What do you expect to achieve with your Tilt?

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sean.mcgrath
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What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sat Mar 11, 2017 3:27 pm

Hi all,

So I've been reading the famous Fama and French out of pure curiosity. In principle I can buy the idea that a reasonable risk/return model could have more than one variable, and that Value and Size might significantly improve the predictive behavior of the model. However, when I estimate how it would work for my own case, part of me asks "is it worth the bother." Here's how I see it for me:

Comfort with risk: 20% Std dev (by pure coincidence, 100% stocks)
Expected equity premium: 7.9%

Now if I stick with my 20% Std dev, I calculate an optimal Tilt (80% stocks, 0.1, 0.8) which gets me an equity premium of 9.6%. Good.

However, there's a fair amount of sensitivity around those numbers of 0.1 and 0.8; it's also not easy to hit them exactly; it would also mean higher ER and more complexity. Plus I don't 100% believe that Value and Size, even if real risks, won't revert to the mean at least a bit as more people know about them, so I'd be tempted to keep part of my portfolio the old way. Put all that together, and I suspect my new expected equity premium would be something like 8.4%. I get that 1/2% is a lot over time, but is it really worth it?

So my question. If you tilt, could you fill out for your portfolio:

Expected std dev [or any other measure of volatility]:
Expected equity premium:

I'm trying to figure out whether Tilters have higher expectations than I, or are more willing to do the extra work for 0.5%.

cheers,
Sean
Last edited by sean.mcgrath on Sun Mar 12, 2017 4:46 pm, edited 1 time in total.

livesoft
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Re: What do you expect to achieve with your Tilt?

Post by livesoft » Sat Mar 11, 2017 3:32 pm

I'm expecting to beat the Vanguard LifeStrategy Moderate Growth fund performance by about 1% on average over the years. I'm also expecting to beat the tilted DFA Global Allocation 60/40 Portfolio Institutional Class mutual fund as well, but by a lesser percentage.

I don't know about standard deviation because it is probably too much work for me to figure out.

Is 1% worth it? On a large portfolio it is.
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Re: What do you expect to achieve with your Tilt?

Post by billyv » Sat Mar 11, 2017 4:35 pm

Plus I don't 100% believe that Value and Size, even if real risks, won't revert to the mean at least a bit as more people know about them


I've seen variations on this statement in a number of threads devoted to value stocks and/or tilts. I think there may be some truth to it, but only up to a point. If everyone employed a long-term buy-and-hold strategy tilting toward small and/or value stocks, then the so-called "value premium" might well disappear, or at least become as scarce as Bigfoot. But of course not everyone invests that way. At any given time, many investors are chasing down the latest fads in tech stocks, quant funds, reverse-hedged Samoan debt and the like. Some people might even be invested in growth stocks! (I know, crazy right?) Thus, when small-caps and value funds finally have their moment in the sun, only those lucky few who were already invested, and who were disciplined enough to stay the course, will reap the full benefit.

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Re: What do you expect to achieve with your Tilt?

Post by dbr » Sat Mar 11, 2017 4:51 pm

This thread is not accumulating many actual answers, so I will supply a baseline data point. My tilt is zero. I expect to achieve and do achieve exactly zero increment in either return or standard deviation over a blend of total US and total international stock market indices. I have no tracking error.

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Re: What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sat Mar 11, 2017 5:09 pm

livesoft wrote:I'm expecting to beat the Vanguard LifeStrategy Moderate Growth fund performance by about 1% on average over the years. I'm also expecting to beat the tilted DFA Global Allocation 60/40 Portfolio Institutional Class mutual fund as well, but by a lesser percentage.

I don't know about standard deviation because it is probably too much work for me to figure out.

Is 1% worth it? On a large portfolio it is.


This one I don't understand, livesoft. If you can expect an additional 1%, you must be making some assumption about volatility -- otherwise you could just move your 60/40 to 70/30 and get a higher expected return.


billyv wrote:If everyone employed a long-term buy-and-hold strategy tilting toward small and/or value stocks, then the so-called "value premium" might well disappear, or at least become as scarce as Bigfoot. But of course not everyone invests that way.


I actually can believe it won't disappear, as it seems to add real volatility that is paid for, but indeed the premium could shrink as it becomes popular.

dbr wrote:This thread is not accumulating many actual answers, so I will supply a baseline data point. My tilt is zero. I expect to achieve and do achieve exactly zero increment in either return or standard deviation over a blend of total US and total international stock market indices. I have no tracking error.


Lol, thanks dbr -- at least I have some data for my research. :happy

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Re: What do you expect to achieve with your Tilt?

Post by livesoft » Sat Mar 11, 2017 5:51 pm

sean.mcgrath wrote:This one I don't understand, livesoft. If you can expect an additional 1%, you must be making some assumption about volatility -- otherwise you could just move your 60/40 to 70/30 and get a higher expected return.

What you wrote is so true. Except that 70/30 would not give 1% better return. This can be seen by looking at the returns of LS Moderate Growth (VSMGX, 60/40) and LS Growth (VASGX, 80/20) which are shown by morningstar.com:

Image

One can see that the 3-year, 10-year, and 15-year average annual returns differ by less than 1%. That suggests that one has to do something else besides just changing asset allocation just as you surmise. One can also see that the small-cap and value-tilted DGSIX has its own problems.
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Re: What do you expect to achieve with your Tilt?

Post by willthrill81 » Sat Mar 11, 2017 6:41 pm

Over the last 47 years, portfolios with my tilt toward MCV, SCB, and SCV have earned about 2.4% over the TSM. But honestly, if 'all' I got were the returns of the S&P 500 over that time frame, I would be very, very happy. :D

So for those economists and those who drink their Kool-Aid who say that equities will earn 4% real over the next decade, if history holds true at all, I should earn close to 6.5%. But the future may look very different from the past.

I see little reason not to tilt a portfolio in favor of asset classes that have a long and fruitful history of outperforming the S&P 500. Even when they have failed to outperform it, their are usually at least about on par. There are some exceptions, but they are just that.
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Re: What do you expect to achieve with your Tilt?

Post by Johnnie » Sat Mar 11, 2017 6:51 pm

sean.mcgrath wrote:...I get that 1/2% is a lot over time, but is it really worth it?

It is more complicated. I just started doing it 18 months ago, and just discovered boglehead style investing through it.

Obviously whether this or Strict Rules of Bogle outperforms will be known only in the fullness of time, so we're throwing darts blindfolded. (We're real close to the board though. :happy )

If it might tweak my odds a tad, and might deliver an extra half-percent with no more risk, then it's worth it to me - but only because I kind of enjoy all the finoodling it requires, and am capable of doing it. When the market's going up I also enjoy watching the "cross-rates" between the different asset classes in my portfolio. (When it's going down I don't peek outside of rebalance time.)

I don't know if I'll still want to mess with it when I'm older and suspect the answer is no. But I'm good for more than 10 years yet. ("I think I'm getting better...")

If you don't enjoy having to periodically muck around with spreadsheets and mutual fund websites then it probably isn't worth it.
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Re: What do you expect to achieve with your Tilt?

Post by aristotelian » Sat Mar 11, 2017 8:40 pm

I recently added Consumer Staples (VDC). My goal there is not to outperform, but to reduce volatility. I am considering adding some sector ETFs more for TLH opportunities than for outperformance.

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Re: What do you expect to achieve with your Tilt?

Post by nisiprius » Sat Mar 11, 2017 9:51 pm

willthrill81 wrote:...Over the last 47 years, portfolios with my tilt toward MCV, SCB, and SCV have earned about 2.4% over the TSM...
A nit-pick, but not a completely trivial nit-pick. I don't believe anyone actually used a portfolio like that over the last 47 years, because the terms, theory, and concepts behind them were not developed or published until 1992. Without a time machine, nobody knew in 1970 what Banz published in 1981 and what Fama and French published in 1992.

So what you are talking about is hypothetical backtesting, and you should probably make a habit of phrasing it that way.

For example, according to Berkin and Swedroe, there is evidence that factor premia decline after they become widely known. Not entirely, but by perhaps 1/3rd or so after the papers describing them are published. So, not only did nobody know in 1970, but if everyone had known about the Fama and French work in 1970, the course of investing history would probably have changed a bit and some of the factor premia would have been arbitraged away.

It is also unclear just how you could have created a "portfolio with my tilt" in 1970, given that there were no index funds targeting these asset classes, in fact no index funds at all. Furthermore, this was the age of fixed commissions, and even the smallest stock purchases cost $100-$200 in commissions. Even if you had known what to do, you would have had to be very wealthy to do it. How many stocks do you think you would have needed to buy? The Vanguard Mid-Cap Value Index Fund holds 208 stocks. If you were paying, say, $150 commission on each one, that implies about $30,000 in commissions. In order to keep expenses down to, say, 0.5%, that implies an investment of at least $6 million to assemble the mid-cap value part of your portfolio alone.
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Re: What do you expect to achieve with your Tilt?

Post by willthrill81 » Sat Mar 11, 2017 10:28 pm

nisiprius wrote:
willthrill81 wrote:...Over the last 47 years, portfolios with my tilt toward MCV, SCB, and SCV have earned about 2.4% over the TSM...
A nit-pick, but not a completely trivial nit-pick. I don't believe anyone actually used a portfolio like that over the last 47 years, because the terms, theory, and concepts behind them were not developed or published until 1992. Without a time machine, nobody knew in 1970 what Banz published in 1981 and what Fama and French published in 1992.

So what you are talking about is hypothetical backtesting, and you should probably make a habit of phrasing it that way.

For example, according to Berkin and Swedroe, there is evidence that factor premia decline after they become widely known. Not entirely, but by perhaps 1/3rd or so after the papers describing them are published. So, not only did nobody know in 1970, but if everyone had known about the Fama and French work in 1970, the course of investing history would probably have changed a bit and some of the factor premia would have been arbitraged away.

It is also unclear just how you could have created a "portfolio with my tilt" in 1970, given that there were no index funds targeting these asset classes, in fact no index funds at all. Furthermore, this was the age of fixed commissions, and even the smallest stock purchases cost $100-$200 in commissions. Even if you had known what to do, you would have had to be very wealthy to do it. How many stocks do you think you would have needed to buy? The Vanguard Mid-Cap Value Index Fund holds 208 stocks. If you were paying, say, $150 commission on each one, that implies about $30,000 in commissions. In order to keep expenses down to, say, 0.5%, that implies an investment of at least $6 million to assemble the mid-cap value part of your portfolio alone.


All accurate.

It's true that it certainly would have been difficult if not practically impossible to implement such a portfolio, but my point is that's what the particular combination of asset classes I've invested in earned over that time frame. And even if a third of that advantage is non-existent going forward, I'll be ecstatic with that result.

And I'm sure that there were people since 1970 whose portfolios had a tilt very much like mine; they just did it with a relatively small number of individual stocks. Some performed better than average and some below, but the net result over all of that, minus commissions, still holds.

Depending on how you want to look at, whether someone could practically implement a portfolio doesn't necessarily mean that the portfolio doesn't exist theoretically. But that might be really nit-picky.
Last edited by willthrill81 on Sat Mar 11, 2017 10:30 pm, edited 1 time in total.
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Re: What do you expect to achieve with your Tilt?

Post by Random Walker » Sat Mar 11, 2017 10:29 pm

Improved portfolio efficiency: improved Sharpe ratio, cut tails by using tilt to decrease overall equity exposure, diversify across independent factors, overall improve portfolio efficiency.

Dave

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Re: What do you expect to achieve with your Tilt?

Post by AlohaJoe » Sat Mar 11, 2017 11:59 pm

I expect to reduce the length and depth of drawdowns during portfolio decumulation.

I don't think standard deviation is a useful metric for non-normal returns that exhibit kurtosis and skew and when upside volatility isn't a bad thing.

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Re: What do you expect to achieve with your Tilt?

Post by whodidntante » Sun Mar 12, 2017 12:03 am

I tilt to small and value and I also overweight EM. I expect to achieve greater risk and greater expected returns.

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Re: What do you expect to achieve with your Tilt?

Post by JoMoney » Sun Mar 12, 2017 12:30 am

My 'tilt' is owning the S&P 500 index rather than some broader 'global' market portfolio.
At a <.05% ER I expect to achieve lower expenses relative to the .11% ER on 'Total International' or 'Total World' fund
I expect further savings from the lack of foreign tax withholding on dividends.
I expect it will be very simple to maintain, with the only 'rebalancing' required being the amount of cash/bonds I want to hold.
I expect I'll sleep a little better not wondering what the implications are from various global currencies and their "race to debase", or feeling a need to understand how my title of 'ownership' of shares of foreign companies is derived and who is actually holding what under what rule of law.

FWIW, there's a reasonably good chance I can expect a lower standard deviation (based on historical SD) but I doubt that's something I'd actually notice.
I expect to have no benchmark risk vs. the most widely used benchmark of the stock market.
I expect to be able to razz tilters on this board with my tilt AWAY from all the so-called "asset classes" they tilt towards attempting to garner something extra... and if it continues the way it has the past few years, I'll be able to do it while having higher returns AND lower SD. :P
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Re: What do you expect to achieve with your Tilt?

Post by Watty » Sun Mar 12, 2017 12:46 am

I'm not really qualified to judge if tilting is a good idea or not so I don't do it, I am skeptical about it because;

1) There have been lots of good arguments over the years that you should tilt towards technology, dividend paying stocks, emerging markets, commodities, gold, REITS, healthcare. etc. Usually people are excited about one of the asset classes for a year or so then something else gets the excitement. The case for small cap value does sound a bit better but at some point the other ones did too.

2) If the case for tilting was real clear cut with a reasonable risk I would think that you would see it more tilting in the Target Retirement Funds or the Life Strategy funds. I might have missed it but the last I looked at those I don't recall any tilting in those funds.

3) Decades ago small cap stocks were much more difficult to invest in. I don't know that I would put a lot of weight on the old performance history since the markets have changed so much.

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Re: What do you expect to achieve with your Tilt?

Post by unclescrooge » Sun Mar 12, 2017 3:12 am

livesoft wrote:
sean.mcgrath wrote:This one I don't understand, livesoft. If you can expect an additional 1%, you must be making some assumption about volatility -- otherwise you could just move your 60/40 to 70/30 and get a higher expected return.

What you wrote is so true. Except that 70/30 would not give 1% better return. This can be seen by looking at the returns of LS Moderate Growth (VSMGX, 60/40) and LS Growth (VASGX, 80/20) which are shown by morningstar.com:

Image

One can see that the 3-year, 10-year, and 15-year average annual returns differ by less than 1%. That suggests that one has to do something else besides just changing asset allocation just as you surmise. One can also see that the small-cap and value-tilted DGSIX has its own problems.


If you really wanted to tilt towards value you wouldn't use vanguard funds. At the end of the day, they're still market cap weighted with minuscule tilts.

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Re: What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sun Mar 12, 2017 4:12 am

Johnnie wrote:Obviously whether this or Strict Rules of Bogle outperforms will be known only in the fullness of time, so we're throwing darts blindfolded. (We're real close to the board though. :happy )

I kind of enjoy all the finoodling it requires, and am capable of doing it.


Hi Johnnie, yes that's a bit why I started looking at it -- it's fun to read the literature and mess around with the spreadsheets. But then you really need to have some measure of risk to go along with your expected return; otherwise the model is unbounded. In general I've been a bit surprised that, while some do have a quantified expectation of return, none of the tilters replying have been able to quantify the risk delta to their strategy.

nisiprius wrote:For example, according to Berkin and Swedroe, there is evidence that factor premia decline after they become widely known. Not entirely, but by perhaps 1/3rd or so after the papers describing them are published.


Thanks Nis, that's pretty much what I expected, and very nice to see a quantification of it.

Random Walker wrote:Improved portfolio efficiency: improved Sharpe ratio, cut tails by using tilt to decrease overall equity exposure, diversify across independent factors, overall improve portfolio efficiency.

Dave


Hi Dave, Yep. And what are the numbers for the expected improvements in your portfolio vs. TSM?

AlohaJoe wrote:I don't think standard deviation is a useful metric for non-normal returns that exhibit kurtosis and skew and when upside volatility isn't a bad thing.


Hi Joe, no offense as your posts have been some of the most useful for me to read here, but isn't that a bit of a cop-out? I mean, there's enough data: it's pretty easy to assume a different distribution with the kurtosis and skew you'd like and calculate the probabilities. But do bear in mind we are comparing portfolios, so we are only talking the delta in deviations between two scenarios. I'm willing to bet that the difference in the delta will be much less than trivial. The upside volatility I do account for: it's a normal distribution, so I divide by two. 8-)



There does seem to be quite a bit of "the past can't predict the future, so why model it" in the replies. But the past is where the Tilt idea came from in the first place. It's the best place to get a handle on the trade-offs and quantify the expected risk/return. For me it's a bit like when I am doing due diligence to acquire a company: of course the past doesn't guarantee the future, but it would be pretty negligent not to have a look.

cheers,
Sean
Last edited by sean.mcgrath on Sun Mar 12, 2017 1:09 pm, edited 1 time in total.

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Re: What do you expect to achieve with your Tilt?

Post by Robert T » Sun Mar 12, 2017 6:42 am

.
Target = 75:25 stock:bond portfolio, with 0.2/0.4 size/value load in equities, and 0.5 term load in bonds.

Actual performance over last 14 years in comparison to two 'market' portfolios with the same stock:bond split

2003-2016: Annualized return / 2008 return

9.3% / -28.7 = Actual portfolio
7.5% / -30.3 = 75% MSCI ACWI (World Stock):25 Agg Bond
7.5% / -32.4 = 75% Vg. Lifestrategy Growth: 25% Lifestrategy Moderate Growth

1.8% excess annualized return.

Obviously no guarantees.

Robert
.

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Re: What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sun Mar 12, 2017 6:58 am

Robert T wrote:.
Target = 75:25 stock:bond portfolio, with 0.2/0.4 size/value load in equities, and 0.5 term load in bonds.

Actual performance over last 14 years in comparison to two 'market' portfolios with the same stock:bond split

2003-2016: Annualized return / 2008 return

9.3% / -28.7 = Actual portfolio
7.5% / -30.3 = 75% MSCI ACWI (World Stock):25 Agg Bond
7.5% / -32.4 = 75% Vg. Lifestrategy Growth: 25% Lifestrategy Moderate Growth

1.8% excess annualized return.

Obviously no guarantees.

Robert
.


Numbers!

Thanks, Robert. Any idea on expected / calculated volatility?

Cheers,
Sean
Last edited by sean.mcgrath on Sun Mar 12, 2017 1:42 pm, edited 1 time in total.

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Re: What do you expect to achieve with your Tilt?

Post by Random Walker » Sun Mar 12, 2017 8:08 am

Hi Sean,
I think the historic small premium has been about 3% and value has been 5%. But those are factor premiums for long-short portfolios. So for long only funds, cut those numbers in half. And as was mentioned above, maybe cut a 1/3 off those numbers because they are well known and increasingly easily investable.
Now, on the positive side, the small premium is probably more substantive if you go to lowest size deciles.
So, the premiums may be smaller: maybe on the order of 1-2% for SV is what I think about. Just as important though, are some completely different numbers, correlation coefficients! Small to market about 0.4, value to market about 0.1, small to value 0.1. Those low correlations can really improve portfolio efficiency. Of course, as you note, it all comes at certain increased costs.

Dave

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Re: What do you expect to achieve with your Tilt?

Post by Random Walker » Sun Mar 12, 2017 8:16 am

Sean,
Certainly past #s significant. As mentioned above, those numbers could well take a haircut in the future. If you are going to tilt, you need more than past numbers in your head to stick with plan. You need to have conviction of belief in a rational risk or behavioral story explaining the premiums. And for behavioral explanations, you need conviction that there are solid reasons for behavioral anomalies to not be arbitraged away. Without a forward looking conviction, the investor will give up on the plan at some point.

Dave

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Re: What do you expect to achieve with your Tilt?

Post by AlohaJoe » Sun Mar 12, 2017 8:38 am

sean.mcgrath wrote:
AlohaJoe wrote:I don't think standard deviation is a useful metric for non-normal returns that exhibit kurtosis and skew and when upside volatility isn't a bad thing.


Hi Joe, no offense as your posts have been some of the most useful for me to read here, but isn't that a bit of a cop-out? I mean, there's enough data: it's pretty easy to assume a different distribution with the kurtosis and skew you'd like and calculate the probabilities.


Here are two different distributions:

Image

Even though the red line has a lower standard deviation, clearly no one would ever pick it. Obviously that's a contrived example but we can also see something similar with more realistic data.

Between 1950 and 1980 Japanese equity real returns had a standard deviation of around 35%. Which is pretty huge, even in comparison to US equities (which have a standard deviation of around 20%). But 20% of that standard deviation (i.e. 7 percentage points) was due to a single year, 1950, when equities returned 134%. No one would consider that a bad outcome, yet it increased "risk" if risk means standard deviation.

The problem is exacerbated when you think that standard deviation is reported annually but few (no?) human beings work that way. We all check our portfolios more than once a year and we don't do it only in January.

If you only check your portfolio every 7 years then a 100% equity portfolio will have the same standard deviation as a 100% bond portfolio that you check every year. Surely how often you check shouldn't affect the risk of your portfolio?

Similarly, if you check your portfolio once a week (which is probably closer to what most people do, at least on Bogleheads!) then a 100% bond portfolio has the same "risk" (19% standard deviation) as a 100% equity portfolio checked every year.

You can try to account for the things I mentioned but then you start to get pretty far from people being able to have any intuitive grasp of what's going on. It is already hard enough with standard deviation. How much extra standard deviation is "worth" extra return?

Here are two distributions that have the same standard deviation and the same average return. Which one is "better"? What does that even mean when we've made the two normal differentiators identical?

Image

The upside volatility I do account for: it's a normal distribution, so I divide by two. 8-)


But that's not how it works, especially for distributions that are skewed, and one reason why I increasingly dislike standard deviation as a metric.

There does seem to be quite a bit of "the past can't predict the future, so why model it" in the replies.


I agree that people are often selectively dismissive about past returns. Just because I don't like standard deviation doesn't mean there aren't other measures out there that I like better. I mentioned one: length & breadth of drawdown. Semideviation is an improvement on standard deviation, especially if paired with some goal (e.g. semideviation of returns below inflation or some such).

Ultimately, I'm in the camp of those that think the real risk is that we run out of money before we expect to. Standard deviation is, at best, a very very imperfect indicator of that.

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Re: What do you expect to achieve with your Tilt?

Post by dbr » Sun Mar 12, 2017 10:26 am

Only Robert T has supplied actual results, unless I overlooked someone.

But, Robert, what was your targeted result? The OP suggested at least the expected mean and expected SD, the usefulness of SD being a point for discussion. The point is that all results are only one instance from a possible distribution and we plan portfolios based on the expected distribution. The whole point of the question, it seems to me, is to specify in numbers what the rationale is for any person's adoption of a tilted portfolio and what that portfolio actually is. Actually would be what investments, and also what the factor loadings of those investments have been over the time concerned.

I recall that when this forum was surveyed more than half the respondents reported that they do tilt, presumably usually meaning small and value.

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Re: What do you expect to achieve with your Tilt?

Post by dbr » Sun Mar 12, 2017 10:33 am

AlohaJoe wrote:
Ultimately, I'm in the camp of those that think the real risk is that we run out of money before we expect to. Standard deviation is, at best, a very very imperfect indicator of that.


Right, so what people do is propose distributions of the return of various assets, make up portfolios using those assets and run Monte-Carlo models or historical periods models and see what reduces the risk of portfolio failure. There is a broad tendency for the increased variability of the investment to offset the increased return of the investment and reduce allocation to a small roll in portfolio failure compared to withdrawal rate or luck. But, the methodology, however approximate, exists to investigate the question, and a lot of people do. I think Larry Swedroe does believe and recommend (or not) that the "Larry" portfolio would have less chance of retirement ruin than a total market portfolio of the same expected return and maybe even of the same expected SD of return. I may be putting words in Larry's mouth a bit here, so we pose this as a speculation rather than as a known fact.

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Re: What do you expect to achieve with your Tilt?

Post by avalpert » Sun Mar 12, 2017 12:05 pm

JoMoney wrote:My 'tilt' is owning the S&P 500 index rather than some broader 'global' market portfolio.
At a <.05% ER I expect to achieve lower expenses relative to the .11% ER on 'Total International' or 'Total World' fund
I expect further savings from the lack of foreign tax withholding on dividends.
I expect it will be very simple to maintain, with the only 'rebalancing' required being the amount of cash/bonds I want to hold.
I expect I'll sleep a little better not wondering what the implications are from various global currencies and their "race to debase", or feeling a need to understand how my title of 'ownership' of shares of foreign companies is derived and who is actually holding what under what rule of law.

FWIW, there's a reasonably good chance I can expect a lower standard deviation (based on historical SD) but I doubt that's something I'd actually notice.
I expect to have no benchmark risk vs. the most widely used benchmark of the stock market.
I expect to be able to razz tilters on this board with my tilt AWAY from all the so-called "asset classes" they tilt towards attempting to garner something extra... and if it continues the way it has the past few years, I'll be able to do it while having higher returns AND lower SD. :P

You could maintain your US bias without the large cap tilt of the S&P 500 using a US total market fund - so you kind of set yourself up a strawman there. It also seems particularly misguided to intentionally choose to not only tilt away from the market portfolio but do so against identified risk factors even if you want to avoid the diversification across companies that happen to reside in different countries from your own.

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Re: What do you expect to achieve with your Tilt?

Post by dkturner » Sun Mar 12, 2017 12:47 pm

nisiprius wrote:
willthrill81 wrote:...Over the last 47 years, portfolios with my tilt toward MCV, SCB, and SCV have earned about 2.4% over the TSM...
A nit-pick, but not a completely trivial nit-pick. I don't believe anyone actually used a portfolio like that over the last 47 years, because the terms, theory, and concepts behind them were not developed or published until 1992. Without a time machine, nobody knew in 1970 what Banz published in 1981 and what Fama and French published in 1992.

So what you are talking about is hypothetical backtesting, and you should probably make a habit of phrasing it that way.

For example, according to Berkin and Swedroe, there is evidence that factor premia decline after they become widely known. Not entirely, but by perhaps 1/3rd or so after the papers describing them are published. So, not only did nobody know in 1970, but if everyone had known about the Fama and French work in 1970, the course of investing history would probably have changed a bit and some of the factor premia would have been arbitraged away.

It is also unclear just how you could have created a "portfolio with my tilt" in 1970, given that there were no index funds targeting these asset classes, in fact no index funds at all. Furthermore, this was the age of fixed commissions, and even the smallest stock purchases cost $100-$200 in commissions. Even if you had known what to do, you would have had to be very wealthy to do it. How many stocks do you think you would have needed to buy? The Vanguard Mid-Cap Value Index Fund holds 208 stocks. If you were paying, say, $150 commission on each one, that implies about $30,000 in commissions. In order to keep expenses down to, say, 0.5%, that implies an investment of at least $6 million to assemble the mid-cap value part of your portfolio alone.


Good points, so what happens when we confine our statistics to the years following 1992?

Russell 1000 Growth annualized return 8.1 standard deviation 20.5
Russell 1000 Value annualized return 10.0 standard deviation 16.5
Russell 2000 Growth annualized return 7.4 standard deviation 21.6
Russell 2000 Value annualized return 10.9 standard deviation 17.9

Looks like Messrs. Fama and French did a pretty good job back in 1992. When researchers in 1992, looking at 1927-1991 data, advance a proposition that works well over the following 24 years they may be on to something. In any event, would an enterprising investor be foolish in tilting a portfolio in attempt to take advantage of that research?

All of the comments on the unavailability of pre 1993 returns to the average retail investor, and the high expenses of executing purchases and sales of value stocks prior to 1970, or some other date, are irrelevant. We are executing our investment translation today at today's expense ratios and brokerage commissions. We look at historical returns solely for guidance in creating an asset allocation that we hope will serve us well in the future.

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Re: What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sun Mar 12, 2017 1:37 pm

AlohaJoe wrote:I agree that people are often selectively dismissive about past returns. Just because I don't like standard deviation doesn't mean there aren't other measures out there that I like better. I mentioned one: length & breadth of drawdown. Semideviation is an improvement on standard deviation, especially if paired with some goal (e.g. semideviation of returns below inflation or some such).

Ultimately, I'm in the camp of those that think the real risk is that we run out of money before we expect to. Standard deviation is, at best, a very very imperfect indicator of that.


Hi Joe, thanks for a very detailed reply. Yes, I agree that in my own case what I am really trying to get at is something like length & breadth of drawdown. I personally interpret my "ability to accept risk" as something like: 1. a once in 100 year chance that my portfolio will drop by 50% at some point; 2. a once in a 1000 year chance that it drops 65%; 3. a very, very high chance that my return will beat risk free bonds over 30 years.

Hopefully my 20% std dev meets those hurdles (actually, I suspect I could go up to 120% stocks, but that's another story). I get all the flaws you mention about St Dev, but when judging risks at that high level my assumption has been that it's reasonable (especially when comparing two portfolios, as I -- admittedly without any data -- believe the "method error" when comparing risk between two options will be very small).

But my main point is there is no sane way for me to compare two portfolio approaches if I don't have any quantification of risk. Do you quantify it at all? If so, how do you quantify the relative length & breadth of drawdown risk between two investment approaches?

cheers,
Sean

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Re: What do you expect to achieve with your Tilt?

Post by sean.mcgrath » Sun Mar 12, 2017 1:39 pm

dbr wrote:The OP suggested at least the expected mean and expected SD, the usefulness of SD being a point for discussion.


Indeed. I'm happy to broaden my question to "expected mean and variation," where posters are free to use a more useful measure than SD for variation.

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Re: What do you expect to achieve with your Tilt?

Post by larryswedroe » Sun Mar 12, 2017 1:51 pm

For me the biggest benefit, as explained in Reducing the Risk of Black Swans, is that the higher expected returns of small value allow one to hold much less equity risk. That allows you to hold much more safe bonds, assets the correlation of which to equities which is about zero on average tends to turn highly negative when equity risks show up (in flights to safety). Historically the result has been far more efficient portfolios, and ones with far less tail risk (trading off some upside potential, but with the left tail cut more than the right tail).

This strategy has benefited investors for the past 20+ years and IMO highly likely to continue to do so--with the main benefit being cutting that left tail.

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Re: What do you expect to achieve with your Tilt?

Post by Theoretical » Sun Mar 12, 2017 1:52 pm

avalpert wrote:
JoMoney wrote:My 'tilt' is owning the S&P 500 index rather than some broader 'global' market portfolio.
At a <.05% ER I expect to achieve lower expenses relative to the .11% ER on 'Total International' or 'Total World' fund
I expect further savings from the lack of foreign tax withholding on dividends.
I expect it will be very simple to maintain, with the only 'rebalancing' required being the amount of cash/bonds I want to hold.
I expect I'll sleep a little better not wondering what the implications are from various global currencies and their "race to debase", or feeling a need to understand how my title of 'ownership' of shares of foreign companies is derived and who is actually holding what under what rule of law.

FWIW, there's a reasonably good chance I can expect a lower standard deviation (based on historical SD) but I doubt that's something I'd actually notice.
I expect to have no benchmark risk vs. the most widely used benchmark of the stock market.
I expect to be able to razz tilters on this board with my tilt AWAY from all the so-called "asset classes" they tilt towards attempting to garner something extra... and if it continues the way it has the past few years, I'll be able to do it while having higher returns AND lower SD. :P

You could maintain your US bias without the large cap tilt of the S&P 500 using a US total market fund - so you kind of set yourself up a strawman there. It also seems particularly misguided to intentionally choose to not only tilt away from the market portfolio but do so against identified risk factors even if you want to avoid the diversification across companies that happen to reside in different countries from your own.


Actually, you can't with a TSM - it's not a strawman. JoMoney's made a conscious choice to tilt to large caps, with a negative small loading (leading to lower volatility), a minimal value loading, slightly negative momentum, and a moderate quality loading (also leading to lower volatility). In addition, JoMoney's elected to not undertake the risks of international investing, especially currency risk. A total stock market fund would be more company-diversified, but would include a lot of companies not desired in the investment plan. That's a perfectly rational tilt.

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Re: What do you expect to achieve with your Tilt?

Post by cfs » Sun Mar 12, 2017 1:58 pm

Back from my LUng Distance Workout [low vis, a lot of fog] and ready to add my two centimos here. I expect to beat the Vanguard balanced fund which I use as my benchmark. What about if you can't beat your benchmark for two consecutive years, cfs? Then I will do an unconditional surrender and move all my money to my benchmark. Can't beat it, join it, no problems! Thanks for reading ~cfs~
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Re: What do you expect to achieve with your Tilt?

Post by triceratop » Sun Mar 12, 2017 2:06 pm

nisiprius wrote:
willthrill81 wrote:...Over the last 47 years, portfolios with my tilt toward MCV, SCB, and SCV have earned about 2.4% over the TSM...
A nit-pick, but not a completely trivial nit-pick. I don't believe anyone actually used a portfolio like that over the last 47 years, because the terms, theory, and concepts behind them were not developed or published until 1992. Without a time machine, nobody knew in 1970 what Banz published in 1981 and what Fama and French published in 1992.

So what you are talking about is hypothetical backtesting, and you should probably make a habit of phrasing it that way.

For example, according to Berkin and Swedroe, there is evidence that factor premia decline after they become widely known. Not entirely, but by perhaps 1/3rd or so after the papers describing them are published. So, not only did nobody know in 1970, but if everyone had known about the Fama and French work in 1970, the course of investing history would probably have changed a bit and some of the factor premia would have been arbitraged away.

It is also unclear just how you could have created a "portfolio with my tilt" in 1970, given that there were no index funds targeting these asset classes, in fact no index funds at all. Furthermore, this was the age of fixed commissions, and even the smallest stock purchases cost $100-$200 in commissions. Even if you had known what to do, you would have had to be very wealthy to do it. How many stocks do you think you would have needed to buy? The Vanguard Mid-Cap Value Index Fund holds 208 stocks. If you were paying, say, $150 commission on each one, that implies about $30,000 in commissions. In order to keep expenses down to, say, 0.5%, that implies an investment of at least $6 million to assemble the mid-cap value part of your portfolio alone.


Index funds didn't exist before 1975, the S&P500 itself didn't exist before 1957; you hinted at this. And yet, people infer from market history as to how index funds would have performed in various market conditions. They also backassembled the S&P500.

As subsequently shown, too, the S/V premia have persisted after publication.
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Re: What do you expect to achieve with your Tilt?

Post by Watty » Sun Mar 12, 2017 3:18 pm

dkturner wrote:All of the comments on the unavailability of pre 1993 returns to the average retail investor, and the high expenses of executing purchases and sales of value stocks prior to 1970, or some other date, are irrelevant.


I would question that statement. In addition to the mechanics of actually buying and selling the stocks it was also difficult to actually get information about small cap companies which in the pre-internet days. That could be a reason for them to have outperformed in the past.

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Re: What do you expect to achieve with your Tilt?

Post by Theoretical » Sun Mar 12, 2017 3:20 pm

cfs wrote:Back from my LUng Distance Workout [low vis, a lot of fog] and ready to add my two centimos here. I expect to beat the Vanguard balanced fund which I use as my benchmark. What about if you can't beat your benchmark for two consecutive years, cfs? Then I will do an unconditional surrender and move all my money to my benchmark. Can't beat it, join it, no problems! Thanks for reading ~cfs~


2 years is way too short of a time to judge on a market benchmark that is different than your tilt like that. Heck, 10 years is too short a time, but can at least give you a reference point as to how your investments did vs the market.

With a benchmark that is tilted, you do want to compare your performance to determine how well or poorly your investments and your implementation of them met the benchmark after costs.

Case in point, on an academic (long-short) basis, the Quality factor in large caps underperformed large junk for over 30 years, and large low beta did for well over a decade from the 1990s-mid 2000s. Even on a long only basis, every factor has its dog days, including beta, which lost to T-BILLS from 2000-2010.
Last edited by Theoretical on Sun Mar 12, 2017 3:26 pm, edited 1 time in total.

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Re: What do you expect to achieve with your Tilt?

Post by willthrill81 » Sun Mar 12, 2017 3:26 pm

Theoretical wrote:
cfs wrote:Back from my LUng Distance Workout [low vis, a lot of fog] and ready to add my two centimos here. I expect to beat the Vanguard balanced fund which I use as my benchmark. What about if you can't beat your benchmark for two consecutive years, cfs? Then I will do an unconditional surrender and move all my money to my benchmark. Can't beat it, join it, no problems! Thanks for reading ~cfs~


2 years is way too short of a time to judge on a market benchmark that is different than your tilt like that. Heck, 10 years is too short a time, but can at least give you a reference point as to how your investments did vs the market.

With a benchmark that is tilted, you do want to compare your performance to determine how well or poorly your investments met the benchmark after costs.


+1

I've seen a few people rant about how the SC premium is gone because they're only looking at the last ten years or so (even though SCB beat LCB by over 1% in real returns from 2007-2017). They ignore the fact that many asset classes with long-term records of beating the S&P 500, for instance, have relatively brief periods in which they have stellar performance, and much of the time they are just on 'middling' or even behind major benchmarks.
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Re: What do you expect to achieve with your Tilt?

Post by cfs » Sun Mar 12, 2017 3:33 pm

Theoretical wrote: . . . 2 years is way too short . . .

willthrill81 wrote: . . . +1 . . . .

Thank you both for your comments. Thanks for reading ~cfs~
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Re: What do you expect to achieve with your Tilt?

Post by Kenkat » Sun Mar 12, 2017 4:57 pm

I expect to achieve better returns basically. Here are my S+D (value and small slant plus EM and REIT) numbers 1999-2016 versus a benchmark of 60 US/20 INTL/20 BOND moving to 50/20/30 over time, so my benchmark started as LS Growth and eventually moved to a matching Target Retirement fund.

My return: 7.36% annualized
Benchmark: 5.17% annualized

Earlier years were better - I crushed my benchmark 2000-2004 while recent years have been more modest.
Last edited by Kenkat on Sun Mar 12, 2017 5:11 pm, edited 1 time in total.

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Re: What do you expect to achieve with your Tilt?

Post by dbr » Sun Mar 12, 2017 4:59 pm

Kenkat wrote:I expect to achieve better returns basically. Here are my numbers 1999-2016; 60 US/20 INTL/20 BOND moving to 50/20/30 over time, so benchmark started as LS Growth and eventually moved to a matching Target Retirement fund.

My return: 7.36% annualized
Benchmark: 5.17% annualized

Earlier years were better - I crushed my benchmark 2000-2004 while recent years have been more modest.


I don't understand. What tilt are you illustrating here? US/Intl/bond is not tilted.

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Re: What do you expect to achieve with your Tilt?

Post by Kenkat » Sun Mar 12, 2017 5:09 pm

dbr wrote:
Kenkat wrote:I expect to achieve better returns basically. Here are my numbers 1999-2016; 60 US/20 INTL/20 BOND moving to 50/20/30 over time, so benchmark started as LS Growth and eventually moved to a matching Target Retirement fund.

My return: 7.36% annualized
Benchmark: 5.17% annualized

Earlier years were better - I crushed my benchmark 2000-2004 while recent years have been more modest.


I don't understand. What tilt are you illustrating here? US/Intl/bond is not tilted.


Sorry, that was the benchmark to compare against; I will edit my post to be more clear, thanks!

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Re: What do you expect to achieve with your Tilt?

Post by Dirghatamas » Sun Mar 12, 2017 6:02 pm

sean.mcgrath wrote:I'm trying to figure out whether Tilters have higher expectations than I, or are more willing to do the extra work for 0.5%.
cheers,
Sean


Sean, IMO you are trying to do brain surgery but only have a hammer and a chisel :wink: You are trying to figure out decimal digits when even the significant digits are unknowable.

For the record, I don't tilt and never have because I am chicken (very defensive and cautious). I always hold a global cap weighted 100% stock portfolio, with no bonds and no tilts: country, small/large, value/growth whatever.

I do want to take a swipe at tilters though and the level of accuracy needed when none exists. Lets say some Nobel prize winner in the early nineties did a bunch of research and found out some so called factors: size, value, momentum etc. which beat the total market for the last N years. So what?

There are many such "factors" that also have back tested to provide market beating (and losing) returns. It is well known that entire industries which get commoditized but have huge capital outlay like Airlines, Memory chips etc. have been very poor performers over the long term. On the other hand "vice stocks" like Tobacco/Alcohol etc. have consistently beaten the market. Entire sectors like healthcare and technology have done so. Sugary drinks are known to have beaten the market.

All of these investments can be made at low cost and in a diversified manner. Most also can be done through so called "passive index funds".

So, my question to tilters is where does it stop? Why do you guys think it is OK to tilt to small cap value but not kosher to invest say 30% of your money in tobacco stocks?

Each time I have thought about this stuff, every back test can be supported by AFTER THE FACT by a very convincing sounding narrative on why the premium exists and why it will continue e.g. small cap value. At the same time, there are excellent narratives on why for example sugary drinks have beaten the market and will continue to do so.

I can also come up with a perfectly good narrative on why the out performance will not continue: small cap value could become overbought and arbitraged away; people will become heath conscious and not drink sugar drinks; healthcare industry profits will suffer with universal healthcare; younger generation will not smoke much; emerging markets will grow a ton or (reverse) share dilution will remove this growth from actual share holder results..

Lets face it, tilting is no different than say active stock picking or sector bets. You are making active bets that you will beat the market consensus: US will beat ex US stocks or small will beat large. For each bet, there is some one on the other side making the opposite bet. That's all there is to it. Making it sound analytical or mathematical with great precision, may give it a sense of intellectual superiority or respect, but you are just betting that you are smarter than the market.

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Re: What do you expect to achieve with your Tilt?

Post by dkturner » Sun Mar 12, 2017 6:15 pm

Watty wrote:
dkturner wrote:All of the comments on the unavailability of pre 1993 returns to the average retail investor, and the high expenses of executing purchases and sales of value stocks prior to 1970, or some other date, are irrelevant.


I would question that statement. In addition to the mechanics of actually buying and selling the stocks it was also difficult to actually get information about small cap companies which in the pre-internet days. That could be a reason for them to have outperformed in the past.


The point I was trying to make, apparently unsuccessfully, was that although it would have been very expensive to assemble a portfolio of value and small stocks back in the olden days, it's irrelevant because we're all investing in the here and now, not in the olden days, and it now very cheap to get broadly diversified portfolios of these types of equities. In 1992 Fama and French didn't invent anything, they merely documented, with extensive data, what well known figures, like Buffett, Graham and Templeton had been saying for decades.

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Re: What do you expect to achieve with your Tilt?

Post by avalpert » Sun Mar 12, 2017 7:21 pm

Dirghatamas wrote:
sean.mcgrath wrote:I'm trying to figure out whether Tilters have higher expectations than I, or are more willing to do the extra work for 0.5%.
cheers,
Sean


Sean, IMO you are trying to do brain surgery but only have a hammer and a chisel :wink: You are trying to figure out decimal digits when even the significant digits are unknowable.

For the record, I don't tilt and never have because I am chicken (very defensive and cautious). I always hold a global cap weighted 100% stock portfolio, with no bonds and no tilts: country, small/large, value/growth whatever.

I do want to take a swipe at tilters though and the level of accuracy needed when none exists. Lets say some Nobel prize winner in the early nineties did a bunch of research and found out some so called factors: size, value, momentum etc. which beat the total market for the last N years. So what?

There are many such "factors" that also have back tested to provide market beating (and losing) returns. It is well known that entire industries which get commoditized but have huge capital outlay like Airlines, Memory chips etc. have been very poor performers over the long term. On the other hand "vice stocks" like Tobacco/Alcohol etc. have consistently beaten the market. Entire sectors like healthcare and technology have done so. Sugary drinks are known to have beaten the market.

All of these investments can be made at low cost and in a diversified manner. Most also can be done through so called "passive index funds".

So, my question to tilters is where does it stop? Why do you guys think it is OK to tilt to small cap value but not kosher to invest say 30% of your money in tobacco stocks?

Each time I have thought about this stuff, every back test can be supported by AFTER THE FACT by a very convincing sounding narrative on why the premium exists and why it will continue e.g. small cap value. At the same time, there are excellent narratives on why for example sugary drinks have beaten the market and will continue to do so.

I can also come up with a perfectly good narrative on why the out performance will not continue: small cap value could become overbought and arbitraged away; people will become heath conscious and not drink sugar drinks; healthcare industry profits will suffer with universal healthcare; younger generation will not smoke much; emerging markets will grow a ton or (reverse) share dilution will remove this growth from actual share holder results..

Lets face it, tilting is no different than say active stock picking or sector bets. You are making active bets that you will beat the market consensus: US will beat ex US stocks or small will beat large. For each bet, there is some one on the other side making the opposite bet. That's all there is to it. Making it sound analytical or mathematical with great precision, may give it a sense of intellectual superiority or respect, but you are just betting that you are smarter than the market.

Have you ever actually read the academic literature? Your caricature her seems to suggest at the very least you don't understand it.

It isn't simply a backtested portfolio that outperformed something else and it is not possible to have many 'factors' that materially improve the ability to explain returns - by definition subsequent factors will have less explanatory power then the ones that came before when you can explain over 90% of returns with four factors, additional ones just won't be able to add much.

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Re: What do you expect to achieve with your Tilt?

Post by willthrill81 » Sun Mar 12, 2017 7:26 pm

Dirghatamas wrote:I do want to take a swipe at tilters though and the level of accuracy needed when none exists. Lets say some Nobel prize winner in the early nineties did a bunch of research and found out some so called factors: size, value, momentum etc. which beat the total market for the last N years. So what?

There are many such "factors" that also have back tested to provide market beating (and losing) returns. It is well known that entire industries which get commoditized but have huge capital outlay like Airlines, Memory chips etc. have been very poor performers over the long term. On the other hand "vice stocks" like Tobacco/Alcohol etc. have consistently beaten the market. Entire sectors like healthcare and technology have done so. Sugary drinks are known to have beaten the market.

All of these investments can be made at low cost and in a diversified manner. Most also can be done through so called "passive index funds".

So, my question to tilters is where does it stop? Why do you guys think it is OK to tilt to small cap value but not kosher to invest say 30% of your money in tobacco stocks?

Each time I have thought about this stuff, every back test can be supported by AFTER THE FACT by a very convincing sounding narrative on why the premium exists and why it will continue e.g. small cap value. At the same time, there are excellent narratives on why for example sugary drinks have beaten the market and will continue to do so.

I can also come up with a perfectly good narrative on why the out performance will not continue: small cap value could become overbought and arbitraged away; people will become heath conscious and not drink sugar drinks; healthcare industry profits will suffer with universal healthcare; younger generation will not smoke much; emerging markets will grow a ton or (reverse) share dilution will remove this growth from actual share holder results..


Personally, if I had a sound a priori reason to believe that any sector of the market that I could invest in would continue to outperform the market, I would consider tilting my portfolio in that direction.

I doubt that we'll continue to see industries like healthcare and tobacco continue to outperform the market over the long-term, so I'm not tilting towards those industries.

Dirghatamas wrote:Lets face it, tilting is no different than say active stock picking or sector bets. You are making active bets that you will beat the market consensus: US will beat ex US stocks or small will beat large. For each bet, there is some one on the other side making the opposite bet. That's all there is to it. Making it sound analytical or mathematical with great precision, may give it a sense of intellectual superiority or respect, but you are just betting that you are smarter than the market.


That's false. Passive investing does not only mean "own the total world stock market" as some purport (you are not the first).

"Passive investing is an investment strategy that aims to maximize returns over the long run by keeping the amount of buying and selling to a minimum. The idea is to avoid the fees and the drag on performance that potentially occur from frequent trading. Passive investing is not aimed at making quick gains or at getting rich with one great bet, but rather on building slow, steady wealth over time."
http://www.investopedia.com/terms/p/pas ... z4bA1eRkfy

By tilting a portfolio toward small caps, for instance, I am passively investing in an asset class which (1) has a very long and international record of outperforming large caps stocks and (2) has very solid theoretical reasons for doing so. Larry Swedroe recently started a thread on that precise topic.

You are essentially arguing that every asset class within the entire equity market should perform the same over the long-term. History has shown that that's not true. For one, there is greater volatility with small caps, so the market demands a higher return for those asset classes. The same applies for bonds; certain segments of the bond market have higher long-term returns, but they also carry greater risk and demand a higher premium as a result (i.e. short-term vs. long-term treasuries).
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Re: What do you expect to achieve with your Tilt?

Post by larryswedroe » Sun Mar 12, 2017 7:53 pm

willthrill
To add to your comments. There is NO logic to thinking all asset classes/factors should have same returns. That literally makes no sense as some are more risky than others and thus should require risk premiums.

With that said, it's logical as an apriori to believe all asset classes/factors should have the same risk-adjusted returns (that would fit with EMH). But if you believe that then you should also believe it makes sense to diversify across factors that aren't perfectly correlated--no reason to concentrate risk as diversification brings free lunch if they all have same risk-adjusted returns

Larry

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Re: What do you expect to achieve with your Tilt?

Post by Dirghatamas » Sun Mar 12, 2017 10:40 pm

avalpert wrote:Have you ever actually read the academic literature? Your caricature her seems to suggest at the very least you don't understand it.

It isn't simply a backtested portfolio that outperformed something else and it is not possible to have many 'factors' that materially improve the ability to explain returns - by definition subsequent factors will have less explanatory power then the ones that came before when you can explain over 90% of returns with four factors, additional ones just won't be able to add much.


Unfortunately, I have. I started investing in 1992 and read everything I could get my hands on then and pretty much every few years since then. As a research engineer by profession, one thing I am good at is being intellectually curious and absorbing lots of information about whatever field interests me. The Fama/French stuff on factors had just about started coming out when I started investing so no I didn't read those till much later. I have seen this incidence of narratives that work till they don't, not just in investing but in pretty much every field.

I have given this example before. When I started in my industry (high-tech), the popular world view was that the Japanese tech industry would decimate the US tech industry. In the eighties, the Japanese auto industry had decimated the US auto industry and the tech industry was the next in terms of Japanese aspirations. After the fact, there were many popular narratives (early 90s) on what factors were involved and it appeared clear to management professors on what had happened. There were courses being taught about Japanese management styles, Japanese style of capitalism and managers traveling to Japan to learn it all. The future in our industry though turned out to be completely different. Folks had under predicted the innovation, immigration etc. in US as well as cost pressure from Korea, Taiwan etc. After the fact in the 2010s another history and narrative could be written about the tech industry in the 90s.. If in the tech industry, you had tried to make investments based on any statistical models or so called factors, you would turn out to be mostly wrong..what happened was organic, didn't rhyme with the past and was mostly unknowable (as opposed to unpredictable).

Going forward, just as an example, consider the small vs. large factor. We have that (and good explanations for why it exists) and yet we have data showing the number of companies in the US has been declining at a rapid rate in the last couple of decades. There is a narrative that "winner take all" is increasingly happening in all industries due to leverage, technology and the sheer advantages of economies of scale. If this turns out to be true, large companies may completely swamp smaller rivals in established fields and the factor models (of size) will turn out to have been wrong in THIS TIME FRAME even though it may have made sense in the last 50..

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willthrill81
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Re: What do you expect to achieve with your Tilt?

Post by willthrill81 » Sun Mar 12, 2017 10:58 pm

Dirghatamas wrote:Going forward, just as an example, consider the small vs. large factor. We have that (and good explanations for why it exists) and yet we have data showing the number of companies in the US has been declining at a rapid rate in the last couple of decades. There is a narrative that "winner take all" is increasingly happening in all industries due to leverage, technology and the sheer advantages of economies of scale. If this turns out to be true, large companies may completely swamp smaller rivals in established fields and the factor models (of size) will turn out to have been wrong in THIS TIME FRAME even though it may have made sense in the last 50..


And you say that we are the ones making the bet? :oops:

Considering that since 2000 large caps have had a real annual return of 2.27% while small caps have returned 5.88%, the 21st century doesn't seem to favor that prediction so far.

When people start saying "this time, it's different," I've learned to back away slowly.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: What do you expect to achieve with your Tilt?

Post by Dirghatamas » Sun Mar 12, 2017 10:59 pm

willthrill81 wrote:That's false. Passive investing does not only mean "own the total world stock market" as some purport (you are not the first).

"Passive investing is an investment strategy that aims to maximize returns over the long run by keeping the amount of buying and selling to a minimum. The idea is to avoid the fees and the drag on performance that potentially occur from frequent trading. Passive investing is not aimed at making quick gains or at getting rich with one great bet, but rather on building slow, steady wealth over time."
http://www.investopedia.com/terms/p/pas ... z4bA1eRkfy

By tilting a portfolio toward small caps, for instance, I am passively investing in an asset class which (1) has a very long and international record of outperforming large caps stocks and (2) has very solid theoretical reasons for doing so. Larry Swedroe recently started a thread on that precise topic.

You are essentially arguing that every asset class within the entire equity market should perform the same over the long-term. History has shown that that's not true. For one, there is greater volatility with small caps, so the market demands a higher return for those asset classes. The same applies for bonds; certain segments of the bond market have higher long-term returns, but they also carry greater risk and demand a higher premium as a result (i.e. short-term vs. long-term treasuries).


I am not arguing about active investors. Just as there are passive index funds for holding small cap value, there are passive index funds for small growth or large growth or large value or whatever. Much of the world investing is now being done by large whales which are Sovereign funds, Huge pension funds, University endowments and the like. They have all the same information you and I have about factors and know fully well that small cap value is the place to be :happy They have longer time frame than you and I. They are not the so called, dumb retail investors.

My position is NOT that all asset classes in the equity market will have same returns. It is that they will be different and you will only know AFTER THE FACT what happened. Just as an example, you can look at Research Affiliates and see that the expected returns on US large and small caps is much smaller than say EAFE or emerging markets. The explanation for this is that investors think of emerging markets as "risky" and as such demand a higher risk premium than US. So, given all these factors about risk premium, should we invest a lot in emerging markets? Some people think you should..

My position is that the global market consensus is an easily defensible and defensive position (so I always stick to that). Once you go away from that, all passive bets are equivalent whether they are based on Country bias or sector or so called factors. You are deviating from the market against others (also passive and rational) investors. In time, your bet could turn out to be good or bad (after the fact).

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Re: What do you expect to achieve with your Tilt?

Post by Dirghatamas » Sun Mar 12, 2017 11:17 pm

willthrill81 wrote:And you say that we are the ones making the bet? :oops:

Considering that since 2000 large caps have had a real annual return of 2.27% while small caps have returned 5.88%, the 21st century doesn't seem to favor that prediction so far.

When people start saying "this time, it's different," I've learned to back away slowly.


I don't think you are seeing my position at all. My position is always "we don't have a clue" and be defensive. I am NOT predicting large will outperform small. Look at your response. Now replace "small" and "large" with US vs. International. Every week, there are threads by posters looking back at the last 20 or 30 year data on US vs. International and asking "why on earth would anyone invest outside the US". Perhaps there is a "factor" called US which explains good returns :shock: Somehow, people find that argument not respectable and argue for global diversification saying past performance is not a good predictor and if the market consensus is such and such, what reason do we have to expect all that to be not factored in..

There isn't a conceptual difference between say Country bias or sector bias or so called factors: they are all bets away from the market consensus.

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Re: What do you expect to achieve with your Tilt?

Post by avalpert » Sun Mar 12, 2017 11:22 pm

Dirghatamas wrote:
avalpert wrote:Have you ever actually read the academic literature? Your caricature her seems to suggest at the very least you don't understand it.

It isn't simply a backtested portfolio that outperformed something else and it is not possible to have many 'factors' that materially improve the ability to explain returns - by definition subsequent factors will have less explanatory power then the ones that came before when you can explain over 90% of returns with four factors, additional ones just won't be able to add much.


Unfortunately, I have. I started investing in 1992 and read everything I could get my hands on then and pretty much every few years since then. As a research engineer by profession, one thing I am good at is being intellectually curious and absorbing lots of information about whatever field interests me. The Fama/French stuff on factors had just about started coming out when I started investing so no I didn't read those till much later. I have seen this incidence of narratives that work till they don't, not just in investing but in pretty much every field.

I have given this example before. When I started in my industry (high-tech), the popular world view was that the Japanese tech industry would decimate the US tech industry. In the eighties, the Japanese auto industry had decimated the US auto industry and the tech industry was the next in terms of Japanese aspirations. After the fact, there were many popular narratives (early 90s) on what factors were involved and it appeared clear to management professors on what had happened. There were courses being taught about Japanese management styles, Japanese style of capitalism and managers traveling to Japan to learn it all. The future in our industry though turned out to be completely different. Folks had under predicted the innovation, immigration etc. in US as well as cost pressure from Korea, Taiwan etc. After the fact in the 2010s another history and narrative could be written about the tech industry in the 90s.. If in the tech industry, you had tried to make investments based on any statistical models or so called factors, you would turn out to be mostly wrong..what happened was organic, didn't rhyme with the past and was mostly unknowable (as opposed to unpredictable).

Going forward, just as an example, consider the small vs. large factor. We have that (and good explanations for why it exists) and yet we have data showing the number of companies in the US has been declining at a rapid rate in the last couple of decades. There is a narrative that "winner take all" is increasingly happening in all industries due to leverage, technology and the sheer advantages of economies of scale. If this turns out to be true, large companies may completely swamp smaller rivals in established fields and the factor models (of size) will turn out to have been wrong in THIS TIME FRAME even though it may have made sense in the last 50..


I am right there with you on our (as a species) tendency to manufacture patterns and narratives to fit whatever random data (in the broadest sense) we come across. That is certainly true in the investment world - and even more so in business operations. I have made a career of deconstructing those narrative and busting open business frames, challenging operating assumptions and redirecting practice. In fact, what I have seen behind the curtain of management at most of the world's leading companies is a big part of why I believe the small and value premiums are structural (though that isn't germane to my point here).

If someone has ever constructed a serious model that showed implementations of lean or kanban or what have you has led to demonstrated outperformance in equity returns I haven't seen it. But the F&F factors are different - they have been tested out of sample across geographies, time periods and markets and consistently stand up. Is it possible that going forward will be systematically different sure, and at some point it will certainly be the case, but is it likely in the near-term - I doubt it and I see no more support for it to be the case than for the equity premium itself.

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