole industry. Who would ever read a web page titled "Seeking A"?

I apologize for the snark, but there are just limits.
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packer16
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Re: Let me get this straight about SCV & factor diversificat

Post by packer16 »

If you judge the DFA products on the same standard as other active in terms of probability of outperformance due to chance the 1.5% to 2% outperformance over 5 to 10 years only gets you a probability of 60% outperformance not due to chance according to the table in Siegle's Stocks for the Long Term.

The one test that I think would be interesting to see is what would the results be for a heavily tilted and factor weighted value portfolios without constraints in terms of industry selection. If these could be built and tested at different levels in terms of number of stocks, I think it would provide some insights to what we are seeing here. If the more concentrated portfolios have about the same return as the less concentrated names then I think the factor argument is more likely, however, if the opposite is the case then I think the mispricing argument is more likely. Do you know of anyone who has run this test?

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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

delete - links don't work, see post below.
Last edited by YDNAL on Sat Sep 06, 2014 11:40 pm, edited 5 times in total.
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Re: Let me get this straight about SCV & factor diversificat

Post by Browser »

Larry - thinking about the net result of combining TSM with SCV. Seems to me that, since TSM is loaded negatively on size and value, the addition of SCV is likely to have the effect of "neutralizing" small and value risk factors - moving the net loading toward zero. The net result is that the equity portion is more purely loaded on beta alone with small and value taken out of the picture as far as their risk and risk premiums are concerned. Does this seem accurate?
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Re: Let me get this straight about SCV & factor diversificat

Post by in_reality »

larryswedroe wrote: Well you have to decide how long is enough. When you have 87 years of US data supported by the evidence totally out of sample exists in the rest of the world, virtually everywhere we look and the factors not only exist in stocks, but other asset classes like commodities and interest rates and currencies, but also in very similar size of the premiums, then IMO you have enough persistence to have a strong conviction. Now you certainly can feel otherwise. But you might be paying a steep price for that skepticism in light of the evidence and the statistical significance of them as well
Does anyone remember 2008?

Didn't everything think housing prices couldn't fall?

Doesn't anyone else see parallels here?

Well, it's 2014 and I am not going to bet the farm on real estate assuming it is destined to always rise. Obviously.

To me, to call a portfolio of small value stocks + bonds as "diversified" is farcical. Obviously.

Anyway, I do greatly appreciate Larry's outstanding work even if I can't buy into it completely. I really can't judge if betting only on the academic factors will stand the test of time. Academics have been wrong before.

I think the correct way of looking at it is this. There is the "market" that none of us hold. We all reduce our diversification (we limit international and tilt US, limit bonds and tilt stock, limit junk bonds maybe, don't go into gold or commodities ...etc. etc. ) in various areas and it works for us to accomplish what we want. So maybe we can cut large caps and growth and it will work wonderfully. Maybe the semi-explained magic of small value will carry the day. To call focusing on small value greater diversification though is non-sensical. Call it something like focusing on where the returns are now.

The point is that if return dynamics change, you won't be as diversified as you thought holding only SV.

So perhaps academics know in the high 90%s of what drive stock returns. OK. So what? Even if they do, to suggest it will always be so is like saying real estate will always rise. Is it not?

I don't mean to quibble. Thanks for the discussion. It helps me sort of understand.
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Re: Let me get this straight about SCV & factor diversificat

Post by dbr »

Browser wrote:Larry - thinking about the net result of combining TSM with SCV. Seems to me that, since TSM is loaded negatively on size and value, the addition of SCV is likely to have the effect of "neutralizing" small and value risk factors - moving the net loading toward zero. The net result is that the equity portion is more purely loaded on beta alone with small and value taken out of the picture as far as their risk and risk premiums are concerned. Does this seem accurate?
TSM is NOT loaded negatively on size and value. By DEFINITION TSM is exactly neutral on size and value. The explanation Larry gave, which may have been misunderstood, is that TSM holds small and value stocks and also large and growth stocks, the whole of which being added together result in zero factor loadings. The statement was that fractions of TSM that are negatively loaded on size and value "neutralize" the fractions of TSM that are positively loaded on size and value. That is a correct statement that was probably aimed at disabusing someone who might think TSM does not hold any small stocks or any value stocks.
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Re: Let me get this straight about SCV & factor diversificat

Post by MrMatt2532 »

Browser wrote:Larry - thinking about the net result of combining TSM with SCV. Seems to me that, since TSM is loaded negatively on size and value, the addition of SCV is likely to have the effect of "neutralizing" small and value risk factors - moving the net loading toward zero. The net result is that the equity portion is more purely loaded on beta alone with small and value taken out of the picture as far as their risk and risk premiums are concerned. Does this seem accurate?
Not Larry, but TSM, by definition, has no tilt and no loading, positive or negative to value or small. You might be thinking of SP500, which has a small tilt to large (i.e. negative tilt towards small), not much in the value direction either way...
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

larryswedroe wrote:Ydnal
IMO the only one misusing anything is you by insisting that there is only one way to think about diversification, when in fact the most if not all of the academic community I believe would disagree with you and not me.
None so blind as those who will not see, comes to mind

Larry
It's funny, Larry, with you "my way or the highway" comes to mind.

Regardless how you want everyone to see diversification ("your" way), an investor is not "diversified" holding ONLY Avis holding Group - top holding (1.73% currently) in DFA US Small Cap Value I DFSVX - and ignoring Hertz Global Holdings Inc HTZ.

[edit] to correct link to HTZ
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Re: Let me get this straight about SCV & factor diversificat

Post by Browser »

dbr wrote:
Browser wrote:Larry - thinking about the net result of combining TSM with SCV. Seems to me that, since TSM is loaded negatively on size and value, the addition of SCV is likely to have the effect of "neutralizing" small and value risk factors - moving the net loading toward zero. The net result is that the equity portion is more purely loaded on beta alone with small and value taken out of the picture as far as their risk and risk premiums are concerned. Does this seem accurate?
TSM is NOT loaded negatively on size and value. By DEFINITION TSM is exactly neutral on size and value. The explanation Larry gave, which may have been misunderstood, is that TSM holds small and value stocks and also large and growth stocks, the whole of which being added together result in zero factor loadings. The statement was that fractions of TSM that are negatively loaded on size and value "neutralize" the fractions of TSM that are positively loaded on size and value. That is a correct statement that was probably aimed at disabusing someone who might think TSM does not hold any small stocks or any value stocks.
Thanks. That clears my head. Using PV I see that the loadings of VTI on small and value are effectively zero. So I guess that means that adding SCV to TSM will in fact "tilt" toward small and value to the degree of your SCV allocation.
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Re: Let me get this straight about SCV & factor diversificat

Post by countmein »

larryswedroe wrote: The key as Rick noted is discipline to stay the course. But that's true of TSM as well. TSM lost 0.3% a year from 2000-09 while DFA SV returned 9.1, an underperformance in terms of total return. Each dollar invested in TSM (even before any expense) "grew" to just 97 cents while each dollar in DFSVX grew to $2.40. How disciplined might someone stay losing money for 10 years while observing this growth in small value?
Even worse is the 2000-02 period when TSM lost 14.5 percent per year while DFSVX earned 6.3, growth of dollar was down to 67 cents for TSM while DFSVX was up to $1.21
Now of course reverse was true in late 90s. But not for ten years.

So this discipline thing works both ways, not just one.
Larry, I think this view of tracking error is a bit off-kilter. You could say the same about a 1 stock portfolio-- hey won't you be jealous when my stock outperforms! The proper dichotomy is between different halves of TSM-- value and growth, or small and large-- but not a subset of TSM vs TSM. For the TSM holder, sometimes their value half wins (2000-02), sometimes their growth half wins (98-99). That's the point. If you hold TSM you're supposed to be at peace with always holding roughly similar amounts of the outperformer and underperformer.
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Re: Let me get this straight about SCV & factor diversificat

Post by Kevin M »

Browser wrote: Thanks. That clears my head. Using PV I see that the loadings of VTI on small and value are effectively zero.
Hmm, I thought we clarified this in my post about 4 hours after your OP (
Bogleheads • View topic - Let me get this straight about SCV & factor diversification):
Kevin M wrote: If you run the regression on TSM, you'll see the loading on the market factor is 1, and the loading on the size and value factors is close to 0. Here is a link to the regression for both funds that shows this: Fama-French Factor Regression Analysis for VTSMX and VISVX.
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

countmein
What debate that, but people can fall prey to tracking error relative to any other "benchmark" be it TSM, the S&P or whatever, perhaps in late 90s the NASDAQ/ But yes
"conventionally" TE is reference to TSM or S&P

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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Just couple of thoughts Yndal
First the larry portfolio contains about 4,000 stocks last I looked. Think it's hard to make case that it isn't "diversified" by any definition as it also contains US, international and EM stocks as well.
As to the statement about "my way or the highway" I don't see how anyone (but you) could come to the conclusion that I was saying that my way or the highway. Simply gave people another way to think about diversification, and in fact it's the way most of academia happens to think about it now. And I showed people another way to think about diversification than the way they are used to thinking about it.
Now you can think about it any way you like
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Re: Let me get this straight about SCV & factor diversificat

Post by Kevin M »

pkcrafter just posted a link in this thread to a paper, "MSCI: Foundations of Factor Investing", that's very relevant to this discussion.

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Re: Let me get this straight about SCV & factor diversificat

Post by Browser »

As well as:

http://www.msci.com/resources/pdfs/Depl ... folios.pdf

In which they too have apparently committed the error of referring to diversification when discussing factors, as this segment illustrates:
Correlations Matter When Selecting Factors: The Diversification Effects of Multi-Factor Index Allocations

When multiple factor indexes are combined into a single multi-factor index, diversification across factors
has historically lead to:
 Lower volatility and higher Sharpe Ratio
 Higher information ratios and lower tracking errors
 Less regime dependency over business cycles
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Re: Let me get this straight about SCV & factor diversificat

Post by in_reality »

Browser wrote:As well as:

In which they too have apparently committed the error of referring to diversification when discussing factors, as this segment illustrates:
Correlations Matter When Selecting Factors: The Diversification Effects of Multi-Factor Index Allocations

When multiple factor indexes are combined into a single multi-factor index, diversification across factors...
I don't see a problem with the term "diversification across factors". It's easy to differentiate that from your typical "diversification".

What I wonder though, is if "diversifying across factors" results in basically making industry bets the way a typical market cap value fund does. I mean some industries have traditionally lower valuation ratios and value funds reflect that.

If (multi) factor investing comes down to making a bet against certain industries (such as technology), then I am not so interested in it. I'd prefer a fundamental index type strategy that also include the relatively more valuey firms in non-valuey industries.

Anyway, "diversification" has a known meaning. I wish the factor camp would call it "multi-factor" investing. The fact is, no matter the number of stocks in your small value fund, you still have less "diversification".
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

larryswedroe wrote:Just couple of thoughts Yndal
First the larry portfolio contains about 4,000 stocks last I looked. Think it's hard to make case that it isn't "diversified" by any definition as it also contains US, international and EM stocks as well.
Self-contradictory statement of the week!
LINK
larryswedroe wrote:In one sense, that is a true statement [that the Larry Portfolio is not well diversified]. The “LP” does limit the stock holdings in both the U.S. and developed international markets to small value stocks, and in emerging markets to value stocks. That means there are no U.S. and international developed-market holdings of small-cap, midcap and large-cap growth companies, and no holding of midcap and large-cap value companies. And in emerging markets, there are no growth stocks, just value stocks.
*****************
larryswedroe wrote:As to the statement about "my way or the highway" I don't see how anyone (but you) could come to the conclusion that I was saying that my way or the highway. Simply gave people another way to think about diversification, and in fact it's the way most of academia happens to think about it now. And I showed people another way to think about diversification than the way they are used to thinking about it.
Now you can think about it any way you like
That response doesn't address the crux of my post:
YDNAL previously wrote:Regardless how you want everyone to see diversification ("your" way), an investor is not "diversified" holding ONLY Avis holding Group - top holding (1.73% currently) in DFA US Small Cap Value I DFSVX - and ignoring Hertz Global Holdings Inc HTZ.
By limiting US stocks to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified - that is, holding Avis and not Hertz. Why? Simple question deserving of a simple answer void of buzz words (academia, literature, etc.).
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Re: Let me get this straight about SCV & factor diversificat

Post by in_reality »

YDNAL wrote: By limiting US stocks to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified - that is, holding Avis and not Hertz. Why? Simple question deserving of a simple answer void of buzz words (academia, literature, etc.).
Because Avis has better fundamentals.

I believe that people over-anticipate expected returns and so I want a value tilt. Yes, the market perhaps knows better than me what expected returns will be, but I do think here is a tendency for people to get carried away.

So if they were equal market cap, and Hertz's valuation was based more on future growth, I'd want to hold less of it.

Same with Ford and Tesla. You might be better off holding the market and taking a full ride on Tesla. I'd like to stick closer to fundamentals. Even the CEO of Tesla admitted things were getting off-base and expectations were too high. Not all CEOs will tell you that though.

Well that's for a fundamental index tilt anyway.
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Re: Let me get this straight about SCV & factor diversificat

Post by lee1026 »

If you don't believe in market efficiency, even in the weak form, it would suggest that active funds are a good idea.
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Re: Let me get this straight about SCV & factor diversificat

Post by JoMoney »

lee1026 wrote:If you don't believe in market efficiency, even in the weak form, it would suggest that active funds are a good idea.
No. Even without the "Efficient Market Hypothesis", there's plenty of empirical evidence that active funds are not a good idea, and the simple arithmetic that within whatever market or market segment you're looking at the aggregate result will be that "average". You would have to believe you're an above average picker of fund managers, and even then the odds would seem to be stacked against you since the empirical evidence shows so few outperform, and the typical out-performance doesn't even cover fees. All that's needed is CMH: The Cost Matters Hypothesis
http://marriottschool.net/emp/SRT/passive.html
...the argument for indexing is even stronger for individual investors if the stock market is not efficient. The game of poker provides, in some respects, an instructive analogy. Poker is a zero sum game, similar to active investing compared to indexing, and poker combines luck and skill, consistent with the assumption of a less than perfectly efficient market. An old adage among professional poker players applies to those deciding to participate in the active investing game. "If you don't know who the mark is, get up and leave the table, because it's you."

About two-thirds of all active investors, whose only financial justification for being active is beating the index, must fail in that objective each year. Press reports that quote the failure rate as substantially higher or lower in any given year, either track only one category of investor, or do not properly measure all active management costs. The two-thirds failure rate among all active investors is as mathematically certain as the forecast that exactly half of the workforce will earn less than the median income. It may seem unfair, but it cannot be otherwise. No amount of hope and luck (if the market is efficient) or work and skill (if it is not) can change that fact. Each individual investor should confront the question "Am I in the top third of everyone who thinks they are?" and the unavoidable answer "Probably not."
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

in_reality » Sun Sep 07, 2014 4:06 am wrote:
YDNAL wrote:By limiting US stocks to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified - that is, holding Avis and not Hertz. Why? Simple question deserving of a simple answer void of buzz words (academia, literature, etc.).
Because Avis has better fundamentals....
First, that means absolutely nothing unless you are willing to discuss what you mean. Then again, Yahoo! Finance shows CAR P/E (ttm) of 111.58 versus HTZ P/E of 37.45. CAR EPS of 0.59 and HTZ EPS of 0.76. Is that something that would be part of your appraisal of "better fundamentals?"
http://finance.yahoo.com/q;_ylt=Ak3Ey70 ... t_gs&s=HTZ

Second, even you were correct and your focus is individual *stock picking*, it absolutely doesn't answer the question of diversification - the subject of my post.
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Re: Let me get this straight about SCV & factor diversificat

Post by Robert T »

.
There seem to be differing opinions on the definition of diversification within equity markets.
  • - Some see it as - TSM, with the view that you can't be more diversified.

    - Some see it as - US:non-US Developed:EM e.g. Swensen "Committing more than fifty percent of a portfolio to a single asset type - domestic stocks - exposes investors to unncessary asset-concentration risk"

    - Some see it as also including allocations to different factors (mkt, size, value, momentum, etc), citing the low correlation across factors.
Swensen has the following 'definition': "...diversification provides investors with a powerful risk management tool. By combinig assets that vary in response to forces that drive markets, investors create efficient portfolios. At a given risk level, properly diversified portfolios provide higher returns than less diversified portfolios. Conversely, through appropriate diversification, a given level of return can be achieved at lower risk. Harry Markowitz, pioneer of modern portfolio theory, maintains that portfolio diversification provides investors with a "free lunch," since risk can be reduced without sacrificing expected return"

If you combine two asset with same return and standard deviation, but with a correlation between the two of less than 1, the combined portfolio will have a higher Sharpe ratio ("return per unit of risk"), all else held equal as per Harry Markowitz (mathematical outcome).

Given this, it makes sense to me to combine lower correlating assets in a portfolio. For example the correlation coefficient between the US market and EAFE since 1992 was 0.77, but with International small cap value it was 0.48. Another example is the correlation coefficient between US market and US small value was 0.61 over the same period, but between US momentum and US small Value it was 0.39. Even if there was no premium, the lower correlating assets combined in a portfolio would have provided a higher diversification benefit (higher return per unit of risk).

Swensen also adds "Purity of asset class composition represents a rarely achieved ideal. Carried to the extreme, the search for purity results in dozens of asset classes, creating an unmanageable multiplicity of alternatives. While market participants disagree on the appropriate number of asset classes, the number should be small enough so that portfolio committments makes a difference, yet large enough that portfolio committments do not make too much of a difference."

Following this I don't expect consensus on asset class definitions any time soon, but think that both international markets (US:EAFE:EM) and factor exposure (mkt, size, value) can add to 'mean-variance' efficiency. Obviously no gaurantees.

Robert
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

YNDAL
My last response to you as you seem incapable of any reasoning blinded by some notions you hold "sacred"
"By limiting US stocks to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified"

Now I NEVER ever said one should hold ONLY DFSVX and have always said one should globally diversify and my own suggestion has been starting point 50/50 and the book specifically talks about a globally diversified portfolio using the three. So where you even come up with these ideas and then try to make some claims is beyond me. Thus nothing at all contradictory about what i wrote, just your behavior.

I'd also note that the "typical" client of my firm has portfolios that hold about 12,000 stocks, globally diversified, not the 4,000 I own, and perhaps 10% of our clients own--as the others own less concentrated portfolios, high tilts but not the maximum tilts I own and discussed in Black Swan book


I would add just this, long before I wrote about a different way to think about diversification others have discussed the idea of risk parity strategies as typical 60/40 portfolios have the vast majority of their risk in one factor, beta, much more than 60% of the risk comes from beta. The idea behind risk parity is the same concept just different way to think about problem of asset allocation and diversification. The idea of diversification across factors isn't new and it is well accepted in the academic and practitioner community (BTW I'm not recommending risk parity just showing the concepts are not mine, but is well integrated into financial theory now)

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Re: Let me get this straight about SCV & factor diversificat

Post by packer16 »

Interesting approach. In other words an asset class is defined by its low correlation to other asset classes. One questions is how stable are the correlations? If they are then I understand the concept but if they are not aren't you to a certain extent data mining in that the correlations in the past are not correlated with correlations in the future?

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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

larryswedroe wrote:YNDAL
My last response to you as you seem incapable of any reasoning blinded by some notions you hold "sacred"
"By limiting US stocks to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified"

Now I NEVER ever said one should hold ONLY DFSVX and have always said one should globally diversify and my own suggestion has been starting point 50/50 and the book specifically talks about a globally diversified portfolio using the three. So where you even come up with these ideas and then try to make some claims is beyond me. Thus nothing at all contradictory about what i wrote, just your behavior.
Larry, you either don't read, or just interpret what you want to interpret - since I didn't say ONLY DFSVX.
YDNAL wrote:By limiting US stocks (added emphasis) only to DFSVX (for argument, don't care what anyone owns), obviously you think that the investor in the quote is diversified - that is, holding Avis and not Hertz. Why? Simple question deserving of a simple answer void of buzz words (academia, literature, etc.).
Additionally, in every single debate your posts turn focus to the individual posting (really bad habit and unprofessional, IMO), and refuse to address simple questions - implying that you have no answer. This is simply a senseless conversation "blinded by some notions you hold sacred."

Have a great day!
Last edited by YDNAL on Sun Sep 07, 2014 8:00 am, edited 2 times in total.
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Re: Let me get this straight about SCV & factor diversificat

Post by in_reality »

YDNAL wrote:obviously you think that the investor in the quote is diversified - that is, holding Avis and not Hertz. Why?
me wrote:Because Avis has better fundamentals....
First, I am speaking hypothetically here. I haven't looked at their fundamentals and don't know what % of each RAFI fundamental indexes hold. I way saying that if the fund held more Avis and less Hertz (assuming equal market cap weighting, so total market would have the same amount) that would be why from a fundamental index view.
YDNAL wrote:First, that means absolutely nothing unless you are willing to discuss what you mean.
Adjusted sales—
Retained operating cash flow—
Dividends plus buybacks—

I mean do you hold junk bonds? Many don't as they don't expect the returns to be worth the risk. Similarly, I'm of the view that companies with too large of their worth due to expected future growth may not be worth the risk.
YDNAL wrote:Second, even you were correct and your focus is individual *stock picking*, it absolutely doesn't answer the question of diversification - the subject of my post.
Are value tilts *stock picking*? The reason I like the above methodology is that I think it's more diversified than a simple value tilt. A simple value tilt will naturally lean towards those sectors that are naturally valuey. Fundamental indexes will by their methodology include the relatively valuey stocks from all sectors. So a value tilt is somewhat of a sector bet and as you say a Fundamental index is more of a bet within the sector -- and holding fewer of stocks that derive their worth from expected future growth.

I will always hold total market in greater proportion than fundamental indexes but think that whatever the great wisdom of the market it, that it has trouble correctly realistically predicting expected future growth.

Part of me isn't so sure though. I mean at the end of the day, if you really properly diversify across factors, maybe you'll just end up with total market returns. I mean factor A outperforms in this time period under these conditions, and you can balance it with factor B which does well in this time period under these conditions, and then you can add factor C ... and maybe if you do it just right ... maybe you'll just get total market.

Still, I feel diversified by holding relatively valuey companies from all sectors and cap sizes.
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Yndal
Just add this, there is nocrux of your posts, I answered every question you posed with exception of the Hertz one since I thought it was so foolish it isn't worth answering.It made no sense. You don't have to own every stock to be diversified, even Vanguard TSM doesn't really own every stock. The question is are you diversified enough, and when you own 12k stocks or 4k stocks you are clearly diversified enough to get rid of any idiosyncratic risks, which is the issue. Now I would add this try comparing the 12k stocks of our more typical portfolio (which is diversified by factors) with say Vanguard total international and see if there is really a difference in idiosyncratic risks being hedge away. Note it's rhetorical
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Re: Let me get this straight about SCV & factor diversificat

Post by YDNAL »

larryswedroe wrote:Yndal
Just add this, there is nocrux of your posts, I answered every question you posed with exception of the Hertz one since I thought it was so foolish it isn't worth answering.It made no sense. You don't have to own every stock to be diversified, even Vanguard TSM doesn't really own every stock. The question is are you diversified enough,...
It is impossible to know what you say when you don't say anything.
  • 1. So you think that making a 1.75% BET (of assets) on CAR, while excluding HTZ "makes sense because one is diversified enough."
    2. It would be hilarious if CAR blows-up while HTZ flourishes. It wouldn't be so much fun to ask for your response and to read it.
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Re: Let me get this straight about SCV & factor diversificat

Post by Browser »

It occurs to me that TSM is actually maximally diversified across all "factors", at least the constituent stocks in the factors, since each factor can only be constructed of some subset of stocks in TSM. It would even encompass some factor constituents that haven't yet been discovered. However, it's the different weighting of stocks and stock subsets in factor investing that differs from the weighting of those stocks and subsets in TSM. With factor investing you are choosing to overweight certain stocks and weight them differently relative to other stocks, compared with the weighting in TSM. Many of the stocks in TSM would have a weighting of zero, since they wouldn't be included at all unless they are included in the factors one has decided to invest in. It all depends on whether such a customized and dynamic approach holds up over time. The theory behind factor investing says it will (or at least it has in the past).
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Browser
Factor are LONG-SHORT portfolios, not long only, thus your idea about TSM isn't correct
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Re: Let me get this straight about SCV & factor diversificat

Post by Robert T »

packer16 wrote:Interesting approach. In other words an asset class is defined by its low correlation to other asset classes. One questions is how stable are the correlations? If they are then I understand the concept but if they are not aren't you to a certain extent data mining in that the correlations in the past are not correlated with correlations in the future?
Here's an exercise. Let's take two assets with the same annualized returns (say 7%) and standard deviation (20) over a 20 year period and combine them as a 50:50 portfolio. Here are the portfolio returns for varying levels of average correlation between the component assets

Correlation coefficient - annualized return/standard deviation

1.0 - 7.00/20.00
0.9 - 7.09/19.49
0.8 - 7.17/18.87
0.7 - 7.23/18.44
0.6 - 7.29/17.89
0.5 - 7.35/17.32
0.4 - 7.41/16.73
0.3 -7.46/16.12

Portfolio returns increased, and SD was lower, with lower correlations. What matters for the result is the overall correlation for the period, not whether the correlations varied within sub-periods. Future correlations across assets will not likely be exactly the same as the past, but think the past is informative of the future (don't think we should disregard the past). The extent of the link is what we each have to decide. Swensen makes his own future 'capital market assumptions' on expected returns, standard deviations, and correlations for his selected asset classes to inform the asset allocation of the Yale Endowment (assumptions which are informed by history). Obviously no guarantees. What the past also shows is that in times of crisis the correlations of risk assets tend to converge towards 1 - so if holding higher risk asset e.g. SV, IMO makes sense to hold some treasury bonds as correlations tend to move in opposite direction.

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Re: Let me get this straight about SCV & factor diversificat

Post by Browser »

larryswedroe wrote:Browser
Factor are LONG-SHORT portfolios, not long only, thus your idea about TSM isn't correct
Larry
I thought the implementation of factors was via long-only funds/ETFs, at least for the most part.
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Browser
That's correct in most cases, but to get POSITIVE exposure to the factors you have to have more than TSM which is zero. TSM has exposure to asset classes, as it owns small and value stocks, but not factors. The large caps and growth stock it owns EXACTLY offsets the positive exposure that it gets from the small and value stocks it owns. So you have to own more of the small and value than TSM to get positive loadings.
Tilted portfolios have exposures to both asset classes and factors. A tilted portfolio can own as many stocks as TSM for example, by weighting differently. That's basically what DFA core portfolios do for example
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Re: Let me get this straight about SCV & factor diversificat

Post by dbr »

larryswedroe wrote:Browser
Factor are LONG-SHORT portfolios, not long only, thus your idea about TSM isn't correct
Larry
For more understanding of this comment reading the top of page 6 in this paper might be helpful (pkcrafter via Kevin M):

http://www.msci.com/resources/pdfs/Foun ... esting.pdf

In fact this whole paper is a very helpful read.

It might or might not be interesting to do an edit-find on the term "divers . . ." and see what turns up. There are 13 matches.

PS For me, when I say some paper or analysis or something is helpful, that means with respect to understanding the discussion. I would never want anyone to think that I am suggesting or not suggesting someone invest this way, that way, or another way or that someone buy into any particular fund or service. Those decisions are for people to make after they judge that they are ready to make such decisions.
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Re: Let me get this straight about SCV & factor diversificat

Post by golfvestor »

larryswedroe wrote:golf investor
Now you certainly can feel otherwise. But you might be paying a steep price for that skepticism in light of the evidence and the statistical significance of them as well

Now as to your point about Sharpe ratios for that period. Makes mistake of looking at things in isolation again. I don't understand why people keep doing it when Markowitz won Nobel Prize for showing that's wrong.
Now look at it the right way,
27-62 60% LG and 40% 5 year Treasury returns 8.3% and SD of 14.7 and worst year -23.4, Now just 33% SV and 67% 5 year returned 8.4 with SD of 14.0 and worst year of 19.2

Hope this is helpful
Larry
Larry,

A difference in SD of 0.7% annually is small, small enough that any investor in 1927-1962 who tried to implement the strategy probably would have seen any theoretical benefit from SV washed out by higher trading costs and adverse tax consequences in the real world. As to statistical significance, I've seen estimates of the statistical significance of the factor premiums, but almost never of the statistical significance of the risk adjusted premiums.
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Re: Let me get this straight about SCV & factor diversificat

Post by larryswedroe »

Golf
First don't know why you look even at risk adjusted returns for say SV vs TSM, or large or whatever, in the sense that no one says that in isolation that they have higher SR, just higher returns and in fact Fama would have said it's risk story. Now the correlations do matter. I would add DFA has since inception last I looked been under 10bp vs it's benchmark. And the worst year gap I would add isn't insignificant. And that's the purpose here, similar returns but less tail risk. Now if you add int'l funds IMO likely cutting tail risks more.
Hope that helps
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Re: Let me get this straight about SCV & factor diversificat

Post by abuss368 »

Rick Ferri wrote:Factor investing is becoming quite popular. I haven't seen actual data, but my gut tells me that "smart beta" and "fundamental indexing" concepts are certainly being applied in more portfolios and in smaller accounts. Given these return premiums must come from somewhere, someone has to be taking the other side of the trade. That would be uninformed traders - the alpha seekers.

Here is my dilemma: where are all the new uniformed traders going to come from who are required to provide premiums to a larger set of factor investors? Factor investors believe they have found a smarter beta, thus there must be many more dumb traders to supply these opportunities. Where are they?

II have not seen any evidence that more dumb alpha chasers exist. Thus, it is reasonable to believe that factors may not work as well in the future as the risk premiums must be spread among many more factor investors. Perhaps these premiums will be spread so thin that the cost of factor investing outweighs the benefit in the future.

Just a thought.

Rick Ferri
Hi Rick,

From the articles and interview's on Vanguard's website, it appears that they acknowledge factor investing but stress a market cap total market approach to indexing. Many of their advisors have noted that anything else is a form of active management.

What are your thoughts and do you think Vanguard will offer a more "DFA" type fund in the future?

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Re: Let me get this straight about SCV & factor diversificat

Post by JoMoney »

abuss368 wrote:...From the articles and interview's on Vanguard's website, it appears that they acknowledge factor investing but stress a market cap total market approach to indexing. Many of their advisors have noted that anything else is a form of active management. ...
I think what Vanguard argues, is that if you're persuaded to have a portfolio based on these "factors", a Cap-Weighted index gives you more control at targeting the small & value factors. Portfolios based on other fundamental techniques could have your portfolio all over the place and not really focused on targeting those factors.
https://advisors.vanguard.com/iwe/pdf/I ... 2Trans.pdf

https://advisors.vanguard.com/iwe/pdf/ISGBPA.pdf
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Re: Let me get this straight about SCV & factor diversificat

Post by abuss368 »

JoMoney wrote:
abuss368 wrote:...From the articles and interview's on Vanguard's website, it appears that they acknowledge factor investing but stress a market cap total market approach to indexing. Many of their advisors have noted that anything else is a form of active management. ...
I think what Vanguard argues, is that if you're persuaded to have a portfolio based on these "factors", a Cap-Weighted index gives you more control at targeting the small & value factors. Portfolios based on other fundamental techniques could have your portfolio all over the place and not really focused on targeting those factors.
https://advisors.vanguard.com/iwe/pdf/I ... 2Trans.pdf

https://advisors.vanguard.com/iwe/pdf/ISGBPA.pdf
Hi JoMoney,

Would that be DFA funds?
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Re: Let me get this straight about SCV & factor diversificat

Post by golfvestor »

larryswedroe wrote:Golf
First don't know why you look even at risk adjusted returns for say SV vs TSM, or large or whatever, in the sense that no one says that in isolation that they have higher SR, just higher returns and in fact Fama would have said it's risk story. Now the correlations do matter. I would add DFA has since inception last I looked been under 10bp vs it's benchmark. And the worst year gap I would add isn't insignificant. And that's the purpose here, similar returns but less tail risk. Now if you add int'l funds IMO likely cutting tail risks more.
Hope that helps
Larry
The difference in the risk adjusted return of the S&P 500 and SCV is not statistically significant. From 1928-2013 a 24% SCV(French 5x5)/76% 10-year T-bond had the same STD as a 50% S&P 500/50% 10-year T-bond portfolio. SCV needed to return 17.81% to have the same risk adjusted return as the 50/50 portfolio. SCV returned a 22.563 annual arithmetic average with a STD of 39.5, so the t-stat of the risk-adjusted return was (22.563-17.81)/(39.5/sqrt(86)) or 1.16. A t-stat of 1.16 is not statistically significant. Since annual stock returns aren't independent, there's probably better mathematical ways to handle the problem, but that's a good first estimate.
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Re: Let me get this straight about SCV & factor diversificat

Post by in_reality »

JoMoney wrote: I think what Vanguard argues, is that if you're persuaded to have a portfolio based on these "factors", a Cap-Weighted index gives you more control at targeting the small & value factors. Portfolios based on other fundamental techniques could have your portfolio all over the place and not really focused on targeting those factors.
https://advisors.vanguard.com/iwe/pdf/I ... 2Trans.pdf

https://advisors.vanguard.com/iwe/pdf/ISGBPA.pdf
I agree that is what Vanguard argues, but I am not sure I agree that what they are saying is the whole story.

Certainly a traditional style based approach will lean towards certain industries. What is wrong with targeting the more valuey companies in a less valuey industries?

The argument against a traditional style based approach is that the value premium is mean reverting, and by only focusing on "value" stocks, you may not be actually catching the full value premium. For instance if two companies have the same price/book and market cap, a traditional style index would hold them equally. If the market cap stays the same, so will their weight. However, if you weight on price/book (or more likely a composite of fundamentals), and the fundamentals of one company changes but the market cap stays the same, you would weight towards the more valuey company. As the price of the over-valued company comes back down to earth, you'll be holding less of it because the fundamentals told the index it seemed overvalued.

Also, if you were to compare exposures to the value factor (HML) between a traditional style value fund and a fundamentally indexed one, you might not see any difference (in their average). If you look at rolling Fama-French regressions though, you will see a wider variation for value spreads for the fundamental index. Even Asness who is fond of dissing fundamental indexes is in the literature saying “value spreads… are important indicators of the attractiveness of value over growth.”

There also appears to be differences across the value cycle, and it's been suggested that the value exposure of a fundamental index may decrease before a period of value underperformance.

Finally, there are difference in momentum exposure as well that may be favorable to a fundamental index. I am not completely clear on this because I understand fundamental indexes to have the same problem as a typical value fund but maybe it is a matter of degree.

So time will tell in the returns of live funds I guess. I read what Vanguard said but unless they address how exposure to the value factor varies in time across market cycles, then their point is a little off I think.

So I look a Schwab's FNDA (Russell Fundamental Index -small mid cap), and I see mid-cap growth has a much larger holding than I would see in Vanguard's mid cap (VOE) or small cap funds (VBR). Do I want to avoid growth companies or do I want exposure to the more valuey companies in what might be less valuey industries?

Anyway, if the value premium is mean reverting, then I like the way the Fundamental Index will adjust to hold relatively more valuey companies.


http://www.iinews.com/site/pdfs/JII_Summer_2014_RA.pdf
http://www.russell.com/documents/indexe ... esting.pdf
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