Strengths/Weaknesses of Market Cap and Value Strategies

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Park
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Strengths/Weaknesses of Market Cap and Value Strategies

Post by Park » Sat May 26, 2018 11:09 am

Every strategy has strengths and weaknesses. People I respect often combine a market cap strategy and a value strategy. Such diversification can make sense, because of differences in strengths and weaknesses between strategies. When I refer to a value strategy, I mean a quantitative value strategy.

The following are some strengths of a market cap strategy:
tax efficient
cost efficient
no capacity/scalability issues
investment products are readily available
if done in a cost effective manner, very likely to outperform the average investor; this outperformance will likely increase with time
easier to compare market cap investment products; they are like commodities, and tracking error can be very informative
a market cap strategy is the simpler of the two with the fewest moving parts. That is an virtue in itself.

The following is some weaknesses of a market cap strategy:
tend to own more of what's overpriced and less of what's underpriced; this leads to exposure to bubbles. An example would be late 1989. A world market cap stock strategy would have had about 40% exposure to the Japanese stock market. At that time, the Japanese stock market had a CAPE of around 90, and not surprisingly has done poorly since.
There are those who would say it is less diversified according to factors. A market cap strategy is a bet on beta alone. This relates to what was written in the last paragraph.

The following are some strengths of a value strategy:
may have less sensitivity to bubbles. In the 2000 bear market, value had less of a bear market than an index strategy
might outperform a market cap strategy

The following are some weaknesses of a value strategy
tracking error from the index and possible associated behavioral issues.
investment products may not be available
higher cost
tend to be less tax efficient
may be higher risk - in the Depression, small cap value did the worst of the 4 categories of size and value
unclear whether there is a large cap value premium
may be becoming a crowded trade: if so, may not outperform a market cap strategy on a precost/pretax basis. On a postcost/posttax basis, may underperform a market cap strategy
not everyone can be a value investor; there are capacity/scalability issues
concentration risk - tendency to be less diversified by the number of stocks
more difficult to compare value investment products; which product has the best strategy and best implementation?
an assumption of a value strategy is that value investors are smarter than investors as a whole. Market cap indices reflect the consensus of all investors. To assume that you are smarter than the market may be a manifestation of overconfidence, which is a common behavioral problem.

I'm uncertain what % market cap and what % value I should use. 100% market cap? 100% value? Somewhere in between?

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by heyyou » Sat May 26, 2018 2:42 pm

Either one could do well enough if you stay with it long enough. A mixture is better for me with my mixed set of behavioral finance biases, and that has done well for the last 40 years. Your goal could be, not whatever will do the best which will always be unknown, but whatever suits you the best now, perhaps with future changes. Also, saving more is easily the best way to grow your portfolio, while the specific allocation is noticeably less important.

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by galeno » Sat May 26, 2018 10:24 pm

Before we become a Bogleheads in 2006 our 80% equity allocation used 12 to 16 individual stocks. Most of those were in the MCV and SCV categories.

I still believe today that if one wants to try to beat the market these two categories are where one should go fishing for out-performing stocks.

I completely agree with the OP.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by JoMoney » Sat May 26, 2018 11:49 pm

Park wrote:
Sat May 26, 2018 11:09 am
...
The following is some weaknesses of a market cap strategy:
tend to own more of what's overpriced and less of what's underpriced; this leads to exposure to bubbles
...
The following are some strengths of a value strategy:
may have less sensitivity to bubbles. In the 2000 bear market, value had less of a bear market than an index strategy
...
I think that's among the delusions people who believe in quantitative value style strategies have. The valuation metrics being used do not tell you whether or not a companies stock is mispriced. As has been evident in the value/growth styles over the past decade +, the higher valuation multiple "growth" style strategies were under-priced relative to the lower valuation multiple but evidently over-priced "value" style strategies.
Also, while growth and momentum style strategies may be more susceptible to "bubbles", value and mean-reversion style strategies are susceptible to value-traps and "rebalancing into oblivion". It's hard to imagine getting into too much trouble with a diversified value fund, but I've witnessed first hand someone losing a fortune chasing a falling knife selling more and more of their good assets chasing something that never recovers. Momentum and trend-following styles have their own weaknesses, but are saved from the "Gambler's fallacy" issue that persuades value/mean-reversion strategies to double-down after a loss. Trend-followers actually poke fun at that, with the saying "losers average losers".

Although a broad-market, buy and hold, market-cap weighted, strategy is the typical opposition strategy to "value" style investing on this board, it's not really the opposite side of the coin. You'd find those same people arguing against the "growth" style if that was the discussion.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by DaufuskieNate » Sun May 27, 2018 8:14 am

Park wrote:
Sat May 26, 2018 11:09 am
I'm uncertain what % market cap and what % value I should use. 100% market cap? 100% value? Somewhere in between?
Your post demonstrates that you have invested time studying these strategies. Now you are asking the critical question. Some suggestions:

1) How concerned are you with tracking error? If this is a key concern, then go no further and simply invest in the market.
2) Make your decision based on evidence. If your strategy is based on things like "faith" and "belief", you will find it difficult to stay the course through periods of underperformance.
3) Don't look for the answer in the opinions of others. If your strategy is based on the opinions of others, you will find it difficult to stay the course through periods of underperformance.
4) Keep studying the evidence until you can build conviction in your chosen strategy. In the meantime, invest in the market.

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Sun May 27, 2018 9:14 am

JoMoney wrote:
Sat May 26, 2018 11:49 pm
Park wrote:
Sat May 26, 2018 11:09 am
...
The following is some weaknesses of a market cap strategy:
tend to own more of what's overpriced and less of what's underpriced; this leads to exposure to bubbles
...
The following are some strengths of a value strategy:
may have less sensitivity to bubbles. In the 2000 bear market, value had less of a bear market than an index strategy
...
I think that's among the delusions people who believe in quantitative value style strategies have. The valuation metrics being used do not tell you whether or not a companies stock is mispriced. As has been evident in the value/growth styles over the past decade +, the higher valuation multiple "growth" style strategies were under-priced relative to the lower valuation multiple but evidently over-priced "value" style strategies.
Also, while growth and momentum style strategies may be more susceptible to "bubbles", value and mean-reversion style strategies are susceptible to value-traps and "rebalancing into oblivion". It's hard to imagine getting into too much trouble with a diversified value fund, but I've witnessed first hand someone losing a fortune chasing a falling knife selling more and more of their good assets chasing something that never recovers. Momentum and trend-following styles have their own weaknesses, but are saved from the "Gambler's fallacy" issue that persuades value/mean-reversion strategies to double-down after a loss. Trend-followers actually poke fun at that, with the saying "losers average losers".
my understanding is that in quantitative value, understood as a form of factor investing (as opposed to value perfromed by analysing individual stocks, as Ben Graham did) you invest in many stocks that as a whole are underpriced; so even though some of them may never recover, statistically if you invest in say the 10 or 20% cheaper stocks of the market (as measured by some metric like P/CF or P/E or P/B); these are likely to outperform as a whole, over the long haul. It's like saying that taller people will on average be better basketball players, though some indivudal tall person might in fact be terrible at it. The person you mentioned seems to have invested a big sum in one single stock, which is a mistake (unless you are as good as Ben Graham or Buffett at value investing - and even they have made mistakes).
Momentum investing that you mention seems to be a good strategy complementary to value, though it has other issues when appled to individual stocks, such as high turnover.
In Europe we have a Vanguard momentum fund called VMOM in which I am tempted to invest, but they only have 30M$ of AUM so I am worried they will delist the ETF....
When everyone is thinking the same, no one is thinking at all

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Sun May 27, 2018 9:22 am

Park wrote:
Sat May 26, 2018 11:09 am
Every strategy has strengths and weaknesses. People I respect often combine a market cap strategy and a value strategy. Such diversification can make sense, because of differences in strengths and weaknesses between strategies. When I refer to a value strategy, I mean a quantitative value strategy.

The following are some strengths of a market cap strategy:
tax efficient
cost efficient
no capacity/scalability issues
investment products are readily available
if done in a cost effective manner, very likely to outperform the average investor; this outperformance will likely increase with time
easier to compare market cap investment products; they are like commodities, and tracking error can be very informative
a market cap strategy is the simpler of the two with the fewest moving parts. That is an virtue in itself.

The following is some weaknesses of a market cap strategy:
tend to own more of what's overpriced and less of what's underpriced; this leads to exposure to bubbles. An example would be late 1989. A world market cap stock strategy would have had about 40% exposure to the Japanese stock market. At that time, the Japanese stock market had a CAPE of around 90, and not surprisingly has done poorly since.
There are those who would say it is less diversified according to factors. A market cap strategy is a bet on beta alone. This relates to what was written in the last paragraph.

The following are some strengths of a value strategy:
may have less sensitivity to bubbles. In the 2000 bear market, value had less of a bear market than an index strategy
might outperform a market cap strategy

The following are some weaknesses of a value strategy
tracking error from the index and possible associated behavioral issues.
investment products may not be available
higher cost
tend to be less tax efficient
may be higher risk - in the Depression, small cap value did the worst of the 4 categories of size and value
unclear whether there is a large cap value premium
may be becoming a crowded trade: if so, may not outperform a market cap strategy on a precost/pretax basis. On a postcost/posttax basis, may underperform a market cap strategy
not everyone can be a value investor; there are capacity/scalability issues
concentration risk - tendency to be less diversified by the number of stocks
more difficult to compare value investment products; which product has the best strategy and best implementation?
an assumption of a value strategy is that value investors are smarter than investors as a whole. Market cap indices reflect the consensus of all investors. To assume that you are smarter than the market may be a manifestation of overconfidence, which is a common behavioral problem.

I'm uncertain what % market cap and what % value I should use. 100% market cap? 100% value? Somewhere in between?
I find your post very good. I think there are two ways in which you can apply value investing using Etfs, as you discuss in your OP. 1) It can be through a value Etf, or 2) it may be by overweighting the geographical regions with lower CAPE (in this case you can use a market cap based Etf for each region, but you would have more EM and Europe and less US say).
I do both strategies. I have 25% of my stocks in value and SCV funds; the rest is in market cap weighted ETFs for different geographical regions (which have the advantage of the being the cheapest products) but with those Etfs I overweight places like EM or Europe, particularly Italy and Spain, so it's still a value strategy as it is informed by considerations such as CAPE.
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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by patrick013 » Sun May 27, 2018 11:57 am

Park wrote:
Sat May 26, 2018 11:09 am
I'm uncertain what % market cap and what % value I should use. 100% market cap? 100% value? Somewhere in between?
Everybody has their day. There have been decades where growth was better
than value and vice-versa. There have been decades where LC was better,
decades where MC was better, and decades where SC was better.

So I would likely have a mix of LC general index, MC general index, and a SC
general index. General index meaning one that has growth and value stocks.

Market cap is fine especially looking at MC and SC performance. For LC equal
weighting has had some good periods, but market cap weighting has not been
dethroned. Ticker VOO (S&P 500) is actually beating ticker RSP (S&P 500 equal
weight) for the last 5 years for example.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Prospero » Sun May 27, 2018 2:27 pm

Thanks for the summary on market cap and value tilt. That was a good read.

I can't tell you how far you should tilt. A lot of it is down to your attitude to risk.

If it helps, my asset allocation is 60% equity and 40% bonds.
I'm in my mid 30's so this is a very conservative allocation. Because it is so conservative I feel I can be riskier on the equity side.


So my equity (60%) split is:
  • Global large cap (20%)
  • Global small cap (20%)
  • Global value (20%)
Bill Bernstein wrote convincingly about the small and value tilt in his Intelligent Asset Allocator book. I don't know what will happen in the future so I hope with a diversified mix both geographically and in type (large/small/value/growth) something has got to go well.

I don't favour 100% this or 100% that. I think that's pretty crazy.

P

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by heyyou » Sun May 27, 2018 4:06 pm

Ticker VOO (S&P 500) is actually beating ticker RSP (S&P 500 equal weight) for the last 5 years for example.
That is from the largest of the Large Growth stocks to which I prefer to have less, but not zero, exposure, ever since the year 2000 Crash of those oversized overgrown Large Caps. Again, there is a whole spectrum of allocations that will be good enough in the long term.

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JoMoney
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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by JoMoney » Sun May 27, 2018 8:20 pm

Lauretta wrote:
Sun May 27, 2018 9:14 am
JoMoney wrote:
Sat May 26, 2018 11:49 pm
Park wrote:
Sat May 26, 2018 11:09 am
...
The following is some weaknesses of a market cap strategy:
tend to own more of what's overpriced and less of what's underpriced; this leads to exposure to bubbles
...
The following are some strengths of a value strategy:
may have less sensitivity to bubbles. In the 2000 bear market, value had less of a bear market than an index strategy
...
I think that's among the delusions people who believe in quantitative value style strategies have. The valuation metrics being used do not tell you whether or not a companies stock is mispriced. As has been evident in the value/growth styles over the past decade +, the higher valuation multiple "growth" style strategies were under-priced relative to the lower valuation multiple but evidently over-priced "value" style strategies.
Also, while growth and momentum style strategies may be more susceptible to "bubbles", value and mean-reversion style strategies are susceptible to value-traps and "rebalancing into oblivion". It's hard to imagine getting into too much trouble with a diversified value fund, but I've witnessed first hand someone losing a fortune chasing a falling knife selling more and more of their good assets chasing something that never recovers. Momentum and trend-following styles have their own weaknesses, but are saved from the "Gambler's fallacy" issue that persuades value/mean-reversion strategies to double-down after a loss. Trend-followers actually poke fun at that, with the saying "losers average losers".
my understanding is that in quantitative value, understood as a form of factor investing (as opposed to value perfromed by analysing individual stocks, as Ben Graham did) you invest in many stocks that as a whole are underpriced; so even though some of them may never recover, statistically if you invest in say the 10 or 20% cheaper stocks of the market (as measured by some metric like P/CF or P/E or P/B); these are likely to outperform as a whole, over the long haul. It's like saying that taller people will on average be better basketball players, though some indivudal tall person might in fact be terrible at it. The person you mentioned seems to have invested a big sum in one single stock, which is a mistake (unless you are as good as Ben Graham or Buffett at value investing - and even they have made mistakes).
Momentum investing that you mention seems to be a good strategy complementary to value, though it has other issues when appled to individual stocks, such as high turnover.
In Europe we have a Vanguard momentum fund called VMOM in which I am tempted to invest, but they only have 30M$ of AUM so I am worried they will delist the ETF....
Yes, the example I gave was an extreme case, and I specifically said that I doubt a diversified fund would have that much trouble.
Over the past 12+ years someone who purchased stocks cheaper on valuation metrics like you mentioned underperformed.
Value style strategies are essentially mean-reversion strategies buying stocks when there values fall, and trading them if/when their value rises. Momentum isn't just "complementary" it's essentially the opposite strategy, buying things as they rise and selling them when they fall. There is another active style, that essentially tries to combine the extremes, it used to be called "GARP - Growth At a Reasonable Price" but in the new factor paradigm is probably some notion of combining these opposing "factors". They all have compelling "stories" by the people selling them, but in aggregate these active styles don't beat each other over the long term (but might skew differently in the way their performance seem to manifest, and might have different weakness).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Alexa9 » Sun May 27, 2018 8:35 pm

The funds I like are:
VTI : Total US
VXUS : Total International
VBR : Small Value (at least 15% or it's insignificant)
VSS : Small International (at least 15%)
If I was a factor guru, I would find a way to use DFA.

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Park » Sun May 27, 2018 11:35 pm

As JoMoney has pointed out, there is the value trap risk of value investing. Quantitative value tend to use historical data, but market prices are predictions of the future. That may be why DFA started screening out stocks with negative momentum, when it came to picking value stocks.

Also, you're taking sector concentration risk with value investing. That risk reared its head in 2007 in the financial sector.

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Mon May 28, 2018 12:48 am

JoMoney wrote:
Sun May 27, 2018 8:20 pm

Value style strategies are essentially mean-reversion strategies buying stocks when there values fall, and trading them if/when their value rises. Momentum isn't just "complementary" it's essentially the opposite strategy, buying things as they rise and selling them when they fall.
Well they are not the opposite (to screen for value you use valuation metrics, to screen for momentum you look at trends, i.e. at price (or earnings) momentum); the strategies have very differnt time horizons, with momentum having a much higher turnover. In fact they can be combined, e.g. by buying value stocks only when their momentum turns positive, and then keeping them in your portfolio even when they are no longer undervalued if their momentum signal is still positive (and that's what one of my funds does):
https://gersteinfisher.com/wp-content/u ... m_JOIM.pdf
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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by JoMoney » Mon May 28, 2018 1:44 am

Lauretta wrote:
Mon May 28, 2018 12:48 am
JoMoney wrote:
Sun May 27, 2018 8:20 pm

Value style strategies are essentially mean-reversion strategies buying stocks when there values fall, and trading them if/when their value rises. Momentum isn't just "complementary" it's essentially the opposite strategy, buying things as they rise and selling them when they fall.
Well they are not the opposite (to screen for value you use valuation metrics, to screen for momentum you look at trends, i.e. at price (or earnings) momentum); the strategies have very differnt time horizons, with momentum having a much higher turnover. In fact they can be combined, e.g. by buying value stocks only when their momentum turns positive, and then keeping them in your portfolio even when they are no longer undervalued if their momentum signal is still positive (and that's what one of my funds does):
https://gersteinfisher.com/wp-content/u ... m_JOIM.pdf
Growth/Value or Momentum/Mean-Reversion are opposite strategies, but as I acknowledged in the post, people do try to combine aspects of them, and the modern factor version of this active strategy trying to combine them has echoes of the "GARP" investing strategy Peter Lynch popularized in decades past.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Mon May 28, 2018 3:08 am

JoMoney wrote:
Mon May 28, 2018 1:44 am

Growth/Value or Momentum/Mean-Reversion are opposite strategies, but as I acknowledged in the post, people do try to combine aspects of them, and the modern factor version of this active strategy trying to combine them has echoes of the "GARP" investing strategy Peter Lynch popularized in decades past.
Ok I don't want to argue this further, it's probably a question of how you use the word 'opposite'. You also seem to use the word growth and momentum interchangeably, whereas of course they are quite different things.
Anyway, for people who are not familiar with how these strategies are concretely implemented, value and momentum do sound like the opposite thing (in value you buy a stock (usually) when the price has gone down, in momentum you buy when it's gone up). But that's about as far as it goes; if you look at how you screen for stocks in the 2 strategies, you will realise that they are implemented quantitatively using completely different parameters (valuation metrics on one side, technical analysis on the other). So it doesn't make any sense to me to say that one is the opposite of the other. You can have value stocks with a high momentum score and conversely you can have expensive stocks with negative momentum.
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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by JoMoney » Mon May 28, 2018 4:20 am

Lauretta wrote:
Mon May 28, 2018 3:08 am
JoMoney wrote:
Mon May 28, 2018 1:44 am

Growth/Value or Momentum/Mean-Reversion are opposite strategies, but as I acknowledged in the post, people do try to combine aspects of them, and the modern factor version of this active strategy trying to combine them has echoes of the "GARP" investing strategy Peter Lynch popularized in decades past.
Ok I don't want to argue this further, it's probably a question of how you use the word 'opposite'. You also seem to use the word growth and momentum interchangeably, whereas of course they are quite different things.
Anyway, for people who are not familiar with how these strategies are concretely implemented, value and momentum do sound like the opposite thing (in value you buy a stock (usually) when the price has gone down, in momentum you buy when it's gone up). But that's about as far as it goes; if you look at how you screen for stocks in the 2 strategies, you will realise that they are implemented quantitatively using completely different parameters (valuation metrics on one side, technical analysis on the other). So it doesn't make any sense to me to say that one is the opposite of the other. You can have value stocks with a high momentum score and conversely you can have expensive stocks with negative momentum.
A "Growth" style fund typically selects stocks that are higher price/metric under the presumption that they offer more growth potential
A "Value" style fund typically selects stocks that are lower in price/metric under the presumption that they're "cheap"

A "Momentum" investing strategy is one that selects based on a hope that some criteria will continue on the trend it's been on.
A "Mean-reversion" investing strategy is one that selects based on a hope that some criteria that has strayed from it's prior course will revert back.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Mon May 28, 2018 5:27 am

JoMoney wrote:
Mon May 28, 2018 4:20 am

A "Momentum" investing strategy is one that selects based on a hope that some criteria will continue on the trend it's been on.
A "Mean-reversion" investing strategy is one that selects based on a hope that some criteria that has strayed from it's prior course will revert back.
I have some trouble understanding what you're saying.
some criteria that has strayed from it's prior course will revert back
which 'criteria' (or perhaps criterion (?) since you then use the verb 'has') do you mean?
what do you mean by 'its prior course'? What course?
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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by JoMoney » Mon May 28, 2018 6:32 am

Lauretta wrote:
Mon May 28, 2018 5:27 am
JoMoney wrote:
Mon May 28, 2018 4:20 am

A "Momentum" investing strategy is one that selects based on a hope that some criteria will continue on the trend it's been on.
A "Mean-reversion" investing strategy is one that selects based on a hope that some criteria that has strayed from it's prior course will revert back.
I have some trouble understanding what you're saying.
some criteria that has strayed from it's prior course will revert back
which 'criteria' (or perhaps criterion (?) since you then use the verb 'has') do you mean?
what do you mean by 'its prior course'? What course?
The criterion/criteria that's being looked at isn't the relevant part, it could be price movement alone, it could be the price to bubble-gum ratio, it could be relative strength compared to something else, or any number of other things. It's 'course' that's it's seen to have diverged from could also be any number of things, it could be a moving average, some specific threshold, GDP growth, etc...
The point is that under one strategy the expectation is that things going up will continue going up (or that those going down will continue to go down), and the other strategy is expecting that things going down will start heading up (and the things heading up will start turning down).
As far as I can tell, these strategies "Momentum" and "Mean-reversion" are opposites.
What do you think the opposing strategy of a "momentum" trader is doing?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Lauretta » Mon May 28, 2018 7:28 am

JoMoney wrote:
Mon May 28, 2018 6:32 am



The point is that under one strategy the expectation is that things going up will continue going up (or that those going down will continue to go down), and the other strategy is expecting that things going down will start heading up (and the things heading up will start turning down).
As far as I can tell, these strategies "Momentum" and "Mean-reversion" are opposites.
What do you think the opposing strategy of a "momentum" trader is doing?
Well to me the opposite strategy to that of a 'momentum' trader (if you define her as someone who buys stock with the highest relative price momentum) is to buy stocks with the lowest relative momentum - which in the past has been a losing strategy.

In the other sentence you speak of
things going down
and
heading up
but momentum and value measure different things (and have different time horizons). To limit the discussion to relative momentum applied to individual stocks, price momentum measures the rate of change in price of stocks over a given look-back period and selects those with the higher relative momentum. Those stocks in the past have statistically outperformed the rest, during the following months. Typically every month a momentum trader has look again at the relative momentum of stocks, sell those whose momentum over the new look-back period has decreased, and buy the new ones with the highest momentum. So it's a high turnover strategy.
When people speak of value of mean reversion, they look at valuation metrics instead (and not at the rate of change with time of price (or earnings)). So they are measuring a different quantity. It's the valuations, such as P/E ratios (or CAPE for a whole market) that are expected to revert to the mean. Also, this process has a much longer time horizon; value investors typically hold stocks for several years and have a much lower turnover.
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Park
Posts: 690
Joined: Sat Nov 06, 2010 4:56 pm

Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Park » Sat Jun 02, 2018 10:15 am

I think market cap indexing and value are both good strategies. For retail investors, the default option should be market cap indexing. Only if you've spent some time learning about value investing, should you use it. And even then, value investing products may not be available. If they are, they may not be cost and tax efficient. Or they may be designed with scalability in mind, so you get a comparatively weak value exposure.

If you truly want a strong exposure to value, a DIY approach is an reasonable option, but only if you're willing to spent a lot of time learning about it. And there will be the ongoing time commitment to maintaining your portfolio.

snarlyjack
Posts: 780
Joined: Fri Aug 28, 2015 12:44 pm
Location: Montana

Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by snarlyjack » Sat Jun 02, 2018 7:26 pm

Strengths & Weaknesses of Market Cap & Value Strategies...

I consider myself a dividend investor (growth & value) but more value.

One of the strengths of the dividend/value strategy is I plan to hold forever.
I' am a young guy & I plan to hold for 70/80 years without selling.

My portfolio looks like this:
1). Large Cap. Value.
2). Medium Cap. Value.
3). Small Cap. Value.

I understand the value strategy. I can hold these forever & collect the
dividend along the way.

The disadvantage is... dividends are taxed.

Topic Author
Park
Posts: 690
Joined: Sat Nov 06, 2010 4:56 pm

Re: Strengths/Weaknesses of Market Cap and Value Strategies

Post by Park » Sun Oct 21, 2018 3:05 pm

When it comes to whether the value premium is risk based or not, I"ve tended to think it isn't risk based. But the following should be considered:

http://www.efficientfrontier.com/ef/999/noise.htm

From William Bernstein:

"during the Great Depression value investing was indeed riskier than growth investing. From January 1929 to July 1932 large value stocks lost 85.6% versus "only" 80.0% for large growth stocks. For small stocks, though, the situation was reversed, with small growth losing 98.1% and small value stocks losing "only" 90.0%."

https://investment-fiduciary.com/2011/0 ... d-returns/

The following data looks like it is nominal US stock data from 1927-2010, although it isn't explicitly stated:

Table 2: Small Cap and Large Cap Historical Risk

Worst1 year Worst5 years Worst10 years Worst20 years
Small Cap Value Index -60.6 -24.9 -7.5 2.4
Large Cap Value Index -53.1 -21.7 -5 3.3
Small Cap Growth Index -45.1 -19 -2.5 2.0
Large Cap Growth Index -43.7 -15 -4.1 3.0

Of the 4 categories, small value has the worst 1 year, 5 year and 10 year returns. Small value's worst 5 year return is -24.9% vs. -15% for large growth. Small value's worst 10 year return is -7.5% vs. -4.1% for large growth.

My guess is that the worst returns for small value are around the time of the Depression. There was deflation at that time, and deflation hurts those with more leverage. Small value tends to be more levered.

With fiat currencies, you can make the case that significant deflation is unlikely.

Nevertheless, the data would suggest that small value is not without risk.

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