Vanguard changed their way of computing PE ratios

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siamond
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Vanguard changed their way of computing PE ratios

Post by siamond » Tue Aug 22, 2017 2:01 pm

As documented on our P/E wiki page, there are several ways of computing a trailing twelve months (TTM) Price/Earnings ratio (PE) for a mutual fund or an index. Morningstar does it one way, S&P (and Prof. Shiller) does it another way, and Vanguard was using a third formula. Long story short, Morningstar's way makes very little sense and is due to historical reasons, while S&P's way makes much more sense, and Vanguard's way, although a tad contorted, was actually mathematically equivalent to S&P. One of the sticky points is the possible exclusion of companies displaying negative earnings in the time period from the computation (Morningstar does it; S&P and Vanguard did not).

Unfortunately, it appears that Vanguard moved to align their procedures with Morningstar. Here are three converging data points:
1. A smart guy at Seeking Alpha figured it out before anybody else (check here). Some of us had noticed a similar discontinuity in a past thread, but didn't figure out why by then.
2. In a recent Wall Street Journal article from Jason Zweig (discussion in this thread), there was a puzzling quote from a Vanguard exec (Rich Powers) stating that negative earnings are eliminated from the Vanguard math, and this math is subcontracted to a company named FactSet.
3. As I was very puzzled by the previous points, I reached out to a reliable Vanguard insider, who did confirm that Mr Powers' statements are indeed correct, and that Vanguard did change their way beginning of Q2 to better align with 'industry best practices' (which appears to mean Morningstar) while subcontracting to FactSet. Oh, and there is no official communication from Vanguard (as of today) on the matter.

Ok, I do understand that it was probably a royal pain for Vanguard support to deal with the confusion that discrepancies between Morningstar (or other companies using the same math, e.g. BlackRock/iShares) and Vanguard were undoubtedly creating.

The trouble is:
a. Morningstar's math is plainly non-sensical, as S&P advocated for many years, and as was discussed on this forum and also in the old diehard forum (see more extensive background information here).
b. Many people use PE quantities in a relative manner, comparing a given value to a frame of reference. This frame of reference is typically historical. Now when you change methodology, you totally mess up any such comparison.
c. More troublesome (imho), the inverse of PE, the Earnings/Price ratio (E/P) can be a pretty decent way of computing expected returns. This has been demonstrated many times, by empirical data as well as simple algebra combined with a bit of common sense. BUT it needs to be computed properly, and certainly not to arbitrarily exclude some of the stocks involved, *notably* the bad apples! And think about the effect on the math in 2009...
d. Vanguard didn't provide any continuity, it just switched from one way to the other without any warning. Common practice would have dictated to provide both ways of doing the math for at least a transition period, if not forever.

Well, I hope that Vanguard will at least officially communicate on the matter in the coming few days or weeks. And that they'll take in consideration that such an abrupt change is terribly inappropriate and will find ways to mitigate the situation.

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Re: Vanguard changed their way of computing PE ratios

Post by asif408 » Tue Aug 22, 2017 2:47 pm

Thanks for the detailed explanation, siamond. I've ignored Vanguard's P/E data since I've been with them just because the numbers always seemed a bit off.

One thing I have noticed about P/E values in general is that there is not standard way they are reported in most of the financial media. I've seen the earnings part calculated 100 different ways.

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Tue Aug 22, 2017 4:06 pm

One more data point. I happen to have archived the P/E for various Vanguard funds at the end of May-17 (before the methodology change) and at the end of June (after the methodology change). When I did it, I was quite surprised by the changes, but didn't analyze any further. Now I've added a relative % computation, and a comparison of the -very small- price change between those two dates. Knowing that one month of new earnings data is quite unlikely to change the trailing twelve months (TTM) earnings by a lot, you can appreciate that the change of methodology is quite impactful on a P/E value (or an E/P value).

EDIT: there was a small mistake in the table being displayed... please check the corrected chart in the post below.
Last edited by siamond on Tue Aug 22, 2017 7:37 pm, edited 1 time in total.

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Re: Vanguard changed their way of computing PE ratios

Post by Doc » Tue Aug 22, 2017 4:36 pm

I don't understand.
siamond wrote:
Tue Aug 22, 2017 2:01 pm
Morningstar does it one way, S&P (and Prof. Shiller) does it another way, and Vanguard was using a third formula.
siamond wrote:
Tue Aug 22, 2017 2:01 pm
Long story short, Morningstar's way makes very little sense and is due to historical reasons, while S&P's way makes much more sense, and Vanguard's way, although a tad contorted, was actually mathematically equivalent to S&P.
Is Vanguard computing p/e's for funds other than their own? If not isn't it better to use a Morningstar to make comparisons between funds from different sponsors even if their method isn't the most rigorous?
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Tue Aug 22, 2017 4:46 pm

Doc wrote:
Tue Aug 22, 2017 4:36 pm
Is Vanguard computing p/e's for funds other than their own? If not isn't it better to use a Morningstar to make comparisons between funds from different sponsors even if their method isn't the most rigorous?
You're right, Vanguard only provides P/E for its own funds, so if you wish to compare with non-Vanguard funds, then better use Morningstar. But many of us (Bogleheads) solely use Vanguard funds, and it was appreciated to have more solid math for those, instead of the 'rosy' perspective provided by Morningstar and others. Notably for E/P computations, where the absolute result is of importance.

Just to be clear though, views do diverge on which methodology is the best, and the Morningstar's way has its supporters, this is a topic where lively debate occurred in the past. I have yet to read a convincing case for the M* way, but well, this is just me...

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Re: Vanguard changed their way of computing PE ratios

Post by Doc » Tue Aug 22, 2017 5:17 pm

siamond wrote:
Tue Aug 22, 2017 4:46 pm
Just to be clear though, views do diverge on which methodology is the best, and the Morningstar's way has its supporters, this is a topic where lively debate occurred in the past. I have yet to read a convincing case for the M* way, but well, this is just me...
M* has several "say what's" in their methodology. But since I do not use only Vanguard funds I opt for consistency over academic rigor. Since I'm usually interest in comparisons not absolute values based on past performance consistency is paramont.

Thanks for the info.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Vanguard changed their way of computing PE ratios

Post by Taylor Larimore » Tue Aug 22, 2017 5:26 pm

Siamond:

Thank you for an interesting report about how Vanguard is changing the way it computes Price/Earnings ratios.

One of the advantages to staying-the-course is that PE and other ratios are nearly meaningless for fund investors.
Stay the course. It is the most important single piece of investment wisdom I can give to you. -- Jack Bogle

Best wishes.
Taylor
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Re: Vanguard changed their way of computing PE ratios

Post by garlandwhizzer » Tue Aug 22, 2017 6:04 pm

The change in computing PEs is but one example of a broad trend in the financial industry to make stocks look more attractive by excluding bad things from data. EBIDA is another example. Estimated future earnings (used by Morningstar) is another. Who estimates these things? Those who sell and market stocks. Historically, estimated 12 month future earnings turn out be on average about 10% lower than what the real future earnings will be and there is a wide dispersion of results. Long term future earnings estimates (Morningstar) tend to be more inaccurate, often not worth the paper they're written on.

All these techniques are used in my opinion to promote increased sales and trading of stocks, something that generates profits, either from advertising dollars (Morningstar, financial media, etc,) or from the stock/fund/etf sales and trading. Another bit of chicanery involves accounting gimmicks and financial engineering to raise EPS and hence stock prices. In the distant past, GAAP earnings was the standard, negative earnings were not ignored in index PEs, and in general the level of painting lipstick on pigs was lower than today.

A modest sense of skepticism is IMO appropriate when evaluating financial data presented to us by those who can profit from it. Some of it is valuable but much of it is more marketing than insight. The market is not in dire straits now IMO, but when we were, in 1999 very few financial analysts suggested selling tech stocks in spite of their astronomical PE ratios, often with consistently negative earnings, nothing but a optimistic story to justify billions of cap weight in the dot.coms. In 2007-9, I can't recall anyone who warned investors to sell before the horrendous collapse started. Rather the mainstream financial firms and media seemed to believe the happy days would continue in both cases. Bogle was one of the very few who suggested moving from stocks to bonds when the tech bubble inflated. Buffett wasn't fooled either but their voices got lost in the chorus of optimistic noise.

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Re: Vanguard changed their way of computing PE ratios

Post by SimpleGift » Tue Aug 22, 2017 6:11 pm

siamond wrote:
Tue Aug 22, 2017 2:01 pm
b. Many people use PE quantities in a relative manner, comparing a given value to a frame of reference. This frame of reference is typically historical. Now when you change methodology, you totally mess up any such comparison.
Excellent investigative reporting, siamond, thanks.

Regarding historical P/E data and earnings yields: As long as S&P doesn't significantly change the way it calculates earnings, then the Shiller data (which uses S&P earnings) will be historically consistent and still a useful resource for the U.S. market as a whole. The real loss will be the ability to compare historical P/E data for individual Vanguard funds. It appears the Morningstar data and methodology will now be the only game in town for individual funds.
Cordially, Todd

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Re: Vanguard changed their way of computing PE ratios

Post by stlutz » Tue Aug 22, 2017 7:03 pm

I think etf.com is doing it the correct way (a.k.a. the S&P/Shiller/the way the other index providers do it way).
For example, for VIOV, they report a PE ratio of 163.67 (which is about what I would expect with the "S&P way" while Vanguard reports 21.9.

https://personal.vanguard.com/us/funds/ ... =INT#tab=2
http://www.etf.com/VIOV

Obviously etf.com only works for ETFs, but it is a good source for comparing ETFs from different providers (to address Doc's question).

I don't think there is nefarious intent by Vanguard, Morningstar etc. I think it's more a case that finance experts aren't necessarily the ones writing the requirements for these web pages. The proper way to calculate it is not the way most people would think of doing it if you asked for, "What is the average PE of XYZ fund?"

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Tue Aug 22, 2017 7:35 pm

stlutz wrote:
Tue Aug 22, 2017 7:03 pm
I think etf.com is doing it the correct way (a.k.a. the S&P/Shiller/the way the other index providers do it way).
Terrific! Yes, you are absolutely right. It so happens that prices didn't change much between end of May, end of June and now, so check the comparison below. I think this proves your point (and SCV is quite eye-popping!). This should help us mitigate Vanguard's unfortunate decision, and also addresses Doc's issue of being able to get the 'right' number for funds beyond Vanguard. Thank you!

Also, here is an article from ETF.com that briefly describes their methodology (yes, same as S&P/Shiller). The author (Dave Nadig) is CEO of ETF.com, so hopefully he will not easily change his mind about this. Interestingly enough, he was previously director of ETFs at FactSet Research Systems - which is used by ETF.com (and now Vanguard) to compile their data! Small world.

Image

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Wed Aug 23, 2017 7:41 pm

I got a quote from Vanguard's PR team about the topic, and they allowed me to reproduce it on our forum (much appreciated!). This addresses changes to the PE computation, as well as other changes of interest.
After careful consideration, we believe the methodology changes we’ve made, detailed below, will remove large outliers that may have an outsized impact on fund characteristics and/or cause large swings month over month. The changes align Vanguard with industry best practices. FactSet has proven to be an industry leader, providing best-in-class data and analytics services across the investment management industry.

P/E: Now excludes negative earnings
-April/May 2017 methodology: The P/E Ratio displayed included negative earnings.
-New methodology: P/E Ratio (excluding negative earnings) is now being displayed.

ROE: Now a weighted median and excludes outliers at +/- 4 std. deviations from the mean
-April/May 2017 methodology: A weighted average showing the 5-year average ROE for the 50% company by weight in the portfolio and benchmark.
-New methodology: A weighted median showing the 5-Year average ROE for the 50% company by weight in the portfolio and benchmark. Outliers are excluded at +/- 4 standard deviations from the mean.

EPS: Now excludes outliers at +/- 4 std. deviations from the mean
-April/May 2017 methodology: A weighted average of the 5-Year EPS Growth of all companies held within the fund or benchmark, using the annualized growth rate in earnings over the past 5 years. For companies without a 5 year history, a period of less than 5 years is used.
(yes, I know, it appears that a 'new methodology' bullet point is missing for the EPS explanation; will edit this post when I get the correction)

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Thu Aug 31, 2017 9:00 am

A couple of updates on this.

First, I updated our P/E wiki page according to the changes described by the Vanguard communication quoted in the previous post. I also added a reference to ETF.com, since IMHO it is now the most trusted source of information now that Vanguard moved to 'the dark side'... :?

I also obtained from the Vanguard PR team (thank you, thank you) all the historical PE numbers (with the old methodology) for the Vanguard funds listed in the Simba backtesting spreadsheet, and some other useful metrics (P/B, SEC Yield, ER, etc). I will document this in a separate thread after reformatting the information in a more digestible manner. I wish we could find a simpler way, but if we track the ETF.com PE numbers of corresponding Vanguard ETFs at the beginning of each new year, then we could keep a historical record with a continuous methodology.

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Thu Aug 31, 2017 9:29 am

Next, I know that MSCI keeps historical track of EPS and P/E information for their indices. Such data isn't publicly available, but companies like Star Capital provide useful CAPE computations derived from such MSCI data, e.g. in their Global Stock Market Valuation Ratios research.

Now this begs the question of which methodology is used by MSCI. When looking at this document (MSCI Fundamental Data Methodology, November 2013), er, well, this isn't too clear, but the couple of statements about negative earnings do NOT seem to be related to PE computations.

When looking to this older document (MSCI Methodology for Calculating Fundamental Data Ratios at Index Level, May 2006), it seems clear that they use the same methodology as S&P and prof. Shiller do (i.e. just add up relevant quantities, and do NOT filter securities with negative earnings). This is confirmed by this extract in the FAQ section:
Q. Can an index-level P/E or P/CE ratio be negative?
A. Yes. When one or a few dominant companies experience significant losses, this would make the P/E or
P/CE at the index-level negative. In these cases, the aggregate P/E or P/CE for that index (countrylevel
or industry–level as the case may be) is published as a negative number.
Now did they change their methodology along the way or since then, I am not sure... I tried to send an e-mail to the Star Capital folks for clarification, I'm sure they know, we'll see if I get an answer. From my past interactions with MSCI support, it is clear that they don't care much about nosy questions from non-subscribers, so I won't even try that... :(

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Mon Sep 04, 2017 6:21 am

Got a gracious answer from Star Capital (from Norbert Keimling himself). He stated the following:
I’m pleased that you are interested in our research. MSCI also includes negative earnings. In my opinion that’s very important because companies have some flexibility to increase or decrease earnings numbers for some time. For that reason I think an average of the last years with good and bad years is more representative than an average without bad years.

If we calculate ratios we use the Shiller approach.
Ok, so MSCI continues to do the right thing (imho), and the Star Capital Global Valuations Web page provides such information while adding the CAPE computation to more basic metrics like P/E, P/B, etc. Cool.

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Re: Vanguard changed their way of computing PE ratios

Post by Calculon » Sun Nov 05, 2017 5:58 pm

For those of us who want to continue using P/E ratios that include companies with negative earnings, does anyone know a source of this information for Vanguard's mutual funds (i.e. not ETFs?). I've been tracking the P/E for several Vanguard funds and not every fund has an ETF equivalent; this is particularly common for their actively managed funds.

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Sun Nov 05, 2017 6:50 pm

Calculon wrote:
Sun Nov 05, 2017 5:58 pm
For those of us who want to continue using P/E ratios that include companies with negative earnings, does anyone know a source of this information for Vanguard's mutual funds (i.e. not ETFs?). I've been tracking the P/E for several Vanguard funds and not every fund has an ETF equivalent; this is particularly common for their actively managed funds.
I fear that you're out of luck for such a case.

It completely boggles my mind that Vanguard gets away with this terribly inappropriate change without even issuing a press release (I asked!), or providing a simple mitigation like documenting the sum of the earnings on a Web page (I asked!), or getting a hard time from a bunch of financial bloggers/writers (only one did afaik, as previously documented on this thread).

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Re: Vanguard changed their way of computing PE ratios

Post by BlueEars » Sun Nov 05, 2017 7:21 pm

I got in the habit of recording VG's PE data roughly annually. Here is the data:

Image

Just saw this thread and now I know why the major changes occurred. Thanks.
It looks like this really affected the SV and SG funds.

Maybe this illustrates the difficulty in making too much of historical comparisons? Price charts are one thing, valuation quite another.

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Re: Vanguard changed their way of computing PE ratios

Post by Taylor Larimore » Sun Nov 05, 2017 9:16 pm

Calculon wrote:
Sun Nov 05, 2017 5:58 pm
For those of us who want to continue using P/E ratios that include companies with negative earnings, does anyone know a source of this information for Vanguard's mutual funds (i.e. not ETFs?). I've been tracking the P/E for several Vanguard funds and not every fund has an ETF equivalent; this is particularly common for their actively managed funds.
Calculon:

Welcome to the Bogleheads Forum!

Many years ago I diligently tracked P/E ratios (there are many kinds) in the belief that I could use the ratios for market-timing purposes. No more! Now I enjoy a comfortable retirement with a simple three-fund portfolio. The Three-Fund Portfolio
Stay the course. No matter what happens, stick to your program. I've said "Stay the course" a thousand times, and I meant it every time. It is the most important single piece of investment wisdom I can give to you. -- John C. Bogle in "Common Sense on Mutual Funds"
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Sun Nov 05, 2017 9:50 pm

BlueEars wrote:
Sun Nov 05, 2017 7:21 pm
Maybe this illustrates the difficulty in making too much of historical comparisons? Price charts are one thing, valuation quite another.
Well, this certainly makes the point that one has to use data series using a consistent methodology, e.g. like Prof. Shiller does. Unfortunately, it appears that Vanguard totally missed that point, and just catered to Morningstar. This is unfortunate to say the least.
Taylor Larimore wrote:
Sun Nov 05, 2017 9:16 pm
Many years ago I diligently tracked P/E ratios (there are many kinds) in the belief that I could use the ratios for market-timing purposes. No more!
Taylor, nobody on this thread mentioned P/E in the context of market timing. John Bogle doesn't use it in such a way, Dr Bernstein doesn't either. Neither do I. I don't know why you're making an inference that somebody looking at a metric like P/E is automatically guilty of market timing, but that is not the case. I think we all learned our lesson in this respect.

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Re: Vanguard changed their way of computing PE ratios

Post by Taylor Larimore » Sun Nov 05, 2017 10:21 pm

Taylor, nobody on this thread mentioned P/E in the context of market timing. John Bogle doesn't use it in such a way, Dr Bernstein doesn't either. Neither do I. I don't know why you're making an inference that somebody looking at a metric like P/E is automatically guilty of market timing, but that is not the case. I think we all learned our lesson in this respect.
saimond:

What do you use Price/Earnings ratios for?

Thank you and best wishes.
Taylor
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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Sun Nov 05, 2017 10:33 pm

Taylor Larimore wrote:
Sun Nov 05, 2017 10:21 pm
What do you use Price/Earnings ratios for?
Mostly to compute expected returns (as a probabilistic quantity), which help in turn for mid/long-term financial planning. Very similar to what our mentors do. Numerous people on this forum do something similar. I personally use E/P more than P/E in such context, as I mentioned in the first post.

I also used P/E historical data series multiple times to *disprove* market timing and tactical asset allocation approaches. Factually disproving such ideas is much more powerful than just asserting that it's a bad idea. This requires a consistent data series though.

This thread is about Vanguard's (change of) methodology to compute such ratios though, not quite about the various possible ways (good, bad, debatable, etc) to use them.

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Re: Vanguard changed their way of computing PE ratios

Post by Taylor Larimore » Sun Nov 05, 2017 10:36 pm

siamond:

I think I understand.

Thank you and best wishes.
Taylor
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Re: Vanguard changed their way of computing PE ratios

Post by 2015 » Mon Nov 06, 2017 12:31 pm

Taylor Larimore wrote:
Sun Nov 05, 2017 9:16 pm
Calculon wrote:
Sun Nov 05, 2017 5:58 pm
For those of us who want to continue using P/E ratios that include companies with negative earnings, does anyone know a source of this information for Vanguard's mutual funds (i.e. not ETFs?). I've been tracking the P/E for several Vanguard funds and not every fund has an ETF equivalent; this is particularly common for their actively managed funds.
Calculon:

Welcome to the Bogleheads Forum!

Many years ago I diligently tracked P/E ratios (there are many kinds) in the belief that I could use the ratios for market-timing purposes. No more! Now I enjoy a comfortable retirement with a simple three-fund portfolio. The Three-Fund Portfolio
Stay the course. No matter what happens, stick to your program. I've said "Stay the course" a thousand times, and I meant it every time. It is the most important single piece of investment wisdom I can give to you. -- John C. Bogle in "Common Sense on Mutual Funds"
Best wishes.
Taylor
+1
Calculon, fortunately, I will never have to regret the minutes, hours, or days I wasted tracking something as meaningless to me as p/e ratios as I've never done it. I don't have to as I have a basic 3 fund PF courtesy of the advice of Taylor and others. As a result of not fiddling, my PF, on its own and without meddling from me, is worth more than I ever projected it would be. I, too, am enjoying a very comfortable and enjoyable retirement focusing on things that matter to me like making this the most fulfilling time of my life.

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Re: Vanguard changed their way of computing PE ratios

Post by siamond » Mon Nov 06, 2017 1:18 pm

BlueEars wrote:
Sun Nov 05, 2017 7:21 pm
Just saw this thread and now I know why the major changes occurred. Thanks.
It looks like this really affected the SV and SG funds.
Sorry, I missed this observation. Yes, you are absolutely right. The smart guy from Seeking Alpha who figured it out before anybody else had the very exact same observation. And we had another thread on this forum where we were scratching our heads about SV and SG too. Welcome to the club! :wink:

I think this is symptomatic of the fact that there are probably more companies with negative earnings in such 'Small' categories, and the difference in methodology therefore becomes much more apparent. And that's quite annoying, because SV is an important component in many Bogleheads portfolios. Now, in a time of deep crisis (e.g. 2008-like), this will clearly impact all large indices/funds as well...

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