Why Wouldn't You Tilt To Small Value?

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mbk734
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Why Wouldn't You Tilt To Small Value?

Post by mbk734 »

If you don't tilt, why not? Do you believe the small/value premium is coincidence/random? If you do tilt away from the three-fund portfolio, how much do you tilt? Many advocate for small and value tilting a la Fama/French. Does this mean that Large Cap and Growth are bad? Something like a Larry Portfolio that is mostly small value with a higher bond allocation performs similarly to a three fund portfolio with less volatility. However, if you want to beat the market (3 fund) you could invest in small value and hold fewer bonds if you have a long time horizon (no guarantees). What would your ideal box look like for a long term investor? Would you tilt away from large/growth and towards small/value?

The three fund portfolio equity box looks something like this:

```` Value Core Growth
Large`` 25 ` 25 ` 25
Medium ` 6 ` 6 ` 6
Small ``` 2 ` 2 ` 2

This has 75% large caps and is equally balanced between growth/value therefore not taking advantage of the small value premium with only 33% in value and 6% in small. It should be known that the Vanguard Target Date/Lifestrategy funds use this allocation and do not take advantage of any small value premiums. To tilt or not to tilt? That is the question! :sharebeer
Last edited by mbk734 on Wed Oct 08, 2014 11:08 am, edited 1 time in total.
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Re: Why Wouldn't You Tilt To Small Value?

Post by cheese_breath »

I don't tilt. I'm happy with TSM index.
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Re: Why Wouldn't You Tilt To Small Value?

Post by Quickfoot »

We tilt but not to small value, our domestic equity is 50% large cap and 50% mid cap and we hold 15% in REITs (We consider REITS a seperate asset class than either equity or fixed). We tilt because we believe in the fundamental asset classes being an added value to our portfolio, not because we want to beat the S&P 500. We aren't interested in small caps or in tilting internationally (emerging markets carry enough risk already). In the event of my death my instructions to my wife are to move everything to a single fund portfolio (Wellington now, Wellesley after retirement).

Everyone has an opinion, the simplest thing to do is not tilt so if you don't enjoy managing investments just go three fund or even better Target Date or Life Strategy and enjoy a well diversified portfolio in a single fund that will outperform the majority of other people's portfolios.
Last edited by Quickfoot on Wed Oct 08, 2014 11:26 am, edited 1 time in total.
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Re: Why Wouldn't You Tilt To Small Value?

Post by crake »

mbk734 wrote:Something like a Larry Portfolio that is mostly small value with a higher bond allocation performs similarly to a three fund portfolio with less volatility.
Let me fix that for you.
mbk734 wrote:Something like a Larry Portfolio that is mostly small value with a higher bond allocation performed similarly to a three fund portfolio with less volatility.
I don't tilt because I do not believe there is any free lunch in investing. Increased expected returns come with an increase in expected risk.

Even if you do believe that a premium exists your next question needs to be can I capture it. If you read the small cap value threads here you'll see it stated again and again that the small cap value premium only exists if you look at the "smallest" and "valueiest" stocks traded. The Morningstar Style box for small and value does not meet the criteria of avid tilters. There are a select few funds which are supposedly able to capture the small cap value premium but they come with an increased ER. Now you need to ask yourself not only is premium real but is it worth more than the added ER.
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Re: Why Wouldn't You Tilt To Small Value?

Post by YDNAL »

mbk734 » Wed Oct 08, 2014 12:05 pm wrote:.... Something like a Larry Portfolio that is mostly small value with a higher bond allocation performs historically performed similarly to a three fund portfolio with less volatility. < snip >
To tilt or not to tilt? That is the question! :sharebeer
A tilt is a bet - and "something like a Larry Portfolio....," as you said in the OP, is betting to certain extreme.

For instance (using DFA DFSVX as proxy), you bet that 1,260 current holdings will compensate for the risk taken, while you are also betting that it makes sense to ignore the other 1,961 stocks currently included in Vanguard Extended Markets - that excludes the humongous companies that make 80% of the market cap in the US.
Last edited by YDNAL on Wed Oct 08, 2014 11:48 am, edited 1 time in total.
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Re: Why Wouldn't You Tilt To Small Value?

Post by mbk734 »

YDNAL wrote:
mbk734 » Wed Oct 08, 2014 12:05 pm wrote:.... Something like a Larry Portfolio that is mostly small value with a higher bond allocation performs historically performed similarly to a three fund portfolio with less volatility. < snip >
To tilt or not to tilt? That is the question! :sharebeer
A tilt is a bet - and "something like a Larry Portfolio....," as you said in the OP, is betting to certain extreme.

For instance (using DFA DFSVX as proxy), you bet that 1,260 current holdings will compensate for the risk taken, while you are also betting that it makes sense to ignore the other 2,475 stocks currently included in TSM.
The Larry Portfolio is taking tilting to an extreme, but regular tilting is not ignoring the other 2,475 stocks. It is just giving less weight to large caps. You could argue that a three fund portfolio is practically ignoring small caps (only 6% in small caps).
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Re: Why Wouldn't You Tilt To Small Value?

Post by MrMatt2532 »

mbk734 wrote: The three fund portfolio equity box looks something like this:

```` Value Core Growth
Large`` 25 ` 25 ` 25
Medium ` 6 ` 6 ` 6
Small ``` 2 ` 2 ` 2

This has 75% large caps and is equally balanced between growth/value therefore not taking advantage of the small value premium with only 33% in value and 6% in small. It should be known that the Vanguard Target Date/Lifestrategy funds use this allocation and do not take advantage of any small value premiums. To tilt or not to tilt? That is the question! :sharebeer
I am someone who tilts, however I would argue that the equity style box should not be used to show you are undiversified! Do you realize that how they are defining Large/Medium/Small is largely arbitrary?
Market weighting is the natural starting point, no question. And just because 75% of the companies in TSM are defined as large (arbitrarily) does not mean you are undiversified.
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Re: Why Wouldn't You Tilt To Small Value?

Post by mbk734 »

MrMatt2532 wrote: I am someone who tilts, however I would argue that the equity style box should not be used to show you are undiversified! Do you realize that how they are defining Large/Medium/Small is largely arbitrary?
Market weighting is the natural starting point, no question. And just because 75% of the companies in TSM are defined as large (arbitrarily) does not mean you are undiversified.
The 10 largest holdings in TSM make up 15% of the total fund. The Top 25 make up 25% of the fund. The argument for choosing TSM over the S&P fund is that TSM outperforms long term because it includes more small caps. Using this logic wouldn't you tilt even more to small cap to outperform VTI? TSM is really a mostly large cap blend fund.
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Re: Why Wouldn't You Tilt To Small Value?

Post by YDNAL »

mbk734 wrote:
YDNAL wrote:
mbk734 » Wed Oct 08, 2014 12:05 pm wrote:.... Something like a Larry Portfolio that is mostly small value with a higher bond allocation performs historically performed similarly to a three fund portfolio with less volatility. < snip >
To tilt or not to tilt? That is the question! :sharebeer
A tilt is a bet - and "something like a Larry Portfolio....," as you said in the OP, is betting to certain extreme.

For instance (using DFA DFSVX as proxy), you bet that 1,260 current holdings will compensate for the risk taken, while you are also betting that it makes sense to ignore the other 1,961 stocks currently included in Vanguard Extended Markets - that excludes the humongous companies that make 80% of the market cap in the US.
The Larry Portfolio is taking tilting to an extreme, but regular tilting is not ignoring the other 2,475 stocks. It is just giving less weight to large caps. You could argue that a three fund portfolio is practically ignoring small caps (only 6% in small caps).
When you posted, I was editing my post to use Extended Markets instead of TSM.
  • 1. Regular tilting is still a bet, but if you hold the total Market, or Extended Market, or ???? you are not betting to ignore the other stocks.
    2. Holding the 3-fund portfolio (TSM I assume you mean) uses market capitalization (for what it is) and doesn't ignore anything.
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Re: Why Wouldn't You Tilt To Small Value?

Post by Grt2bOutdoors »

I tilt but slightly, I have no stomach for a 50/50 approach, it appears that some on here have that appetite and more. Each IPS is based on your needs, ability and willingness to take risk. In other words, tilting is highly individual preference to take a ride on the wild side. Some people prefer to go cliff diving too.......
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Re: Why Wouldn't You Tilt To Small Value?

Post by pkcrafter »

Why not tilt? Well, now it looks like any outperformance from small is mostly due to microcaps. If investors want to get into microcaps, I don't think there will be any problem understanding there is going to higher risk. Value seems to be most effective in small, so the new trendy S/D portfolio now is small value and microcap.

http://www.bogleheads.org/forum/viewtop ... 0&t=148464
The Larry Portfolio is taking tilting to an extreme, but regular tilting is not ignoring the other 2,475 stocks. It is just giving less weight to large caps. You could argue that a three fund portfolio is practically ignoring small caps (only 6% in small caps).
If something more than 6% (9%) small was optimal, investors would be doing it, and the market would integrate it and the profile would reflect it. Tilting is simply an attempt to beat the market and that ain't easy to do. There must be more risk in trying it. Risk simply means there are times when your effort will just cost more and you won't get the expected reward--and worse, you won't even get the market return.

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Re: Why Wouldn't You Tilt To Small Value?

Post by MrMatt2532 »

mbk734 wrote:
MrMatt2532 wrote: I am someone who tilts, however I would argue that the equity style box should not be used to show you are undiversified! Do you realize that how they are defining Large/Medium/Small is largely arbitrary?
Market weighting is the natural starting point, no question. And just because 75% of the companies in TSM are defined as large (arbitrarily) does not mean you are undiversified.
The 10 largest holdings in TSM make up 15% of the total fund. The Top 25 make up 25% of the fund. The argument for choosing TSM over the S&P fund is that TSM outperforms long term because it includes more small caps. Using this logic wouldn't you tilt even more to small cap to outperform VTI? TSM is really a mostly large cap blend fund.
The 10 largest holdings are conglomerates that are the equivalent of many smaller businesses. They should have MUCH more weighting than your local pizza place down the street.
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Re: Why Wouldn't You Tilt To Small Value?

Post by CABob »

Tilt? Yes I guess I do since I hold the SCV fund at about 10% of equities (and also a similar holding in a REIT fund).
But to be honest I have been thinking recently that these tilts may not be appropriate for me and I may get rid of them.
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Re: Why Wouldn't You Tilt To Small Value?

Post by YDNAL »

pkcrafter wrote:Why not tilt? Well, now it looks like any outperformance from small is mostly due to microcaps....

http://www.bogleheads.org/forum/viewtop ... 0&t=148464
LOL

Factors du jour. What is tomorrow's flavor - the lowest 10% of 1,379 micros?

You know, Paul, it is unfortunate that many posters are lured by "experts' opinions" - regardless how well informed or well intended - to invest in a manner they (1) don't understand, and (2) should not be attempting to follow.
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Re: Why Wouldn't You Tilt To Small Value?

Post by SimpleGift »

mbk734 wrote:If you don't tilt, why not?
There are several sound reasons, I believe, for an investor NOT to tilt toward small-cap value:
  • 1. You have an average or lower-than-average risk tolerance.
    2. You don't like underperforming the broader market indexes for long periods.
    3. You prefer portfolio simplicity.
    4. You don't trust back-tested studies and research.
    5. You prefer not to pay higher costs for a premium that may not show up (after taxes and costs).
Personally, I have a mild tilt toward small-cap value, but I certainly see the reasoning of those who do not.
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Re: Why Wouldn't You Tilt To Small Value?

Post by White Coat Investor »

Two reasons in my view:

1) Lower costs to not tilt
2) It's possible for SV to underperform in the long run.

Tracking error isn't a huge deal to me, especially since my tilt isn't massive. The additional complexity also isn't a huge deal.
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Re: Why Wouldn't You Tilt To Small Value?

Post by White Coat Investor »

mbk734 wrote:
MrMatt2532 wrote: I am someone who tilts, however I would argue that the equity style box should not be used to show you are undiversified! Do you realize that how they are defining Large/Medium/Small is largely arbitrary?
Market weighting is the natural starting point, no question. And just because 75% of the companies in TSM are defined as large (arbitrarily) does not mean you are undiversified.
The 10 largest holdings in TSM make up 15% of the total fund. The Top 25 make up 25% of the fund. The argument for choosing TSM over the S&P fund is that TSM outperforms long term because it includes more small caps. Using this logic wouldn't you tilt even more to small cap to outperform VTI? TSM is really a mostly large cap blend fund.
That's not the only argument. TSM also provides broader diversification (less risk) and eliminates the front running seen by S&P Index funds, lowering their returns. There are also lower transaction costs as stocks move in and out of the S&P 500. The elimination of the large cap tilt you get with an S&P 500 approach is pretty minor, but also equally useful in my view. I'm pleased to see Jack Bogle and Rick Ferri agree with me (and probably you) that TSM is a better holding than 500 Index.
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Re: Why Wouldn't You Tilt To Small Value?

Post by placeholder »

EmergDoc wrote:1) Lower costs to not tilt
2) It's possible for SV to underperform in the long run.
The difference between Vanguard's VTI (total stock) and VBR (small value) is a whopping 4 basis points.
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Re: Why Wouldn't You Tilt To Small Value?

Post by telemark »

MrMatt2532 wrote: The 10 largest holdings are conglomerates that are the equivalent of many smaller businesses. They should have MUCH more weighting than your local pizza place down the street.
The top five holdings in VTSMX are

Code: Select all

Symbol % Assets YTD Return %
AAPL   2.78     25.47
XOM    1.92     -6.25
MSFT   1.52     24.94
JNJ    1.32     16.13
WFC    1.22     15.11
That's Apple, Exxon Mobil, Microsoft, Johnson & Johnson, and Wells Fargo. I'll buy Johnson & Johnson as a diversified conglomerate, not so sure about the others.
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Re: Why Wouldn't You Tilt To Small Value?

Post by rkhusky »

MrMatt2532 wrote: The 10 largest holdings are conglomerates that are the equivalent of many smaller businesses. They should have MUCH more weighting than your local pizza place down the street.
That is a really great point. If one broke Nabisco and others like it into separate companies, one for each brand or product, would that make a difference in how people view market cap?

Edit: Even Apple could be broken up into iPhone, iPad, Mac, iTunes, and software companies
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Re: Why Wouldn't You Tilt To Small Value?

Post by MrMatt2532 »

telemark wrote:
MrMatt2532 wrote: The 10 largest holdings are conglomerates that are the equivalent of many smaller businesses. They should have MUCH more weighting than your local pizza place down the street.
The top five holdings in VTSMX are

Code: Select all

Symbol % Assets YTD Return %
AAPL   2.78     25.47
XOM    1.92     -6.25
MSFT   1.52     24.94
JNJ    1.32     16.13
WFC    1.22     15.11
That's Apple, Exxon Mobil, Microsoft, Johnson & Johnson, and Wells Fargo. I'll buy Johnson & Johnson as a diversified conglomerate, not so sure about the others.
Sure, maybe not the classical definition of a conglomerate, but just look at how many smaller companies these companies buy up each year...
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Re: Why Wouldn't You Tilt To Small Value?

Post by crake »

placeholder wrote:
EmergDoc wrote:1) Lower costs to not tilt
2) It's possible for SV to underperform in the long run.
The difference between Vanguard's VTI (total stock) and VBR (small value) is a whopping 4 basis points.
The latest I've been hearing from tilting advocates has been that VBR and other funds that fit into M*'s small value style box are not small or valuey enough to capture the premium. Fund companies I have seen recommended are DFA and Bridgeway. For these funds it seems like you will be paying at least a .5% ER and probably higher.

I've noticed a lot of people trying to tilt with VBR. I do not understand it.
  1. Tilting Experts say there is a small cap value premium.
  2. Other experts post graph showing the Vanguard small cap growth(VBK) beat Vanguard small cap value (VBR) over some long time period.
  3. Tilting Experts say VBR isn't small or valuey enough to capture the premium and advocate DFA/Bridgeway.
  4. Non experts who want to emulate tilting experts buy VBR.
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Re: Why Wouldn't You Tilt To Small Value?

Post by asif408 »

mbk734 wrote:If you don't tilt, why not?
I am not convinced a small tilt will make a huge difference one way or the other, though I am considering it. I believe that my savings rate, overall stock/bond allocation, and overall exposure to the market (total market funds) are the most important considerations. Past that, I think the law of diminishing returns comes into play (i.e., the benefits of tilts is relatively small in the big scheme of things). I don't really want to complicate things more than necessary, especially for my spouse who has little interest in investing.
mbk734 wrote:Do you believe the small/value premium is coincidence/random?
Not sure. Obviously it was there in the past, but who knows going forward? And which fund/ETF would best match the past performance? I'm not aware of any small cap value funds that have been around for any extended period of time.
mbk734 wrote:Would you tilt away from large/growth and towards small/value?
I would consider it, but probably wouldn't consider a big tilt and would pick a relatively cheap fund such as VBR to do it with, since I don't know if the premium will show up or not.
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Re: Why Wouldn't You Tilt To Small Value?

Post by Day9 »

Here is one person's opinion about various domestic small-value funds: http://www.altruistfa.com/USsmallcapvaluefunds.htm

Note how Vanguard's fund is quite low on the list. Other posters have already said how it is not small nor valuey enough. It also holds a lot of REITs.
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Re: Why Wouldn't You Tilt To Small Value?

Post by Steadfast »

I do not tilt to small value because TSM is good enough. The total market is ruthlessly efficient. Anything else is a bet you can win, or lose.

Savings rate, costs, and ability to stay the course will have far, far greater impact on long term performance than tilting.
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Re: Why Wouldn't You Tilt To Small Value?

Post by RetiredinKaty »

I tilted for a while but not any more. I have been retired for about 3 years. Early on I was worried about having enough, but those worries abated soon. Then I started worrying about how to make my portfolio more old age proof and survivor friendly. My expectation is that later in life my portfolio will be simple, perhaps even Target Retirement Income. So for me, tilting changed from being a life long strategy to an intermediate term bet. Even the most ardent tilting advocates don't recommend it as near term strategy. If the back end of retirement investing is going to be simple and fit for service, the front end probably should be too.

By the way, another reason I stopped tilting is I wasn't very good at it. Every few months I would come up with a better, improved tilt. I was a classic hunter for the perfect portfolio. Now I am not.

Regards.
Last edited by RetiredinKaty on Wed Oct 08, 2014 1:29 pm, edited 1 time in total.
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Re: Why Wouldn't You Tilt To Small Value?

Post by sls239 »

I think the mere fact that the discussion is about "tilting" makes it clear why I would not do that. Mere tilting wouldn't help much, and I'm obviously too chicken to go all in.

Also, I didn't start with a tilt, my default is to keep it that way.
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Re: Why Wouldn't You Tilt To Small Value?

Post by subham »

when building my AA, I was in two minds as tilt or not tilt based on opposing views from the books i read. On one hand i wanted to make sure i did not give up any premium that tilting gives based on the works of Larry Swedore and Paul Marriam. On the other hand i did not have the guts to go equal weighting across all factors as they suggest. So in the end I went with 75% VTSAX and 25% VBR (based on Rick Ferri's advise) and am still in two minds if i did the right thing.

In just one month the VTSAX dropped by 3% and VBR by 7%.

I will be DCAing the remaining portion of my cash over next 6 months and i was wondering if i should stop adding money into VBR to tilt away from small value and give more weight to US total (and hopefully keep it untitled for the rest of my life).

I know this can be a buyers remorse + market timing behavior. Should i stick to my original allocation and add money into VBR anyway per my AA given that i will be "buying low" now?

Do you folks have any words of wisdom for a newbie?
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Re: Why Wouldn't You Tilt To Small Value?

Post by JohnnyFive »

subham wrote:when building my AA, I was in two minds as tilt or not tilt based on opposing views from the books i read.

In the end I went with 75% VTSAX and 25% VBR and am still in two minds if i did the right thing.

In just one month the VTSAX dropped by 3% and VBR by 7%.

I will be DCAing the remaining portion of my cash over next 6 months and i was wondering if i should should stop adding money into VBR to tilt away from small value and give more weight to US total.

I know this can be a buyers remorse + market timing behavior. Should i stick to my original allocation and add money into VBR anyway given that i will be "buying low"?

Do you folks have any words of wisdom for a newbie?

I think you are precisely the type of person that should NOT tilt. Tracking error and the like, will always be a concern for someone like you. You MUST have a long term (20+ years) horizon to tilt and NOT be frustrated about relative under-performance for (sometimes) prolonged periods of time. The fact that you are considering rebalancing AWAY from the tilt, at a time when it's under performing, is precisely the reason that, long term, you will likely under perform the market (namely, performance chasing).
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Re: Why Wouldn't You Tilt To Small Value?

Post by subham »

JohnnyFive wrote:
I think you are precisely the type of person that should NOT tilt. Tracking error and the like, will always be a concern for someone like you. You MUST have a long term (20+ years) horizon to tilt and NOT be frustrated about relative under-performance for (sometimes) prolonged periods of time. The fact that you are considering rebalancing AWAY from the tilt, at a time when it's under performing, is precisely the reason that, long term, you will likely under perform the market (namely, performance chasing).
Thanks for quick response. I added a bit more detail for my choices.

Anyway i am still very new to this and learning not to watch the markets on a daily basis. I do have 10-20 years to go and so i should learn to ignore the short term trends.

Given that i have 6 months worth of DCAing to go I am getting a taste of what exactly investing entails watching different assets falling by different amounts. And so this is my chance to truly evaluate my risk profile as opposed to the text book approach.
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Re: Why Wouldn't You Tilt To Small Value?

Post by asif408 »

subham wrote:Thanks for quick response. I added a bit more detail for my choices.

Anyway i am still very new to this and learning not to watch the markets on a daily basis. I do have 10-20 years to go and so i should learn to ignore the short term trends.

Given that i have 6 months worth of DCAing to go I am getting a taste of what exactly investing entails watching different assets falling by different amounts. And so this is my chance to truly evaluate my risk profile as opposed to the text book approach.
subham,

Maybe this will give you some perspective: http://www.portfoliovisualizer.com/hist ... ss-returns

You can see that periodically small value trails total market by 10% or more (e.g., 1989, 1990, 1998, 1999, 2007). If a few percentage points in tracking error bothers you now, how will you react when it underperforms by 10 or 20% for several years? Something to consider if you plan to stick with this strategy.
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Re: Why Wouldn't You Tilt To Small Value?

Post by SmileyFace »

RetiredinKaty wrote:
By the way, another reason I stopped tilting is I wasn't very good at it. Every few months I would come up with a better, improved tilt. I was a classic hunter for the perfect portfolio. Now I am not.

Regards.
Well stated - I too fell into this trap for a while. Every time I read another book - or ran new data - I thought I had a better (or yet-another) tilt (e.g. not just value - but at one point I was about to break out my Total-International-Index to EMEA/AJPAC/Emerging categories in order to tilt towards Emerging, etc.). That said I still have a small value tilt based but am considering reducing or eliminating it eventually.
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Re: Why Wouldn't You Tilt To Small Value?

Post by nisiprius »

These are the reasons I don't tilt to small value. They wouldn't apply to everyone. As Taylor Larimore likes to say, "there are many roads to Dublin," and my belief is that there are a large number of investing strategies that are all within what might be called the "blur circle." You can't tell in advance which of them is going to do best, and you can't tell after the fact whether the one that did best did so because it was superior, or because of luck.

Since I haven't been tilting, for me tilting would be a change, and I am highly biased toward staying the course. It takes a lot of time and a lot of evidence to convince me to change. Basically, there is nothing at all that convinces me that the benefits of small value tilts are all that robust, all that widely accepted by authorities I trust, or all that certain to have a beneficial effect on my portfolio during the specific chunk of years I will be holding it.

Reason #1: Fama's own statements. Oh, interesting, it appears as if DFA has removed the video that used to be on their website... but they used to have one posted, made around 2002, I think:
Interviewer: Some people cite your research showing that value and small firms have higher average returns over time and they assume that you would recommend most investors have a big helping of small and value stocks in their portfolios. Is that a fair representation of your views?

Fama: Um, no. (Laughs) Basically this a risk story the way we tell it, so there is no optimal portfolio. The way I like to talk about it when I give presentations for DFA or other people is, in every asset pricing model, the market portfolio is always an efficient portfolio. It’s always a relevant portfolio for an investor to hold. And investors can decide to tilt away from that based on their personal tastes.

But that’s what it amounts to. You can decide to tilt toward more value or smaller size based on your tastes for these dimensions of risk. But you needn’t do it. You could also decide to go the other way. You could look at the premiums and say, no, I think I like the growth stocks better. Then, as long as you get a diversified portfolio of them, I can’t argue with that either.

So there’s a whole multi-dimensional continuum here of efficient portfolios that anybody can decide to buy that I can’t quarrel with. And I have no recommendations about because I think it’s totally a matter of taste. If you eat oranges and I eat apples I can’t really quarrel very much with that.
Reason #2: As a casual investor, I tend to invest on the assumption that everything is liquid, everything has a market value, and you can sell and actually get that market value whenever you like. In fact one of the reasons I like mutual funds is that they promise me that. I can redeem at the end-of-day NAV, and whether or not they can actually sell my assets for that amount of money is their problem, not mine. However--it's been a long, slow double-take--I'm starting to think that I should have been paying more attention to liquidity all along. And that potentially weird stuff can happen--in both ETFs and mutual funds--when the assumption of liquidity breaks down.

Well, small stocks are less liquid than large stocks, and small value stocks are less liquid still, and the connoisseurs prefer the gourmet funds that are even smaller and more value-y and therefore, I assume, even less liquid.

It's not so much that the market isn't compensating investors for taking that risk--maybe it is. It's that it clearly gets into an area where I have no idea what I'm doing, can't really evaluate what the risks might or might be--and am competing against investors who have better knowledge than I do. This is all true for large-cap stocks, too, but it is clearly more true for small-cap value.

Reason #3: Larry Swedroe somewhere--ah, here cites some research on the reason for the small value premium, and it concludes that of course standard deviation only captures one dimension of risk and that there are others. In particular, most investors prefer the "lottery ticket" pattern of risk--losses, though frequent, are small, while wins, though rare, are large. This preference causes these stocks to be bid up. Well, you know what? I personally share that preference. Larry Swedroe presents is as an irrational mistake to be avoided, but I regard it as simply part of my "utility function."

To put it another way, it's not about return, it's about the relationship between risk and return, and if you're going to go in for small value you really need to examine that and decide whether you like the kind of risk it has.

Reason #4: Like many really plausible-sounding statements about how investments "tend to" behave, if you look for yourself, the statements often don't check out. The classic example is this: in 16 years since inception, the difference between Vanguard Small-Cap Value index and Vanguard Small-Cap Growth Index hasn't been large, and overall is very close to a dead heat: 8.43% for Small-Cap Value Index, 8.42% for Small-Cap Growth Index. One basis point.

Image

Now, advocates for tilting have a bunch of alibis for this particular performance. It amounts to saying that Morningstar's definitions of "small-cap value" and "small-cap growth" are no good, the index providers' definitions are no good, and Vanguard index funds are no good. I say that in my world, I don't need to use Galileo's telescope to see the moons of Jupiter, any old pair of decent binoculars will work--just maybe not as well. I say if the characteristics of small value are clear, strong, robust, and reliable, all the things people say about them ought to be visible even with the wrong brand of mutual fund.

If it basically doesn't show up with Vanguard index funds, it may be there but it isn't too big to ignore.
Last edited by nisiprius on Thu Oct 09, 2014 5:35 am, edited 1 time in total.
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subham
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Re: Why Wouldn't You Tilt To Small Value?

Post by subham »

Sorry if this has been discussed before, but I am not able to convince myself that market-cap weighting is optimal. I have heard people say that it leads to bubbles when one or few large companies over power TSM dragging the entire performance with them (recently APPLE dragged down S&P). In that sense shouldn't one at least have some small tilt to balance out?

On a similar note, i heard the equal weighted index out performed capital weighted index but people brush aside this as "no free lunch" as the extra returns came at an extra risk. But isn't the cap weighted index taking a systematic risk of bubbles that is hard to quantify?

Please share any info that would put my misgivings to rest for good :)

Also both LarryS and PaulM (authors i highly regard) show that titling can improve returns for same standard deviation. I understand standard deviation is not the only metric for risk, but the experts use it anyway. Shouldn't they put a disclaimer that a novice should start with TSM and add tilt later on instead of proposing only tilted strategies? I came to regard these authors highly as they give very actionable advice which allowed me to break my analysis-paralysis, but it seems unfair not to explicitly show how tilting can lead to behavioral mistakes which i was about to make by reacting to tracking errors as a novice.
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Re: Why Wouldn't You Tilt To Small Value?

Post by stlutz »

I invest 100% in the single stock that is at the bottom left of the M* style-box--i.e the most valuey microcap out there. My portfolio will crush all of yours. :moneybag
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Re: Why Wouldn't You Tilt To Small Value?

Post by avalpert »

telemark wrote:
MrMatt2532 wrote: The 10 largest holdings are conglomerates that are the equivalent of many smaller businesses. They should have MUCH more weighting than your local pizza place down the street.
The top five holdings in VTSMX are

Code: Select all

Symbol % Assets YTD Return %
AAPL   2.78     25.47
XOM    1.92     -6.25
MSFT   1.52     24.94
JNJ    1.32     16.13
WFC    1.22     15.11
That's Apple, Exxon Mobil, Microsoft, Johnson & Johnson, and Wells Fargo. I'll buy Johnson & Johnson as a diversified conglomerate, not so sure about the others.
Exxon Mobil is a pretty diversified conglomerate all be it concentrated in the energy sector.
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Taylor Larimore
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Cap Weighted Total Stock Market is Efficient

Post by Taylor Larimore »

I am not able to convince myself that market-cap weighting is optimal.
This article by John Norstad will help:

Three Proofs that the Total Stock Market is Efficient

Best wishes.
Taylor
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columbia
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Re: Why Wouldn't You Tilt To Small Value?

Post by columbia »

I'm more interested in "good enough" than conceptipns of what might or might not turn out to better.
Why complicate things, if you are already utilizing a sound strategy?
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Re: Why Wouldn't You Tilt To Small Value?

Post by BigJohn »

Why I don't tilt in three catch phrases....

1) "Past performance is no guarantee of future results". Even the proponents of tilting will agree that they are higher risk and can under perform for long (ie 10+ years) periods. Lots of statistical analysis and theories as to why the factor premiums exist but there are just theories not science. I am not willing to take more risk and make a bet they are going to persistent, especially because of....

2) "Rekenthaler's Rule: If the bozos know about it, it doesn't work any more." All the historical analysis is based on a time when it was not easy for everyone to invest in SCV and other factors. In the last 10 years there has been an explosion of mutual funds and financial advisers all competing to invest in the same very small part of the market. Even if I believed that history proved persistence, the current "system" is far different than the one that existed 10 years ago. For examples of Rekenthaler's rule in action read Bill Berstein's "Skating Where the Puck Was". Even if I could get past this worry and was convinced that tilts were real and would persist there's still the fact that .......

3) "Costs Matter". Let's say the tilts over time will actually return an incremental 1% vs a market index. If I'm willing to risk 25% of my stock in tilting and have a 60/40 allocation, tilting will increase my total portfolio return by 0.15% (say from 3% real to 3.15% real return). This makes a big assumption which is that I can tilt and not increase expenses or taxes. If I incur an increase in either, I end up lower than 3.15%. If extra costs exceed incremental returns, I will end up lower than 3.0%. Why do I want all that extra complexity and risk for at best a very small win that may be a loss if I'm not careful?
"The greatest enemy of a good plan is the dream of a perfect plan" - Carl Von Clausewitz
subham
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Re: Cap Weighted Total Stock Market is Efficient

Post by subham »

Taylor Larimore wrote:
I am not able to convince myself that market-cap weighting is optimal.
This article by John Norstad will help:

Three Proofs that the Total Stock Market is Efficient

Best wishes.
Taylor
Thanks a lot Taylor. I read it and it sure is food for thought, although all there models seem to be describing a static euqillibrium.

Do you have anything specific to say about TSM prone to bubbles (as opposed to say an equal weighted index which will not runaway in a bubble)?

What way does a boglehead justify its still the right choice? Is it because TSM will eventually return to mean and will save the day for a buy and hold strategy?
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Re: Why Wouldn't You Tilt To Small Value?

Post by subham »

BigJohn wrote:Why I don't tilt in three catch phrases....

3) "Costs Matter". Let's say the tilts over time will actually return an incremental 1% vs a market index. If I'm willing to risk 25% of my stock in tilting and have a 60/40 allocation, tilting will increase my total portfolio return by 0.15% (say from 3% real to 3.15% real return). This makes a big assumption which is that I can tilt and not increase expenses or taxes. If I incur an increase in either, I end up lower than 3.15%. If extra costs exceed incremental returns, I will end up lower than 3.0%. Why do I want all that extra complexity and risk for at best a very small win that may be a loss if I'm not careful?
I didnt think of this! You are right I have exactly same problem and now realize that all this titling i did was only for the extra 0.15 - fees return which may cost me dearly due to behavioral mistakes.

Now that i already committed 50% of 25%, i am think of leaving it alone and cut my SV tilt to 12.5% so that my next 6 months DCA will not go into SV but boost my TSM. All future dollars i will put in my AA minus SV so that % wise it weakens over time.

Is this a good exit strategy w/o incurring any real losses?
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Re: Why Wouldn't You Tilt To Small Value?

Post by asset_chaos »

Why Wouldn't You Tilt To Small Value? First off, there's extra risk. I think the evidence supports the conclusion that the extra risk is compensated with extra return, as long as your extra costs for tilt are small enough. (My elaboration of that point here http://www.bogleheads.org/forum/viewtop ... 0&t=144217, along with some friendly attempts at refutation-).) But it is perfectly reasonable for anyone to decide that they don't care for the extra risk. Then, tilting most likely involves extra complication in a portfolio. It is perfectly reasonable for anyone to decide that they assign a high value to maximum simplicity in their portfolio. Other good reasons already given above. Tilting to small value is just not the slam dunk obvious choice for everyone that, say, changing to low-cost from high-cost investing is.
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countmein
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Re: Why Wouldn't You Tilt To Small Value?

Post by countmein »

subham wrote:
BigJohn wrote:Why I don't tilt in three catch phrases....

3) "Costs Matter". Let's say the tilts over time will actually return an incremental 1% vs a market index. If I'm willing to risk 25% of my stock in tilting and have a 60/40 allocation, tilting will increase my total portfolio return by 0.15% (say from 3% real to 3.15% real return). This makes a big assumption which is that I can tilt and not increase expenses or taxes. If I incur an increase in either, I end up lower than 3.15%. If extra costs exceed incremental returns, I will end up lower than 3.0%. Why do I want all that extra complexity and risk for at best a very small win that may be a loss if I'm not careful?
I didnt think of this! You are right I have exactly same problem and now realize that all this titling i did was only for the extra 0.15 - fees return which may cost me dearly due to behavioral mistakes.

Now that i already committed 50% of 25%, i am think of leaving it alone and cut my SV tilt to 12.5% so that my next 6 months DCA will not go into SV but boost my TSM. All future dollars i will put in my AA minus SV so that % wise it weakens over time.

Is this a good exit strategy w/o incurring any real losses?
I did a little experiment to address this thought. Let's take roughly the last 20 years, 1994-2013, and compare two 60/40 portfolios: Port A is 60% VFINX (SP500), 40% TBM. Port B is same but replace half the equity side with DFSVX (DFA small value).

If you started with 100K, at the end of the period:
Port A = $485 K
Port B = $607 K

Say you invest internationally. 1/2 US, 1/2 Ex-US, Port A is again un-tilted, Port B is again 50% tilted using DFA's DISVX and DFEVX. From 1999-2013 (chosen due to inception of dfevx), you'd get the following results:

Port A = $230 K
Port B = $323 K

So you can see that tilting has had made a major real-world difference in the recent past. The idea that it's just the number 3.0 versus the number 3.15 is a bit deceptive. Of course, whether or not this attractive backtest has anything to do with the future is another matter.
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Re: Why Wouldn't You Tilt To Small Value?

Post by BigJohn »

countmein wrote:So you can see that tilting has had made a major real-world difference in the recent past. The idea that it's just the number 3.0 versus the number 3.15 is a bit deceptive. Of course, whether or not this attractive backtest has anything to do with the future is another matter.
countmein, a couple of comments.

First, picking a 14 year window and using that to draw conclusions can be very dangerous, especially if that period contained a much higher than average performance of SCV. See this recent comment by Rick Ferri http://www.bogleheads.org/forum/viewtop ... 5#p2188775

Second, no magic about the 1%, just an assumption on my part but everything I've read, even from tilting advocates, would indicate you should not count on a whole lot more than that over the long term. Here are a few other comments by Rick Ferri on this point http://www.bogleheads.org/forum/viewtop ... 0#p2193360, http://www.bogleheads.org/forum/viewtop ... 2#p2069592

So, I stand by my example as representative of what you might reasonably want as a planning basis if you tilt. Yes, you can increase risk and tilt at 50% vs 25% or you can be more bullish and assume you'll get 2% premium vs 1%. However, in both cases you still only get to 3.3% at best if there are no incremental fees or taxes (a big if in my mind).
"The greatest enemy of a good plan is the dream of a perfect plan" - Carl Von Clausewitz
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Re: Why Wouldn't You Tilt To Small Value?

Post by tarheel »

Domestic I'm 33% TSM 16.5% SCV (VISVX). I am more than happy to pay the miniscule ER of VISVX for the exposure to the small and value factors. I get both of these with one SCV fund, which is a minimal increase in complexity of the portfolio.

Yes, I would probably favor Dimensional if I had access. I don't. I understand I don't get quite the factor exposure with VISVX, but the whole perfect the enemy of the good, etc.

I am a big believer in the academic side. At worst, maybe SCV doesn't OUTPERFORM in the long run, but with an ER of around 0.20 no big deal. My horizon is very long.
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Re: Why Wouldn't You Tilt To Small Value?

Post by JoMoney »

BigJohn wrote:..."Rekenthaler's Rule: If the bozos know about it, it doesn't work any more." All the historical analysis is based on a time when it was not easy for everyone to invest in SCV and other factors. In the last 10 years there has been an explosion of mutual funds and financial advisers all competing to invest in the same very small part of the market. Even if I believed that history proved persistence, the current "system" is far different than the one that existed 10 years ago. ...
...
BigJohn wrote:
countmein wrote:So you can see that tilting has had made a major real-world difference in the recent past. The idea that it's just the number 3.0 versus the number 3.15 is a bit deceptive. Of course, whether or not this attractive backtest has anything to do with the future is another matter.
countmein, a couple of comments.

First, picking a 14 year window and using that to draw conclusions can be very dangerous, especially if that period contained a much higher than average performance of SCV. ...
... Just thought I'd point out that by some measures the Total Market (as represented by Vanguard's Total Stock Market Admiral class has out performed the popular DFA Small-Value over the past 10 years, and done so with lower risk, and no need to pay an "adviser" to access funds with Vanguard...
It only just out-nudged it with the recent performance, but with the general outlook on small-caps I wouldn't be surprised if it's just the beginning.
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Re: Why Wouldn't You Tilt To Small Value?

Post by larryswedroe »

few thoughts
First, one should only invest in something they understand the risks of, and that includes not just volatility, but psychological risks like tracking error, and how the risks correlate with your labor capital

Second, the market (TSM) is clearly not perfectly efficient--there are many well documented anomalies, mostly in small pockets of the market that cannot be explained if markets were perfectly efficient. You can improve on TSM type portfolios simply by avoiding the anomalies, like extreme small growth stocks, very high beta/volatility stocks (with high short interest), penny stocks, IPOs, and negative momentum stocks, among others---this is all well documented and really not debated in the financial community.

Third, there are two ways, not one, to use the SV premium. One is to take more risk, the same reason you own more stocks than bonds. The other is to use the higher expected returns to lower market exposure to achieve same expected return--the way I personally use it. And it diversifies the sources of risk more effectively as you have more diversification across the factors that have been demonstrated to be the sources of returns. And that has historically given a superior risk-adjusted return and IMO there is every reason to believe it will LIKELY continue to do so because of the way correlations tend to work. The reason is that when the big economic risk to small value stocks shows up (deflationary shocks, liquidity shocks) the safe bonds in the rest of your portfolio tend to see their correlations to stocks go sharply negative, just when needed most. That's why historically the left tail risk has been cut by more than the right tail (safe bonds don't necessarily do poorly when stocks do well, while they tend to do very well when stocks get hit hard)

I would add this, even an extreme tilt like the Larry Portfolio we typically have say 4k stocks in it, so idiosyncratic risk is basically eliminated, certainly more so than in say the S&P 500, where you might have 5% in a single stock. You're also diversified globally, across US, developed and EM markets, hedging economic and geopolitical risks. And you are more diversified by sources of returns than TSM which has only exposure to one source, beta. So you have all your "bets" on beta, in one beta basket.

If you believe risk and expected return are related perhaps you might want to consider diversifying across other sources of returns that have been shown to be both persistent and pervasive. And if you believe markets are efficient than you should expect higher returns for that risk (and you can now lower beta exposure!!). If you believe that there are pockets of inefficiency, like extreme small growth or other lottery tickets, than you should expect higher returns for no more risk and even more reason to tilt.

Individuals have advantages over big institutions here. Individuals can put say 10% in small value, or more. But a CalPERS could not, their just too big. hard for them to allocate large % to small sector of the market. So they don't.

Finally, it's likely any strategy will underperform for even long periods, so whatever asset allocation you choose you have to have discipline. TSM is NO DIFFERENT. Just think the 10 years from 2000-09, and during that period small value did fairly well.

You can also think about such legendary investors like Buffett and Graham and Dodd who all were value investors, tilters if you will,not TSMers.

The bottom line IMO is that the most important decision is choosing the allocation you are most likely to be able to stick with--that's the right one for you. So if tilting will cause you to increase the risk of abandoning your plan you should not tilt. But TSM is not any different, only thing don't have is tracking error risk.

Hope that is helpful


Larry
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Re: Why Wouldn't You Tilt To Small Value?

Post by asif408 »

larryswedroe wrote:few thoughts
Third, there are two ways, not one, to use the SV premium. One is to take more risk, the same reason you own more stocks than bonds. The other is to use the higher expected returns to lower market exposure to achieve same expected return--the way I personally use it. And it diversifies the sources of risk more effectively as you have more diversification across the factors that have been demonstrated to be the sources of returns. And that has historically given a superior risk-adjusted return and IMO there is every reason to believe it will LIKELY continue to do so because of the way correlations tend to work. The reason is that when the big economic risk to small value stocks shows up (deflationary shocks, liquidity shocks) the safe bonds in the rest of your portfolio tend to see their correlations to stocks go sharply negative, just when needed most. That's why historically the left tail risk has been cut by more than the right tail (safe bonds don't necessarily do poorly when stocks do well, while they tend to do very well when stocks get hit hard)

I would add this, even an extreme tilt like the Larry Portfolio we typically have say 4k stocks in it, so idiosyncratic risk is basically eliminated, certainly more so than in say the S&P 500, where you might have 5% in a single stock. You're also diversified globally, across US, developed and EM markets, hedging economic and geopolitical risks. And you are more diversified by sources of returns than TSM which has only exposure to one source, beta. So you have all your "bets" on beta, in one beta basket.
Larry,

Thanks for your insight. How much could an individual investor capture the small value premium with the funds available at a low cost brokerage (i.e., Vanguard, Schwab, Fidelity, etc.) ? I believe you use the DFA funds, so for those who don't have access to DFA funds I wonder how much of the premium could be captured. I have an account at Vanguard, and Vanguard's small cap value fund, VBR, for example, is more a mix of mid and small cap value when you look under the hood. Vanguard does have a few other small value funds (VIOV & VTWV) that appear to be smaller and more valuey, but they seem to be pushing investors away from those funds. In addition, there is not international small value fund that I am aware of at Vanguard. VSS is the only small cap option, and it appears to be more of a mid and small cap value blend heavier in mid-caps.

For the record, I like the idea of using the small value premium to lower market exposure, I just have doubts as to how well I would be able to do that with the funds that are available through Vanguard.
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Taylor Larimore
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Jack Bogle answers your question.

Post by Taylor Larimore »

"Why wouldn't you tilt to small Value?"
Mr. Bogle answers:

The Telltale Chart

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Why Wouldn't You Tilt To Small Value?

Post by larryswedroe »

asif
there are many funds and etfs now with higher loadings on small value than Vanguard. These have been discussed here many times. so your choice is not limited to DFA or not. Having said that the higher the loading (the lower the market cap and the lower the prices to book, earnings, sales, etc), the higher the expected return and the more you can cut beta.

as to The telltale chart. Unfortunately Bogle made error of looking at ACTIVE funds and performance. And growth funds drift and buy value and value funds drift and buy growth so you don't tend to see much difference. now if he looked at returns of the asset classes, say using data available at Ken French's website he would have come to different conclusion. The telltale chart IMO is just bad "science" unfortunately, and has led many to draw the wrong conclusion.

Clearly DFA and others have shown one can earn returns similar to the results French showed as DFA SV has come very close to matching the index returns even AFTER expenses, and an index has no expenses. Securities lending helps to offset some of the expenses. And so does avoiding some of the "black holes"

Larry
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