Lazy Portfolio with Sector Funds

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robtkatz
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Lazy Portfolio with Sector Funds

Postby robtkatz » Mon Jan 09, 2017 10:16 am

Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert

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Taylor Larimore
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Re: Lazy Portfolio with Sector Funds

Postby Taylor Larimore » Mon Jan 09, 2017 12:02 pm

robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert

Robert:

Welcome to the Bogleheads Forum!

There are dozens (probably hundreds) of sector funds. Why did you pick these two?

Thank you.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Lazy Portfolio with Sector Funds

Postby robtkatz » Mon Jan 09, 2017 12:55 pm

Taylor Larimore wrote:
robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert

Robert:

Welcome to the Bogleheads Forum!

There are dozens (probably hundreds) of sector funds. Why did you pick these two?

Thank you.
Taylor


Hi Taylor,

I wanted something that tracked the entire stock market. I guess VTI is a good one. I noticed that VDC correlates well with VTI, but seems much less volatile -- I'm sure there are others besides VDC that do the same. Then I wanted something not correlated with the market, so I came up with a long term treasury. Ergo VDC and EDV.

Regards,
Robert

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Re: Lazy Portfolio with Sector Funds

Postby nisiprius » Mon Jan 09, 2017 12:59 pm

Since I don't follow much of the financial press except as it pops up in Bogleheads, does someone happen to know why oh why oh why we are suddenly seeing so much about consumer staples? There are eleven sectors, and you'd expect them to be fairly different from each other, and I've no doubt that the past performance of the best sector has been much better than the past performance of the worst sector, but... so what?

1) Consumer Staples turned in a dramatic performance in 2008-2009, by dropping much less than stocks in general (which accounts for most of the superiority in recent data), but that was eight years ago... so why are we hearing so much about it now? (Or is it just me?)

2) Why, exactly, don't you think investors are willing to pay as much for consumer staples stocks as they are worth?

As for "much less risky," Vanguard puts the Vanguard Consumer Staples Index Fund in its highest risk tier, 5, compared with 4 for broad-based funds like Total Stock Market, and says, "The fund’s main risk is its narrow scope—it invests solely in consumer staples stocks. An investor should expect high volatility from the fund, which should be considered only as a small portion of an already well-diversified portfolio."

Image

Larry Swedroe has written:
In 'The Quest for Alpha,' p. 156, Larry Swedroe wrote:#17: Owning individual stocks and sector funds is more akin to speculating, not investing. The market compensates investors for risks that cannot be diversified away, like the risk of investing in stocks versus bonds. Investors shouldn't expect compensation for diversifiable risk--the unique risks related to owning one stock or sector or country fund. Prudent investors only accept risk for which they will be compensated with higher expected returns.
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Re: Lazy Portfolio with Sector Funds

Postby RyeWhiskey » Mon Jan 09, 2017 1:09 pm

robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert


That portfolio assumes much unnecessary risk, for little return. EDV is subject to enormous interest rate risk and we are sitting at the end (or late middle) of historically low rates. In all likelihood, rates will rise and this fund will suffer over the course of this rising. To balance this risk you are introducing a sector equity fund that is too narrow to serve as a main fund. What if consumer staples do excessively poorly over the next 10 years? Will you not panic and jump onto the next "less risky" sector?

If you want to reduce stock/equity risk, add safe bonds (not EDV). EDV has a very particular purpose in a portfolio and it is not 100% of said bond allocation. Not even the Permanent Portfolio advocates for such a heavy amount of stripped bonds. The Total Bond Index will dampen stock market fluctuations very well and is diversified enough to support changing market conditions.

As to the equity portion, given that there is no real logic in choosing VDC, why not stick with a total market index (or even a total world index) and cut out the guess work?

:sharebeer
This post was brought to you by Vanguard Total World Stock Index (VTWSX/VT).

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Re: Lazy Portfolio with Sector Funds

Postby qwertyjazz » Mon Jan 09, 2017 1:17 pm

nisiprius wrote:Since I don't follow much of the financial press except as it pops up in Bogleheads, does someone happen to know why oh why oh why we are suddenly seeing so much about consumer staples? There are eleven sectors, and you'd expect them to be fairly different from each other, and I've no doubt that the past performance of the best sector has been much better than the past performance of the worst sector, but... so what?

1) Consumer Staples turned in a dramatic performance in 2008-2009, by dropping much less than stocks in general (which accounts for most of the superiority in recent data), but that was eight years ago... so why are we hearing so much about it now? (Or is it just me?)

2) Why, exactly, don't you think investors are willing to pay as much for consumer staples stocks as they are worth?

As for "much less risky," Vanguard puts the Vanguard Consumer Staples Index Fund in its highest risk tier, 5, compared with 4 for broad-based funds like Total Stock Market, and says, "The fund’s main risk is its narrow scope—it invests solely in consumer staples stocks. An investor should expect high volatility from the fund, which should be considered only as a small portion of an already well-diversified portfolio."

Image

Larry Swedroe has written:
In 'The Quest for Alpha,' p. 156, Larry Swedroe wrote:#17: Owning individual stocks and sector funds is more akin to speculating, not investing. The market compensates investors for risks that cannot be diversified away, like the risk of investing in stocks versus bonds. Investors shouldn't expect compensation for diversifiable risk--the unique risks related to owning one stock or sector or country fund. Prudent investors only accept risk for which they will be compensated with higher expected returns.


Fear of politics stuff - there is a belief cut might be less for things people might need

Healthcare is an unknown - biotech is dependent on people moving and trade etc etc

Same reason it seems like there is more talk of gold
Interesting how gold (the ultimate in useless) and staples seem to go together
G.E. Box "All models are wrong, but some are useful."

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Re: Lazy Portfolio with Sector Funds

Postby lack_ey » Mon Jan 09, 2017 1:37 pm

nisiprius wrote:Since I don't follow much of the financial press except as it pops up in Bogleheads, does someone happen to know why oh why oh why we are suddenly seeing so much about consumer staples? There are eleven sectors, and you'd expect them to be fairly different from each other, and I've no doubt that the past performance of the best sector has been much better than the past performance of the worst sector, but... so what?

1) Consumer Staples turned in a dramatic performance in 2008-2009, by dropping much less than stocks in general (which accounts for most of the superiority in recent data), but that was eight years ago... so why are we hearing so much about it now? (Or is it just me?)

2) Why, exactly, don't you think investors are willing to pay as much for consumer staples stocks as they are worth?

As for "much less risky," Vanguard puts the Vanguard Consumer Staples Index Fund in its highest risk tier, 5, compared with 4 for broad-based funds like Total Stock Market, and says, "The fund’s main risk is its narrow scope—it invests solely in consumer staples stocks. An investor should expect high volatility from the fund, which should be considered only as a small portion of an already well-diversified portfolio."

This is another case where I would take Vanguard's personal investors website's risk-o-meter as likely wrong (here also the product summary on the mutual fund, which is for whatever reason different from the points given on the ETF page) and probably not thought out by anybody who particularly knows something at Vanguard.

By the way, even if you exclude 2008-2009, consumer staples has been less volatile than the rest of the market.
end 1998 - end 2007
start 2010 - present

It's historically significantly lower beta than the rest of the market (utilities also low). Also for reasons that follow economically. Though in these cases the lower beta is more from the performance not really lining up with the market, rather than vol being that low.

In any case, it seems difficult to me to justify putting all the sectors on the same risk 5/5, and Vanguard has some explaining to do with regards to expecting high volatility.


It's also a terrible investment plan to do anything like what the OP suggested and make such a strong single-sector bet, and all else equal you shouldn't expect equivalent or similar returns when you're taking less market beta. There's a lot of in-theory uncompensated risk. Never mind long-term Treasury zeroes. I think these points are covered in previous posts, though, so I don't have anything to add on that front.

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Sector Funds vs.The Three-Fund Portfolio

Postby Taylor Larimore » Mon Jan 09, 2017 2:35 pm

Hi Taylor,

I wanted something that tracked the entire stock market. I guess VTI is a good one. I noticed that VDC correlates well with VTI, but seems much less volatile -- I'm sure there are others besides VDC that do the same. Then I wanted something not correlated with the market, so I came up with a long term treasury. Ergo VDC and EDV.

Regards,
Robert

Robert:

Thank you for your reply.

When I am undecided, I listen to our great mentor, Jack Bogle (who knows more about investing than any of us):

"You could go your entire life without ever owning a sector fund and probably never miss it." -- "Don't look for the needle. Buy the haystack."


Consider The Three-Fund Portfolio

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Lazy Portfolio with Sector Funds

Postby CaliJim » Mon Jan 09, 2017 3:10 pm

I agree with Taylor and Nisi .... and also...

I believe in the weak version of the efficient market hypothesis: the stock market is mostly efficient (risk and reward to hand in hand) and there may be inefficiencies in the market over short periods of time, but these inefficiencies are very difficult to capture.

I also believe it takes pretty much all sectors working together to make the economy work. Over long periods of time...no one sector is better than another. Investing in sectors increases non-systemic risk without increasing expected return.

This is my belief and I offer no substantiation other than that if there was more money to be made in one sector over another at the same level of risk, arbiters will in time erase the difference.

As a result.... I don't believe investing in sectors is worthwhile.

(I'm also not quite so sure about small and value... even though I tilt to small and value a tiny bit, for historical reasons.... but that is a topic for another thread.)
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Re: Lazy Portfolio with Sector Funds

Postby nisiprius » Mon Jan 09, 2017 3:11 pm

lack_ey wrote:...This is another case where I would take Vanguard's personal investors website's risk-o-meter as likely wrong (here also the product summary on the mutual fund, which is for whatever reason different from the points given on the ETF page) and probably not thought out by anybody who particularly knows something at Vanguard.... By the way, even if you exclude 2008-2009, consumer staples has been less volatile than the rest of the market....

It's also a terrible investment plan to do anything like what the OP suggested and make such a strong single-sector bet...
Which is it? You suggest that Vanguard's risk categorization is wrong, and that in fact this sector is less risky than the rest of the market... just as robtkatz believes. But then you turn around and say it is "a terrible thing to make such a strong single-sector bet." Why is it a terrible thing... unless you believe that Vanguard is right and that any single-sector bets are riskier than the total market, even consumer staples?
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Re: Lazy Portfolio with Sector Funds

Postby TJSI » Mon Jan 09, 2017 3:39 pm

The Vanguard paper said: " An investor should expect high volatility from the fund."

Wow, they are living in a different universe. Consumer Staples is a low volatility sector and as a defensive investment is not bad. And there is a lot of research that over long periods, low volatility stocks outperform the market. So if you want something a bit conservative with a decent chance of matching or beating the market over time, consumer staples is a good choice.


TJSI

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Re: Lazy Portfolio with Sector Funds

Postby Ethelred » Mon Jan 09, 2017 4:16 pm

TJSI wrote:And there is a lot of research that over long periods, low volatility stocks outperform the market.

There is? Can you link to some of that research? Because that's directly the opposite of what is generally expected from the "risk premium".

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Re: Lazy Portfolio with Sector Funds

Postby lack_ey » Mon Jan 09, 2017 4:43 pm

nisiprius wrote:
lack_ey wrote:...This is another case where I would take Vanguard's personal investors website's risk-o-meter as likely wrong (here also the product summary on the mutual fund, which is for whatever reason different from the points given on the ETF page) and probably not thought out by anybody who particularly knows something at Vanguard.... By the way, even if you exclude 2008-2009, consumer staples has been less volatile than the rest of the market....

It's also a terrible investment plan to do anything like what the OP suggested and make such a strong single-sector bet...
Which is it? You suggest that Vanguard's risk categorization is wrong, and that in fact this sector is less risky than the rest of the market... just as robtkatz believes. But then you turn around and say it is "a terrible thing to make such a strong single-sector bet." Why is it a terrible thing... unless you believe that Vanguard is right and that any single-sector bets are riskier than the total market, even consumer staples?

Okay, there are a few issues here, some of which are the fault of my explanation before.

1. I did not say that consumer staples is less risky than the market. I said it was less volatile (which is a bit more specific) than the rest of the market (which refers to the market ex-consumer staples, though the statement is fine referring to the whole market as well, as there's not a ton of difference between those two). Futhermore, there is a difference in tense. I was referring to a past result, more narrowly framed, supported by historical return data.

2. Though not explicitly mentioned there, I did not mean to imply that the difference in vol between consumer staples and the market was significant enough to predict in the future that definitely it will be meaningfully less volatile (or risky or anything). Vanguard's position there, which you're citing, is that consumer staples deserves a 5/5 risk rating. My position is that 5/5 is wrong—I would suggest 4/5 as closer, as clunky as these whole numbers are and as potentially not-really-all-that-well-defined the scale is about. I'm absolutely not making a case for 3/5.

3. As far as I can tell, Vanguard's risk scale is effectively rating shallow risk, short-term (1 year, something like that) volatility, or something similar. Otherwise, their ratings make even less sense. After all, if they're looking at performance over multiple decades, I would think the stock funds would be safer in some senses than the bond funds, having greater dispersion of outcomes but a large majority being better than a large majority of the possible bond returns. For that matter, for a longer timescale, the intermediate-term bond funds should probably be better than the short-term bond funds, less likely to do poorly. However, when you do asset allocation for the long term, you should be interested in deep risk and longer-term considerations, not just volatility. Therefore a judgment about Vanguard's risk rating uses different criteria than a judgment about characteristics and suitability for long-term portfolio construction.

4. In a reasonably efficient market we expect that each sector should probably have worse ex-ante risk/return characteristics than the market as a whole. After all, a single sector is significantly less diversified, evidenced by economic fundamentals as well as the covariances of actual returns. As such to cast away all other sectors is to take uncompensated risk. If a sector is similarly volatile as the total market, it probably should have an expected return lower than the market (okay, there may be some low vol anomaly/effect in play as well to at least some degree). But as above, it goes beyond volatility. We really don't know what to expect or have any good estimates at expected return for different sectors. It could well be that the long-term trajectory for consumer staples is relatively similar vol but significantly lower return than the market. Maybe it's better than that; maybe it's even worse. In any case, it's not a good bet in my opinion and not one to take lightly.

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Re: Lazy Portfolio with Sector Funds

Postby smartinwate » Mon Jan 09, 2017 4:57 pm

nisiprius wrote:Since I don't follow much of the financial press except as it pops up in Bogleheads, does someone happen to know why oh why oh why we are suddenly seeing so much about consumer staples?


Just a guess, I'd say it's because we're seeing so much more noise in the financial press about " :( The :( Impending :( Recession :( ", and because historically Consumer Staples has done well during recessions (people gotta eat, even if they can't afford their iPhones).
TANSTAAFL

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Re: Lazy Portfolio with Sector Funds

Postby lack_ey » Mon Jan 09, 2017 5:00 pm

Ethelred wrote:
TJSI wrote:And there is a lot of research that over long periods, low volatility stocks outperform the market.

There is? Can you link to some of that research? Because that's directly the opposite of what is generally expected from the "risk premium".

There are a few different formulations and it really depends on which data you look at, but in the very least people have noticed that low volatility (or low beta, which is not the same but at least related) parts of the market tend to have better risk/return than high volatility (or high beta) parts of the market.

In some periods you see the low vol stuff beating the market outright; in other investigations perhaps just better risk/return.

This kind of goes back to old papers by Fischer Black in 1972 but has gained a lot more interest in the last several years or so, with plenty of ETFs designed around this concept available. There's been additional research extending beyond stocks into other assets as well.

Short wiki page:
https://en.wikipedia.org/wiki/Low-volatility_anomaly

Here is one list of references for the category:
https://www.aqr.com/library/bibliograph ... strategies

A few fairly recent papers:
http://rnm.simon.rochester.edu/research/UDE.pdf
https://www.aqr.com/library/journal-art ... mispricing
https://papers.ssrn.com/sol3/papers.cfm ... id=2055431

Some others don't really see much to this formulation and interpret low vol at least in stocks as a combination of other factors like value, size, etc.; low vol as an explanatory tool doesn't contribute all that much more if you already consider other things.

Low volatility has been heavily discussed prior so you can search the forum as well. A related concept is minimum volatility strategies/funds, which instead of owning purely the low vol stocks within a market, try to take advantage of estimated correlations between stocks to choose a combination that has as low a vol as possible (this will end up meaning a higher exposure to low vol stocks but won't use them exclusively). Most min vol formulations intended to be investable tend to be constrained in terms of individual security weightings, sector weightings, etc. so as to not deviate too heavily from the market (reducing tracking error) while still ending up with a relatively low volatility overall. Vanguard runs such a fund, and there are ETFs in the space too.

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Re: Lazy Portfolio with Sector Funds

Postby patrick013 » Mon Jan 09, 2017 5:10 pm

I think most investors would agree Staples and Utilities are
defensive sectors. Ticker XLU - Utilities right now has a
PE 15.26 and Dividend Yield of 4.37% and beta of .22

Consumer Discretionary is considered a new business cycle
favorite and Energy can be the last place for the quest for
gains in an old business cycle.

But in buy-and-hold Utilities has good characteristics IMO
and the Financial sector is determined to disappoint in the
future to some extent.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Lazy Portfolio with Sector Funds

Postby CaliJim » Mon Jan 09, 2017 5:11 pm

People got to eat, but they'll also buy low profit margin foods in a recession - rice and beans.
Utilities are subject to disruption from technology.

All I want to say now is that humans are very good at finding patterns where non really exist - constellations in the stars - that sort of thing.

"It is tough to make predictions, especially about the future. " -yogi
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Re: Lazy Portfolio with Sector Funds

Postby TJSI » Mon Jan 09, 2017 5:44 pm

Ethelred asked : "Can you link some of that research?"

A good study by Ibbotson & Kim (Jan 2016) is " "Risk & Return Within the Stock Market: What Works Best? "

Another reference is: "The Low-Volatility Effect: A Comprehensive Look"

(http://us.spindices.com/documents/resea ... 201208.pdf)

As lack_ey said : Type in Low Volatility in the Boglehead search and you will find lots of good reading.

TJSI

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Re: Lazy Portfolio with Sector Funds

Postby nisiprius » Mon Jan 09, 2017 6:00 pm

Ethelred wrote:
TJSI wrote:And there is a lot of research that over long periods, low volatility stocks outperform the market.

There is? Can you link to some of that research? Because that's directly the opposite of what is generally expected from the "risk premium".
Yes, there are indeed claims that low volatility stocks have outperformed the market. Verb-tense disease, verb-tense disease: I don't think it's possible that an honest academic would say that low volatility stocks do outperform the market, rather than that they have done so.

I think the big honcho academic behind them is named Haugen? Yep...
(Wikipedia) "Low-volatility anomaly."
Shortly after, Robert Haugen and A. James Heins produced a working paper titled “On the Evidence Supporting the Existence of Risk Premiums in the Capital Market”. Studying the period from 1926 to 1971, they concluded that "over the long run stock portfolios with lesser variance in monthly returns have experienced greater average returns than their ‘riskier’ counterparts."
I, too, find it hard to believe. You don't need to be a mystic about the efficient market to wonder why people wouldn't be willing to pay more for lower volatility.
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Re: Lazy Portfolio with Sector Funds

Postby nisiprius » Mon Jan 09, 2017 6:11 pm

lack_ey wrote:...3. As far as I can tell, Vanguard's risk scale is effectively rating shallow risk, short-term (1 year, something like that) volatility, or something similar...
Although I have no idea how Vanguard determines them, I agree with you that in all likelihood it is a very simplistic categorization. They decided to "put sector funds at 5." Unlike you I think this is a useful thing to do. As to what they mean by the ratings, they say so explicitly, click on the line "How the potential for risk affects your investment," which is a link although they don't make it obvious. The language is carefully weasel-worded. The purpose of the ratings is not to measure anything quantitative, but to "help you select an appropriate fund for your investing needs.
The potential for risk in Vanguard funds can be categorized in levels from 1 to 5. Knowing the risk level you're comfortable with and the length of time you expect to invest can help you select an appropriate fund for your investing needs.

Conservative funds—Risk level 1
Vanguard funds are classified as conservative if their share prices are expected to remain stable or to fluctuate only slightly. Such funds may be appropriate for the short-term reserves portion of a long-term investment portfolio, or for investors with short-term investment horizons (three years or less).

Conservative to moderate funds—Risk level 2
Vanguard funds classified as conservative to moderate are subject to low-to-moderate fluctuations in share prices. In general, such funds may be appropriate for investors with medium-term investment horizons (four to ten years).

Moderate funds—Risk level 3
Vanguard funds classified as moderate are subject to a moderate degree of fluctuation in share prices. In general, such funds may be appropriate for investors who have a relatively long investment horizon (more than five years).

Moderate to aggressive funds—Risk level 4
Vanguard funds of this type are broadly diversified but are subject to wide fluctuations in share price because they hold virtually all of their assets in common stocks. These funds may be appropriate for investors who have a long-term investment horizon (ten years or longer).

Aggressive funds—Risk level 5
Vanguard funds classified as aggressive are subject to extremely wide fluctuations in share price. These funds may be appropriate for investors who have a long-term investment horizon (ten years or longer). The unusually high volatility associated with these funds may stem from a number of strategies.
(Shrug) Both levels 4 and 5 represent funds that "may be appropriate" for investors who plan to hold for "ten years or longer," but "level 4" has "wide" fluctuations and "level 5" has "very wide fluctuations."

I think I see indications that Vanguard tries to act as a nanny by trying to discourage ordinary retail investors from investing in certain funds, such as the sector funds and Market Neutral, using the risk levels and the minimum investment. You'll notice the sector funds are only available as Admiral Shares, for example.
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Re: Lazy Portfolio with Sector Funds

Postby lack_ey » Mon Jan 09, 2017 6:28 pm

If nothing else I think it would be bad "politics" to slap different ratings for different sectors, even though consumer staples and utilities probably should be more a 4 than a 5. People would take it the wrong way or draw conclusions or do things they shouldn't.

nisiprius wrote:I think I see indications that Vanguard tries to act as a nanny by trying to discourage ordinary retail investors from investing in certain funds, such as the sector funds and Market Neutral, using the risk levels and the minimum investment. You'll notice the sector funds are only available as Admiral Shares, for example.

If this is the case and the assessment is knowingly biased or possibly intentionally misrepresented with these other considerations in mind (out of a sense of protecting investors), then doesn't it mean that the ratings shouldn't be cited to make your own points as accurate indications of risk? I mean, if you think Vanguard is putting its thumb on the scale to make a point, regardless of whether or not you believe in their point, don't cite the readings from the scale.

The way I see it based on the above, it's more an indication of "Vanguard thinks you should be more wary of this" than "this fund will actually have higher fluctuations than that other fund."

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Re: Lazy Portfolio with Sector Funds

Postby robtkatz » Tue Jan 10, 2017 7:23 pm

On a scale of 1-5, Morningstar assesses VTI with a Return of 4 and a Risk of 3. For VDC the numbers are a Return of 4 and a Risk of 2.

In the market depression of Nov 2007 to Feb 2009, a portfolio composed of 40% VTSMX (Vanguard Total Stock Market Index Fund), 40% VBMFX (Vanguard Total Bond Market Index Fund), and 20% VGTSX (Vanguard Total International Stock Index Fund) lost about 32.50%, enough to make me panic and look for something less risky.

Maybe the less capitalist the economy, the more unreliable the markets? Maybe it makes sense to avoid foreign markets altogether?

Maybe a sensible portfolio design greatly depends on whether one covers expenses with income outside the portfolio or whether one regularly draws down from the portfolio?

Maybe it makes sense to set up retirement so regular income is generated outside the portfolio?

Maybe it makes sense to set up a not-used-for-income retirement portfolio with 100% of the assets in VTI (and rebalance yearly :happy)?

Maybe the old adages about retirement income and portfolio design ought to be considered more carefully?

If there's a needle in a haystack; and the needle doesn't get any bigger, but the haystack keeps getting bigger and bigger (without limit), maybe one shouldn't buy the haystack?

I don't know the answers, but maybe this is a more difficult problem than first thought.

Thanks to all for your input.
Robert

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Re: Lazy Portfolio with Sector Funds

Postby Ethelred » Tue Jan 10, 2017 7:30 pm

Thanks very much to everyone who replied to me in this thread. I glanced through the "Comprehensive Look" paper and it looks interesting. I've bookmarked it, and I'll read through when I have a free hour or so.

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Re: Lazy Portfolio with Sector Funds

Postby rkhusky » Tue Jan 10, 2017 9:11 pm

Ethelred wrote:
TJSI wrote:And there is a lot of research that over long periods, low volatility stocks outperform the market.

There is? Can you link to some of that research? Because that's directly the opposite of what is generally expected from the "risk premium".

Volatility does not equal risk. They may be somewhat correlated, but they are not the same thing.

And rather than investing in one sector, perhaps investing equally (or is some other fixed proportion) in all of them and rebalancing would be interesting, if the ER for the sector funds is not too high.

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Taylor Larimore
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Adjusting Risk in The Three-Fund Portfolio

Postby Taylor Larimore » Tue Jan 10, 2017 10:54 pm

robtkatz:

Welcome to the Bogleheads forum!
robtkatz wrote: In the market depression of Nov 2007 to Feb 2009, a portfolio composed of 40% VTSMX (Vanguard Total Stock Market Index Fund), 40% VBMFX (Vanguard Total Bond Market Index Fund), and 20% VGTSX (Vanguard Total International Stock Index Fund) lost about 32.50%, enough to make me panic and look for something less risky. ---- `I don't know the answers, but maybe this is a more difficult problem than first thought.

robtkatz:

It is not a "difficult problem." The Three-Fund Portfolio is made "less risky" by simply increasing its bond allocation.

A general rule of thumb is that a portfolio should expect to decline in a bad bear market at least 50% of its stock allocation.

In other words, a 50% stock/50% bond portfolio might be expected to decline about 25%. This is similar to the figures you quoted.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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nedsaid
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Re: Lazy Portfolio with Sector Funds

Postby nedsaid » Tue Jan 10, 2017 11:43 pm

robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert


Robert, I would suggest you check out Larry Swedroe's threads and posts on Low Volatility stocks. Did some checking.

Check out this thread:

viewtopic.php?t=196563

Pretty much, consumer staples are an important component of the low volatility stocks. My concern is that you are piling into a sector that a whole of other people have piled into also. In other words, these type of stocks have been very popular the last few years and this might not be the best time to buy them. Larry believes that such stocks are growthy right now.

Larry Swedroe said:
Turns out that going back to 1920s low vol (volatility) is growthy about 40% of time and valuey about 60% of time. When it's valuey it outperforms market by 2.2% with 3% less SD(standard deviation), the holy grail if you will When it's growthy it UNDERPERFORMS market by 1.4% though with 5% less SD(standard deviation).
A fool and his money are good for business.

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Re: Adjusting Risk in The Three-Fund Portfolio

Postby robtkatz » Wed Jan 11, 2017 1:37 am

Taylor Larimore wrote:robtkatz:

Welcome to the Bogleheads forum!
robtkatz wrote: In the market depression of Nov 2007 to Feb 2009, a portfolio composed of 40% VTSMX (Vanguard Total Stock Market Index Fund), 40% VBMFX (Vanguard Total Bond Market Index Fund), and 20% VGTSX (Vanguard Total International Stock Index Fund) lost about 32.50%, enough to make me panic and look for something less risky. ---- `I don't know the answers, but maybe this is a more difficult problem than first thought.

robtkatz:

It is not a "difficult problem." The Three-Fund Portfolio is made "less risky" by simply increasing its bond allocation.

A general rule of thumb is that a portfolio should expect to decline in a bad bear market at least 50% of its stock allocation.

In other words, a 50% stock/50% bond portfolio might be expected to decline about 25%. This is similar to the figures you quoted.

Best wishes.
Taylor


Hi Taylor,

The tough thing to withstand is a big drop in a portfolio that's used to provide income. If income is provided independently -- business, work, annuity, etc-- then I'd go 100% in VTI.

I like that rule of thumb. If the Nov '07 to Feb '09 were composed of 50% VTSMX, 50% VBMFX, and 0% VGTSX, the loss would have been about 25%, as you said.

Of course, a single example doesn't prove anything, but I'm still thinking its a mistake to appropriate any portion to the Total International Stock Index.

Regards,
Robert

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Re: Lazy Portfolio with Sector Funds

Postby robtkatz » Wed Jan 11, 2017 1:48 am

nedsaid wrote:
robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert


Robert, I would suggest you check out Larry Swedroe's threads and posts on Low Volatility stocks. Did some checking.

Check out this thread:

viewtopic.php?t=196563

Pretty much, consumer staples are an important component of the low volatility stocks. My concern is that you are piling into a sector that a whole of other people have piled into also. In other words, these type of stocks have been very popular the last few years and this might not be the best time to buy them. Larry believes that such stocks are growthy right now.

Larry Swedroe said:
Turns out that going back to 1920s low vol (volatility) is growthy about 40% of time and valuey about 60% of time. When it's valuey it outperforms market by 2.2% with 3% less SD(standard deviation), the holy grail if you will When it's growthy it UNDERPERFORMS market by 1.4% though with 5% less SD(standard deviation).


Hi Ned,

Thanks for the references. And here I thought I was the only one to hook onto VDC :happy. Really, I haven't looked around much yet. I think VDC is unique. I don't think any of the other 10 Vanguard Sector ETFs would do the same trick, not even VHT, the Health Care ETF.

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Re: Lazy Portfolio with Sector Funds

Postby freyj6 » Wed Jan 11, 2017 4:19 pm

Personally I think consumer staples (VDC) is a really interesting fund.

I held it for a year or so from July or August 2015 to mid-July 2016 and was obviously very happy with it. I had planned to hold it as a long-term investment (10-15% of portfolio) but there was so much buzz around VDC, VPU, VNQ and other dividend type indexes last summer that I didn't want to be part of that mess. I still think it's quite expensive, but I'd like to buy back in at some point.

Why staples?

Well, despite what the vanguard website says it's extremely stable for a stock index. It also tends to do particularly well in bear markets -- people still need toilet paper and groceries.

The fact that it's been the highest returning stock index for the past 50 years is nice, but like others have said, who knows if that will continue. But on a risk adjusted basis, I'd expect higher returns from VDC than, say, 75% in a more volatile index and 25% in bonds.

Personally I think it's still too expensive though because of the rush to dividends this last year.

EDV... be careful. A small hike in interest rates means EDV loses a big chunk of money.

Cheers

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Re: Lazy Portfolio with Sector Funds

Postby lack_ey » Wed Jan 11, 2017 4:45 pm

nedsaid wrote:
robtkatz wrote:Has anyone looked at using sector funds ETFs instead of general market ETFs in designing lazy portfolios? It seems that VDC (Vanguard Consumer Staples ETF) might be as robust as VTI, but much less risky. In particular, I was looking at this two fund ETF portfolio: 75% VDC(Vanguard Consumer Staples ETF), 25% EDV (Vanguard Extended Duration Treasury).

Thank you,
Robert


Robert, I would suggest you check out Larry Swedroe's threads and posts on Low Volatility stocks. Did some checking.

Check out this thread:

viewtopic.php?t=196563

Pretty much, consumer staples are an important component of the low volatility stocks. My concern is that you are piling into a sector that a whole of other people have piled into also. In other words, these type of stocks have been very popular the last few years and this might not be the best time to buy them. Larry believes that such stocks are growthy right now.

Larry Swedroe said:
Turns out that going back to 1920s low vol (volatility) is growthy about 40% of time and valuey about 60% of time. When it's valuey it outperforms market by 2.2% with 3% less SD(standard deviation), the holy grail if you will When it's growthy it UNDERPERFORMS market by 1.4% though with 5% less SD(standard deviation).

I think you may be overselling the connection between low volatility funds/research and consumer staples.

For example, one of the more popular low volatility funds is Powershares S&P 500 Low Volatility Portfolio (SPLV), which just owns the 100 stocks in the S&P 500 with low vol over the past year. This is only 17.5% consumer defensive (i.e. staples, consumer non-cyclical), according to Morningstar, compared to 9.4% for the plain S&P 500.

In other words, you should not use low vol to understand consumer staples, as they are not the same thing. I think it's more that most other sectors contain more volatile stocks, rather than the lowest volatility stocks overall being heavily consumer staples. That's what makes the consumer staples sector less volatile than other sectors.

For reference, these are the top holdings in Vanguard's consumer staples fund:

Image

That's a considerable concentration in the top and probably are the names you expect (well, you may or may not have expected the retailers there too).

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Re: Lazy Portfolio with Sector Funds

Postby nedsaid » Wed Jan 11, 2017 5:20 pm

Lack_ey, my thesis was that Low Volatility is overvalued and that Consumer Staples is also overvalued. Just cautioning the original poster that chasing recently hot asset classes might not be a good idea. So let's check it out. This is today's data from Morningstar.

Fidelity Total Market Index Fund
Forward P/E 19.67
Price/Book 2.58
Price/Sales 1.75
Price/Cash Flow 9.86
Dividend Yield 2.17%

Powershares S&P 500 Low Volatility Portfolio
Forward P/E 19.23
Price/Book 3.11
Price/Sales 1.98
Price/Cash Flow 11.12
Dividend Yield 2.65%

Vanguard Consumer Staples Index
Forward P/E 20.60
Price/Book 4.20
Price/Sales 1.18
Price/Cash Flow 13.96
Dividend Yield 2.72%

Yep, I was right. Consumer Staples looks expensive, even more expensive than Low Volatility and the US Total Stock Market. The stat that is the lone exception is Price/Sales.

Lack_ey, your comments about Consumer Staples being only a part of low volatility were correct. They are not the same, one is a subset of another. Both Low Volatility and Consumer Staples have higher than market dividend yields, my suspicion is that with rising interest rates that both will underperform the broad market. Just advising caution here.
A fool and his money are good for business.

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Re: Lazy Portfolio with Sector Funds

Postby nedsaid » Wed Jan 11, 2017 5:38 pm

One reason I am tuned into this issue is that I recently purchased shares of Coca-Cola. It is the ultimate consumer products stock. This is a stock that I have wanted to own for years, like Jimmy Carter I had lust in my heart, but lust in my heart for stocks. I looked at the valuation ratios and Coke certainly doesn't sell at a bargain price. I did some thinking and hemming and hawing over this, finally I just plunged in and bought. A quality stock like Coke is just never cheap. Warren Buffett also owns a lot of Coke too.
A fool and his money are good for business.

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Re: Lazy Portfolio with Sector Funds

Postby TJSI » Thu Jan 12, 2017 12:25 am

nedsaid,

Isn't everything overvalued due to low interest rates? Are consumer staples more, less, or about the same overvalue as the market?

Is there a Shiller P/E for consumer staples? Might be interesting to find out.

TJSI

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Re: Lazy Portfolio with Sector Funds

Postby nedsaid » Thu Jan 12, 2017 9:56 pm

TJSI wrote:nedsaid,

Isn't everything overvalued due to low interest rates? Are consumer staples more, less, or about the same overvalue as the market?

Is there a Shiller P/E for consumer staples? Might be interesting to find out.

TJSI


Cash flows become more valuable as interest rates drop. If you have a bond with a 4% coupon and rates drop to 3%, the market will pay more for your bond. This works to a degree with stocks, too. Lower interest rates tend towards higher P/E's and higher stock prices but not necessarily. So I wouldn't say that low interest rates have caused stocks to be overvalued. What I will say is that stocks are not cheap, but what do you expect after a seven year bull market?

Consumer staples tend to have higher dividend yields than the market and I think that part of it is flight to safer, less volatile stocks and part of the high prices is yield chasing. I am cautioning that consumer staples are expensive relative to the market as a whole. If people originally bought these sort of as a bond substitute, as interest rates go back up, people will go back to real bonds and not substitute bonds.

Coke was not cheap. Pretty much held my nose and bought anyways hoping that it will work out long term. I can always blame it on Buffett if things go wrong. It wasn't a big position anyway.
A fool and his money are good for business.


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