FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

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Lauretta
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FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 12:47 am

In a previous post I expressed my doubts about market cap weighted indexing viewtopic.php?f=10&t=248220
and explained why to me equal weighting seems a more logical approach.

Since writing that post, I have seen other convincing arguments against market cap weighting, such as this :
In only two years since the S&P 500 went to a capitalization-weighting composition in 1988, was a top ten weighted stock at the end of the previous year a top ten performer in the following year (1995 (Microsoft) and 2008 (Wal-Mart)).
as well as this paper:
https://us.spindices.com/documents/rese ... ndices.pdf

However, following Marchinne's sudden death yesterday, having seen Fiat's stock (making up nearly 6% of MSCI Italy) drop 15% in less than an hour, I have thought of still another argument against market cap weighting: the risk of death of the CEO or of a key person in the firm. Death is both certain and indefinite (since Marchionne studied philosphy I thought I'd quote Heidegger on this ;-) ) meaning that it could happen anytime. A lot of big stocks (such as Amazon or Tesla) have a valuation which is highly dependent on a particular person being alive, and by market cap weighting (i.e. concentrating one's wealth in these big stocks) one is more vulnerable to the eventuality of their death than if one were doing equal weighting.

Does this makes sense to you or do you have any counter-arguments to this?
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by TIAX » Thu Jul 26, 2018 1:01 am

If you want to tilt small, just do that. Equal-weight indexes are an inefficient way of capturing the small premium.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Theoretical » Thu Jul 26, 2018 1:08 am

Here's a nice cheap way to get it:

http://portfolios.morningstar.com/fund/ ... ture=en-US - SPDR Portfolio Mid Cap - It's the S&P 1000, which is cap weighted mid and small cap. The single largest holding is .48% of the fund. If you want to see how it did historically, use 70% IJH and 30% IJR.

Ignore the turnover rate, as that's coming from its change of indexes last year. The S&P 400 had a turnover of 10% and the 600 of 12%.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by david1082b » Thu Jul 26, 2018 1:21 am

From the S&P PDF:
Annual Outperformance of Equal-Weight Indices

S&P SmallCap 600® 0.2%
In 2010 an ETF called $EWSC appeared that followed the equal-weight smallcap 600: http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

Not exactly outperformance since then, more like massive underperformance.
Past performance is no guarantee of future results.
Well indeed. I have never seen anyone promote $EWSC as something they'd want to do. Equal-weighting the S&P 500 gets mentioned every week here pretty much, I guess because the equal-weight S&P 500 ETF $RSP had a better track record than $EWSC. This looks like performance chasing more than anything to me. If equal-weight S&P 500 doesn't outperform in future it will just be forgotten about like so many other strategies that once outperformed. Then new strategies will appear in hindsight for people to put their money into.

As for Fiat being 6% of Italy, this is one more good argument for a globally-diverse portfolio, since the biggest stock in the world makes up much less than 6% of a global stock index. Of course, USA is 50% of a global index due to cap-weighting, and what if you want to equal-weight each nation? iShares ETFs are the answer perhaps, since iShares seems to have a mission to have an ETF for every nation in the world -- sometimes two, one for large-cap and one for small-cap, but alas no equal-weights yet. An ideal index for equal-weighters would be each nation being equal-weight and each stock being equal-weighted. I imagine an ETF for that would only appear after outperformance.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 2:03 am

david1082b wrote:
Thu Jul 26, 2018 1:21 am
what if you want to equal-weight each nation? iShares ETFs are the answer perhaps, since iShares seems to have a mission to have an ETF for every nation in the world -- sometimes two, one for large-cap and one for small-cap, but alas no equal-weights yet. An ideal index for equal-weighters would be each nation being equal-weight and each stock being equal-weighted. I imagine an ETF for that would only appear after outperformance.
indeed I think it's a good idea to equal weight each geographical region (for each individual country it's more difficult and expensive) - I have done something like that since last year and even though this recently underperformed relative to MSCI World (because of the recent strengthening of the USD) I am more confortable with this strategy than with having 50% in the US (which for me would add currency risk as I am in Italy).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by jbranx » Thu Jul 26, 2018 2:07 am

Market cap weighting is indexing; any other scheme is active management. I think that is my overstatement of what Gus Sauter, the long-term ex-manager of Vanguard's index funds, once said at a forum, maybe BH's. The point is a simple one: all the history of index success vs active mgt. is built on market cap wgts; ditto for much of the academic work on portfolio theory.

The mirror image of Fiat Chrysler is Berkshire or Microsoft or Apple since 1997, when it nearly went bankrupt. Easy to overcome worries about over-concentration of Italy index: buy EU index; even better, look at VT World percentages vs VOO, the S&P 500. Search on here for the Bessembinder paper that found only a handful of stocks account for historical returns. It goes without saying that an auto company with all the global overcapacity is not likely to survive long at the top of any index.

Warren Buffet, long ago was claiming indexing was mindless; why buy every business in town when you can buy only the good businesses, he once said, referring to his essay on Graham and Doddsville where Graham students beat the socks off the 500. He's since changed his mind. Market cap weighting will give you Amazon and Apple, one of which is likely to soon be the first trillion dollar stock. Cisco was once thought to get there back before the Dot-Com crash at 80 or so; think the low in 2001 was low teens.

Nice thing about indexing when you're hit with a Fiat Chrysler type disaster is that the index auto-rebalances for you to the next highest market cap.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Valuethinker » Thu Jul 26, 2018 3:37 am

Lauretta wrote:
Thu Jul 26, 2018 2:03 am
david1082b wrote:
Thu Jul 26, 2018 1:21 am
what if you want to equal-weight each nation? iShares ETFs are the answer perhaps, since iShares seems to have a mission to have an ETF for every nation in the world -- sometimes two, one for large-cap and one for small-cap, but alas no equal-weights yet. An ideal index for equal-weighters would be each nation being equal-weight and each stock being equal-weighted. I imagine an ETF for that would only appear after outperformance.
indeed I think it's a good idea to equal weight each geographical region (for each individual country it's more difficult and expensive) - I have done something like that since last year and even though this recently underperformed relative to MSCI World (because of the recent strengthening of the USD) I am more confortable with this strategy than with having 50% in the US (which for me would add currency risk as I am in Italy).
The loss of diversification of an equal weighting of all countries is huge. Mind bogglingly huge.

No one has found a better solution than market cap weighting. Tax and transactions costs kill other strategies even if you could show that they lead to a better risk-return tradeoff (and no one has shown that other than the usual data mining approaches, correlations in historic data that don't then work in future data).

One can always currency hedge a stock portfolio. The reason we don't is because, generally, we feel that Purchasing Power Parity holds in the long run-- stock markets don't become permanently cheap or expensive because of exchange rate moves. For example, when the GBP fell out of bed after the Brexit vote, a say -10% fall in GBP led to a 6-7% rise in the FTSE 100, reflecting the currency translation effect on profits earned overseas.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 4:35 am

Valuethinker wrote:
Thu Jul 26, 2018 3:37 am

The loss of diversification of an equal weighting of all countries is huge. Mind bogglingly huge.

No one has found a better solution than market cap weighting. Tax and transactions costs kill other strategies even if you could show that they lead to a better risk-return tradeoff (and no one has shown that other than the usual data mining approaches, correlations in historic data that don't then work in future data).

One can always currency hedge a stock portfolio. The reason we don't is because, generally, we feel that Purchasing Power Parity holds in the long run-- stock markets don't become permanently cheap or expensive because of exchange rate moves. For example, when the GBP fell out of bed after the Brexit vote, a say -10% fall in GBP led to a 6-7% rise in the FTSE 100, reflecting the currency translation effect on profits earned overseas.
well there are a number of studies in favour of a simple 1/N portfolio, such as this:
http://faculty.london.edu/avmiguel/DeMi ... al-RFS.pdf

I'm not in favour of buying each indivudial country; for a start the Etfs fees are quite high for some of those ETFs; but of buying big geographical areas (Europe, Emerging markets, US, Asia Pacific+Japan) and roughly EW them. Actually the fees for this are lower than for an MSCI world ETF, at least in Europe.

Re currency hedging what you say about the currency dropping and the market going up correspondingly is generally true of the Uk (and e.g. Japan I think) as far as I understand; however my understanding is that for the US it's precisely the opposite (i.e. when the USDX goes up, the US market also tends to do well and outperform the rest of the world; and viceversa).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Valuethinker » Thu Jul 26, 2018 7:32 am

Lauretta wrote:
Thu Jul 26, 2018 4:35 am
Valuethinker wrote:
Thu Jul 26, 2018 3:37 am

The loss of diversification of an equal weighting of all countries is huge. Mind bogglingly huge.

No one has found a better solution than market cap weighting. Tax and transactions costs kill other strategies even if you could show that they lead to a better risk-return tradeoff (and no one has shown that other than the usual data mining approaches, correlations in historic data that don't then work in future data).

One can always currency hedge a stock portfolio. The reason we don't is because, generally, we feel that Purchasing Power Parity holds in the long run-- stock markets don't become permanently cheap or expensive because of exchange rate moves. For example, when the GBP fell out of bed after the Brexit vote, a say -10% fall in GBP led to a 6-7% rise in the FTSE 100, reflecting the currency translation effect on profits earned overseas.
well there are a number of studies in favour of a simple 1/N portfolio, such as this:
http://faculty.london.edu/avmiguel/DeMi ... al-RFS.pdf
I don't think the paper supports your argument in the way you say it does - at least from reading the Abstract? It would be interesting to see how they tackle transactions costs.

If you strip out Small Cap and Value effects I am not sure there is any "beef" in the 1/N asset allocation model.
I'm not in favour of buying each indivudial country; for a start the Etfs fees are quite high for some of those ETFs; but of buying big geographical areas (Europe, Emerging markets, US, Asia Pacific+Japan) and roughly EW them. Actually the fees for this are lower than for an MSCI world ETF, at least in Europe.
You are throwing away a lot of diversification benefit. I think you are still trying to outsmart Mr Market, and that has a long term poor record. If you can do that then you should not be posting here, you should be behind the desk at some hedge fund implementing your trading strategy.

I have looked at many fundamentally based indexing strategies, and keep coming back to the observation that they look like data mining-- sincere data mining, but data mining nonetheless. And even with the "factors" like value, profitability, momentum, size, the actual implementations (in retail funds) don't seem to capture the premia that we see in the data (paging DFA).
Re currency hedging what you say about the currency dropping and the market going up correspondingly is generally true of the Uk (and e.g. Japan I think) as far as I understand; however my understanding is that for the US it's precisely the opposite (i.e. when the USDX goes up, the US market also tends to do well and outperform the rest of the world; and viceversa).
Those are short term moves. Generally, here, we think PPP holds in the long run - divergences of currencies are mean reverting.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by MichCPA » Thu Jul 26, 2018 7:40 am

Lauretta wrote:
Thu Jul 26, 2018 12:47 am
In a previous post I expressed my doubts about market cap weighted indexing viewtopic.php?f=10&t=248220
and explained why to me equal weighting seems a more logical approach.

Since writing that post, I have seen other convincing arguments against market cap weighting, such as this :
In only two years since the S&P 500 went to a capitalization-weighting composition in 1988, was a top ten weighted stock at the end of the previous year a top ten performer in the following year (1995 (Microsoft) and 2008 (Wal-Mart)).
as well as this paper:
https://us.spindices.com/documents/rese ... ndices.pdf

However, following Marchinne's sudden death yesterday, having seen Fiat's stock (making up nearly 6% of MSCI Italy) drop 15% in less than an hour, I have thought of still another argument against market cap weighting: the risk of death of the CEO or of a key person in the firm. Death is both certain and indefinite (since Marchionne studied philosphy I thought I'd quote Heidegger on this ;-) ) meaning that it could happen anytime. A lot of big stocks (such as Amazon or Tesla) have a valuation which is highly dependent on a particular person being alive, and by market cap weighting (i.e. concentrating one's wealth in these big stocks) one is more vulnerable to the eventuality of their death than if one were doing equal weighting.

Does this makes sense to you or do you have any counter-arguments to this?
My counter argument is that equal weighting sells out of growing companies intentionally. As far as this specific case goes, just because it dropped 15% yesterday doesn't mean it won't be up 1 year from now. Marchionne was great but is he worth the $4 billion market cap hit over his replacement. I don't think that this is a given.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Jags4186 » Thu Jul 26, 2018 7:46 am

jbranx wrote:
Thu Jul 26, 2018 2:07 am
Market cap weighting is indexing; any other scheme is active management.


I just think that is at best a poorly worded statement or at worst purposefully misleading. Every investment decision is an active statement. Do people who believe in market cap weighting indexing hold the market weight of stocks and bonds? After all, the bond market is about 25% larger than the stock market. Where is the position on precious metals and commodities?

Passively managed index funds are the best way for most people to access markets, but your asset allocation is most certainly an active decision.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by tibbitts » Thu Jul 26, 2018 7:58 am

Isn't it a bit of a mystery why a stock would drop 15% suddenly, days after he had resigned, and it was more or less widely known he was very close to the end of his life? I would have made more sense earlier in the week, no?

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by RadAudit » Thu Jul 26, 2018 8:34 am

Lauretta wrote:
Thu Jul 26, 2018 12:47 am
do you have any counter-arguments to this?
Not necessarily a counter argument; but, it sure may be a reason to avoid a narrowly diversified fund and / or some single stock investments [FB, yesterday].
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 9:29 am

Valuethinker wrote:
Thu Jul 26, 2018 7:32 am

You are throwing away a lot of diversification benefit. I think you are still trying to outsmart Mr Market, and that has a long term poor record. If you can do that then you should not be posting here, you should be behind the desk at some hedge fund implementing your trading strategy.
Well according to some people the market is not so hard to beat really:
https://www.youtube.com/watch?v=Tn-A7eCUrYk

I have some old friends from university who went on to work for companies like Fidelity and (at least for some time) beat the market (they retired early so they don't have a very long track record ;-) ). I don't recall them being particularly smart people.

I don't have a sophisticated trading strategy; I just feel uneasy for example with allocating 50% of my wealth in stocks to the US, since there is a lot of evidence on the inverse relationship between starting valuations and long term returns (e.g. by RA, GMO, StarCapital etc). My 1/N strategy has amongst its benefits the fact that it has a lower allocation to the US than market cap.

Also as it has been pointed out in this thread, basically everyone in practice deviates from Mr Market (e.g. in the relative alloaction to stocks and bonds).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by greg24 » Thu Jul 26, 2018 9:39 am

How is a CEO death a market-cap weighting-specific concern?

Stocks go up. Stocks go down.

As said above, market-cap weighting is following the market. You're advocating something other than indexing.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Stinky » Thu Jul 26, 2018 9:49 am

greg24 wrote:
Thu Jul 26, 2018 9:39 am

Stocks go up. Stocks go down.
Will the sudden death of a CEO in 2018 materially affect the value of that company in 2028 or 2038? More importantly, will it affect the value of the total stock market in 2028 or 2038? (Obvious answer - NO).

Investing is a long-term game. Short-term fluctuations happen - sometimes pretty violent ones. Stay the course on long-term asset allocation.
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by David Jay » Thu Jul 26, 2018 10:22 am

Lauretta wrote:
Thu Jul 26, 2018 12:47 am
Does this makes sense to you or do you have any counter-arguments to this?
Your argument seems to be very short sighted. What is the net effect of a one day drop in one stock in a broad based index fund?

Equal weighting prevents you from fully reaping the benefits of "the next big thing". The effect of equal weight is selling growth companies and buying legacy companies (like Fiat - your equal weight fund would have purchased Fiat yesterday).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 10:39 am

David Jay wrote:
Thu Jul 26, 2018 10:22 am
The effect of equal weight is selling growth companies and buying legacy companies (like Fiat - your equal weight fund would have purchased Fiat yesterday).
Well that would have been a smart move: today Fiat is up 3.5% :D
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by nisiprius » Thu Jul 26, 2018 10:46 am

Image

I hadn't paid any attention. Now that I'm paying attention, it doesn't seem to have mattered much to my cap-weighted portfolio.

Lauretta, how much was your personal portfolio affected by the decline in Fiat stock?

With regard to equal weighting, I don't think I've ever heard a logical explanation of "where to stop." In another post someone was asking about the S&P 500 equal-weighted ETF, RSP. Well, which is it? Do you think you should use capitalization in deciding your allocation or not? If you decide to weight the S&P 500 equally, then you have apparently decided to ignore capitalization. But if you decide to invest only in the stocks in the S&P 500, and exclude the 3,300 or so stocks that are not in the S&P 500, then you have apparently decided to invest only in large-caps. If the idea is not to weight by capitalization, why is it reasonable to give 500 large-caps (and a few mid-caps) a weight of 1, and the other 3,300 small-cap and mid-cap stocks a weight of zero?
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Valuethinker » Thu Jul 26, 2018 11:13 am

tibbitts wrote:
Thu Jul 26, 2018 7:58 am
Isn't it a bit of a mystery why a stock would drop 15% suddenly, days after he had resigned, and it was more or less widely known he was very close to the end of his life? I would have made more sense earlier in the week, no?
I haven't tracked this, but was it really so widely known that he was mortally ill?

His retirement had been announced, but the papers this morning said his death resulted after a shoulder operation (perhaps it was cancer in his shoulder).

Information dispersal is not perfect and instantaneous.

Europe is sweltering in the middle of the worst heatwave since 2003 so perhaps that slowed down our responses?

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Valuethinker » Thu Jul 26, 2018 11:14 am

Lauretta wrote:
Thu Jul 26, 2018 9:29 am
Valuethinker wrote:
Thu Jul 26, 2018 7:32 am

You are throwing away a lot of diversification benefit. I think you are still trying to outsmart Mr Market, and that has a long term poor record. If you can do that then you should not be posting here, you should be behind the desk at some hedge fund implementing your trading strategy.
Well according to some people the market is not so hard to beat really:
https://www.youtube.com/watch?v=Tn-A7eCUrYk

I have some old friends from university who went on to work for companies like Fidelity and (at least for some time) beat the market (they retired early so they don't have a very long track record ;-) ). I don't recall them being particularly smart people.

I don't have a sophisticated trading strategy; I just feel uneasy for example with allocating 50% of my wealth in stocks to the US, since there is a lot of evidence on the inverse relationship between starting valuations and long term returns (e.g. by RA, GMO, StarCapital etc). My 1/N strategy has amongst its benefits the fact that it has a lower allocation to the US than market cap.

Also as it has been pointed out in this thread, basically everyone in practice deviates from Mr Market (e.g. in the relative alloaction to stocks and bonds).
1/N is then a way of implementing a view based on valuation?

Should you not, therefore, implement a strategy based on valuation, rather than on 1/N?

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by jbranx » Thu Jul 26, 2018 11:33 am

When we use the term "indexing" we are referring to a long history of attempting to determine if there is an optimal way to get the best investing results. Bill Fouse, who started the first index fund at Wells Fargo in the seventies, first tried managing an equal-weighted NYSE Composite. It failed miserably. He then went to the S&P 500, which began in 1926 as 90 cap-weighted stocks and moved to 500 in 1957. All the academic history and all the practical experimenting has shown that cap weighting gets investors the best returns provided the costs of doing so are low.

The topic has been debated to death, but here's one quote from Gus Sauter at a debate with Rob Arnott that explains why indexing is cap weighting and any other approach might as well be called active mgt:

"So then the question is, what is the market? The market by definition is cap-weighted, as it is the collection of all of our holdings. And, therefore, cap weighting, which is the definition of the market, will outperform a majority of investors. It doesn't rule out that active management may be able to add value, but it does point out that active management is a very, very difficult game. Anything other than a cap-weighted index is taking active bets against the market, and I would just ask the rhetorical question: Is it really so easy for active management to be able to add value?"

Here's the link on ETF.com from 2007 on "The Fundamental Indexing Smackdown:'

http://www.etf.com/publications/journal ... nopaging=1

The only attempt to something that looked like indexing before the seventies was the Lexington Corporate Leaders Fund (now Voya with a high expense ratio) which bought the Dow stocks and made no changes except to keep whatever spinoffs were made. It outperformed the 500 in many years.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 11:33 am

Valuethinker wrote:
Thu Jul 26, 2018 11:14 am
Lauretta wrote:
Thu Jul 26, 2018 9:29 am
Valuethinker wrote:
Thu Jul 26, 2018 7:32 am

You are throwing away a lot of diversification benefit. I think you are still trying to outsmart Mr Market, and that has a long term poor record. If you can do that then you should not be posting here, you should be behind the desk at some hedge fund implementing your trading strategy.
Well according to some people the market is not so hard to beat really:
https://www.youtube.com/watch?v=Tn-A7eCUrYk

I have some old friends from university who went on to work for companies like Fidelity and (at least for some time) beat the market (they retired early so they don't have a very long track record ;-) ). I don't recall them being particularly smart people.

I don't have a sophisticated trading strategy; I just feel uneasy for example with allocating 50% of my wealth in stocks to the US, since there is a lot of evidence on the inverse relationship between starting valuations and long term returns (e.g. by RA, GMO, StarCapital etc). My 1/N strategy has amongst its benefits the fact that it has a lower allocation to the US than market cap.

Also as it has been pointed out in this thread, basically everyone in practice deviates from Mr Market (e.g. in the relative alloaction to stocks and bonds).
1/N is then a way of implementing a view based on valuation?

Should you not, therefore, implement a strategy based on valuation, rather than on 1/N?
Just like a market cap strategy is a momentum strategy, see:
http://awealthofcommonsense.com/2016/05 ... -strategy/
an equal weight strategy goes in the sense of a value strategy. I can't be bothered to implement a value strategy with individual countries, the very simple strategy I outlined above has in practice the effect of overweighting EM and underweighting the US - and is thus consistent with a global value strategy.
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Thu Jul 26, 2018 11:41 am

nisiprius wrote:
Thu Jul 26, 2018 10:46 am
Image

I hadn't paid any attention. Now that I'm paying attention, it doesn't seem to have mattered much to my cap-weighted portfolio.

Lauretta, how much was your personal portfolio affected by the decline in Fiat stock?

With regard to equal weighting, I don't think I've ever heard a logical explanation of "where to stop." In another post someone was asking about the S&P 500 equal-weighted ETF, RSP. Well, which is it? Do you think you should use capitalization in deciding your allocation or not? If you decide to weight the S&P 500 equally, then you have apparently decided to ignore capitalization. But if you decide to invest only in the stocks in the S&P 500, and exclude the 3,300 or so stocks that are not in the S&P 500, then you have apparently decided to invest only in large-caps. If the idea is not to weight by capitalization, why is it reasonable to give 500 large-caps (and a few mid-caps) a weight of 1, and the other 3,300 small-cap and mid-cap stocks a weight of zero?
because investing is not a science, so there is no 'perfect' or perfectly logical way to proceed. It's only a question of avoiding mistakes (overweighting the big stocks might well be one mistake). I haven't logged on for a while, but the last time I did I remember you spoke favourably of the methods developed by TOBAM - I imagine because the math looks good so they seem rigorous - though in practice their funds have generaly underperformed the index. Treating investing as if it were a science and looking for a perfectly logical solution; or looking at the markets as if they belonged to some kind of Platonic world, is IMO quite misleading. I find Taleb's critique of MPT quite interesting, e.g. here
https://www.ft.com/content/4eb6ae86-816 ... 00779fd2ac
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by asa1973 » Thu Jul 26, 2018 11:48 am

Valuethinker wrote:
Thu Jul 26, 2018 11:13 am
tibbitts wrote:
Thu Jul 26, 2018 7:58 am
Isn't it a bit of a mystery why a stock would drop 15% suddenly, days after he had resigned, and it was more or less widely known he was very close to the end of his life? I would have made more sense earlier in the week, no?
I haven't tracked this, but was it really so widely known that he was mortally ill?

No, he was not. It was a PLANNED operation that resulted in coma due to insult aka black swan. Thus market knee-jerk (irrational as usual) reaction.

I didn't tracked this closely except from F1 side :) and his "departure to NEVERLAND" was really unexpected ...

This one (and yesterday's FB stocks emotional reaction) is a perfect illustration why to index and why deiversify.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by asif408 » Thu Jul 26, 2018 12:30 pm

My counter argument is that sure, you can devise a way to avoid big stocks with high valuations by using something other than market cap, but the problem is you could also miss out on many years of gains that may offset any large future losses. So in the market cap case, yes, you may fall harder when the losses show up, but if you have large gains preceding it, I don't see how the endpoint would be dramatically different than a strategy where you miss out on some of the upside to protect from some of the downside. Plus you almost invariably have more expenses with a strategy other than market cap, so your performance has to be better not only before but after expenses.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by z3r0c00l » Thu Jul 26, 2018 12:42 pm

15% of 6% of 12% of my portfolio. And I suspect the drop is just temporary, the company will do what it was going to do all along, succeed or fail over the next few decades. Apple is the case against this fear, since no other company had such an outsize market cap with a corresponding cult of personality at its helm. Yet apple has done just fine without Jobs. In fact, isn't it up 300% since then?

I am concerned about these companies just swelling to near trillion dollar valuations, and never returning cash to investors which Apple and Amazon have largely failed to do. That only a few companies account for so much of the US market cap is a reason for concern. The company should not grow forever, it should mature into a machine that generates steady, sustainable profits and returns them to shareholders. This is a problem that has largely been created by tax policy on dividends vs capital gains.
Last edited by z3r0c00l on Thu Jul 26, 2018 12:47 pm, edited 1 time in total.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by bottlecap » Thu Jul 26, 2018 12:46 pm

If CEOs of companies represented in equal weighted indexes don’t die, then I want to be the CEO of one of those companies.

This is a rare event. Markets overeact. It will be noise in the end.

Equal weighting many reduce the overall short term affect of a large cap company CEO suddenly dying, but it will increase the effect of a small cap company CEO dying. And there are more small cap companies, increasing the chance.

Overall, this is a very weak argument for abandoning market cap weighting.

JT

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by david1082b » Thu Jul 26, 2018 12:52 pm

asif408 wrote:
Thu Jul 26, 2018 12:30 pm
So in the market cap case, yes, you may fall harder when the losses show up
Equal-weight ETFs actually have a history of falling harder during stock market downturns. The industry that is promoting equal-weight seems to have created the myth that equal-weight will somehow shield investors during downturns, but the exact opposite has been the case.

Equal-weight $RSP in 2008 versus $SPY: http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

2011: http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

2015 to early 2016: http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by NonnyGoGo » Thu Jul 26, 2018 1:05 pm

Fiat reported earnings on the same day. It was not good news. I doubt the death had much to do with the stock drop.

https://www.thestreet.com/markets/sergi ... y-14661136
Fiat said adjusted second quarter operating earnings came in at €1.66 billion, well shy of the €2 billion consensus forecast on sales of €28.99 billion.

However, Fiat trimmed its full-year revenue guidance to between €115 billion and €118 billion, down from a prior forecast of €125 billion and said its adjusted operating earnings would fall into the €7.5 billion to €8 billion range.

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Market-Cap Weighting ?

Post by Taylor Larimore » Thu Jul 26, 2018 1:37 pm

Bogleheads:

I am glad that my index funds have the market-cap weighting in the largest and most successful companies in the world.

Best wishes.
Taylor
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by nisiprius » Fri Jul 27, 2018 6:30 am

Lauretta wrote:
Thu Jul 26, 2018 11:41 am
...because investing is not a science, so there is no 'perfect' or perfectly logical way to proceed. It's only a question of avoiding mistakes...
I agree 100% with that.
... (overweighting the big stocks might well be one mistake)...
Nobody is advocating overweighting the big stocks. Or at least, the Bogleheads investment philosophy doesn't advocate it. (Certainly there exists a school of thought that favors a portfolio consisting of a small number of individual blue-chip stocks rather than indexing. I do not belong to that school.)
...I remember you spoke favourably of the methods developed by TOBAM - I imagine because the math looks good so they seem rigorous - though in practice their funds have generaly underperformed the index.
No, that wasn't me. I never even heard of TOBAM until Vineviz posted about the "diversification ratio," which he used as a tacit definition of "diversification," to claim that the market portfolio isn't the most diversified portfolio. It turns out that the papers on the diversification ratio he cited were all written by people at TOBAM, and that in fact "diversification ratio" is a registered trademark (!) of TOBAM. I was trying to understand it. I wasn't advocating for it.
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Sat Jul 28, 2018 5:52 am

nisiprius wrote:
Fri Jul 27, 2018 6:30 am
Nobody is advocating overweighting the big stocks. Or at least, the Bogleheads investment philosophy doesn't advocate it. (Certainly there exists a school of thought that favors a portfolio consisting of a small number of individual blue-chip stocks rather than indexing. I do not belong to that school.
Yes I am sorry I was writing quickly; what I meant was weighting stocks according to their market cap, which means assigning a big portion of one's assets to the largest stocks. I find the fist chart in this post quite revealing - and a bit scary:
http://theirrelevantinvestor.com/2018/07/19/pareto/

In a previous thread I got a good answer in favour of market cap weighting from someone:
Why not own future dividends of the whole stock market without preferring one company or other? If Apple is believed to produce multiple times the dividends of some other company, own multiple times the value in Apple vs the other company.
So according to this argument you allocate to Facebook say 100 times more cash than to Quanta Services because Facebook is thought to generates proportionally more earnings, as reflected by its market cap. The trouble with this argument is that one single event (say the Cambridge Analytica scandal) can damage a company like Facebook in a way that a single similar event (I mean a specific event like that, not a recession or a general bear market) is not likely to damage at the same time the 50 to 100 smallest companies in the S&P500 to which you allocate in total the same amount as to Facebook. So a market cap based strategy seems to me much more vulnerable than EW to single specific events (the death of the CEO, Cambridge Analytica's scandal for Facebook, Deepwater Horizon for BP) that can happen to a single large company.
The same goes for geographical allocation. If something negative were to happen specifically to the US (Soros for example said at Davos that Mr Trump is 'making it up as he goes along' and that the markets will eventually go down because of his policies - I am not at all competent to judge but I am just using this as an example) as it happend to Japan when it was approaching half of the global market cap, then someone allocating 50% (or more) to the US will be more affected than someone who spreads their wealth more equally in all geographical regions.
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by columbia » Sat Jul 28, 2018 7:02 am

One could call this “CEO risk” and there’s not too many companies, where it might exist. BRK comes to mind.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by JoMoney » Sat Jul 28, 2018 7:17 am

Lauretta wrote:
Thu Jul 26, 2018 12:47 am
... I have seen other convincing arguments against market cap weighting, such as this :
In only two years since the S&P 500 went to a capitalization-weighting composition in 1988, was a top ten weighted stock at the end of the previous year a top ten performer in the following year (1995 (Microsoft) and 2008 (Wal-Mart)).
What are the odds of that happening all else equal? 10 out of 500, or 1 in 50 ... and it happened twice in thirty years? That doesn't sound bad. Especially since the larger stocks are generally less volatile more stable longer history lower credit risk etc..
"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: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by JoMoney » Sat Jul 28, 2018 8:39 am

Lauretta wrote:
Thu Jul 26, 2018 12:47 am
... by market cap weighting (i.e. concentrating one's wealth in these big stocks) one is more vulnerable ...
John Bogle in The Policy Portfolio in an Era of Subdued Returns, June 2003 wrote: http://johncbogle.com/speeches/JCB_IASC0603.pdf
... It’s easy to argue, of course that having, as the S&P 500 Index currently does, 24% of assets in its
10 largest stocks is inadequate diversification. But the reality is that that level of concentration is in fact
also below historic norms. In 1950, for example, the largest ten stocks composed fully 51%(!) of the total
value of the Index, and even in 1964 the top ten composed 38%. Is such diversification adequate?
There’s no way to be certain. But if the actual goal of investing is to capture as close as possible to 100%
of the return of the stock market, one simply tries to own the market itself, warts and all, with each
company weighted by its own market capitalization.
Image
... But I urge you not to forget that, for all the inevitable density in the fog of investing, there remains much that we do
know:
*We know the sources of returns in the stock and bond markets, and that’s the beginning of
wisdom.
*We know that cost matters, moderately in the short run and overpoweringly in the long run.
*We know that specific-security risk can be eliminated by diversification, so that only market
risk remains. (And that risk seems quite large enough, thank you!)

*We know that neither beating the market nor successful market timing can be generalized
without self-contradiction.
*We know that alternative asset classes aren’t really “alternative,” but simply pools of capital
that invest—or over-invest or disinvest—in the very stocks and bonds that comprise the
policy portfolio.
*Finally, we know what we don’t know. We can never be certain how our world will look
tomorrow, and we know even less about how it will look a decade hence. But we also know
that not investing is doomed to failure.
...
"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: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Sat Jul 28, 2018 9:01 am

JoMoney wrote:
Sat Jul 28, 2018 7:17 am
Lauretta wrote:
Thu Jul 26, 2018 12:47 am
... I have seen other convincing arguments against market cap weighting, such as this :
In only two years since the S&P 500 went to a capitalization-weighting composition in 1988, was a top ten weighted stock at the end of the previous year a top ten performer in the following year (1995 (Microsoft) and 2008 (Wal-Mart)).
What are the odds of that happening all else equal? 10 out of 500, or 1 in 50 ... and it happened twice in thirty years? That doesn't sound bad. Especially since the larger stocks are generally less volatile more stable longer history lower credit risk etc..
exactly, if the odds are 1/50 that those 10 stocks are top performers, why should you have between 20 and 25% of your wealth in them? It would seem to make more sense to have 1/50 of your wealth (as in EW) in them rather than 1/5 (=20%) or 1/4 (=25%).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by JoMoney » Sat Jul 28, 2018 9:35 am

Lauretta wrote:
Sat Jul 28, 2018 9:01 am
JoMoney wrote:
Sat Jul 28, 2018 7:17 am
Lauretta wrote:
Thu Jul 26, 2018 12:47 am
... I have seen other convincing arguments against market cap weighting, such as this :
In only two years since the S&P 500 went to a capitalization-weighting composition in 1988, was a top ten weighted stock at the end of the previous year a top ten performer in the following year (1995 (Microsoft) and 2008 (Wal-Mart)).
What are the odds of that happening all else equal? 10 out of 500, or 1 in 50 ... and it happened twice in thirty years? That doesn't sound bad. Especially since the larger stocks are generally less volatile more stable longer history lower credit risk etc..
exactly, if the odds are 1/50 that those 10 stocks are top performers, why should you have between 20 and 25% of your wealth in them? It would seem to make more sense to have 1/50 of your wealth (as in EW) in them rather than 1/5 (=20%) or 1/4 (=25%).
Personally,
Because I'm aiming at getting the markets return, and that's how the market in aggregate values it.
Because I'm not interested in increasing expenses that comes with the trading involved with other weighting schemes.
Because I'm not interested in taking above average risks that come with weighting smaller stocks heavier, or with the lower 'risk adjusted' returns that equal-weight funds like RSP have shown.
So no, it doesn't seem to me that's a better way to have my wealth allocated.
"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: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by JoMoney » Sat Jul 28, 2018 9:53 am

Here's another way to consider framing it: For those who poo-poo cap weighting as being heavy in the 'over priced' stocks, consider that at some point you will be winding down the portfolio and selling it off... so future you will be able to pat themselves on the back for selling off a proportionately larger amount of whatever those top stocks are in the future :D
"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: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Sat Jul 28, 2018 10:44 am

JoMoney wrote:
Sat Jul 28, 2018 9:35 am

Because I'm not interested in increasing expenses that comes with the trading involved with other weighting schemes.
Yes I agree with this point. In fact I do use market cap weigthted index funds; I must confess that the reason is that when I started investing I just relied on the theories of famous academics like Sharpe - after all they got the Nobel prize so I thought that those theories must be respectable... Since then, as I have given some thought to the matter, I have personally become more and more convinced that Taleb is making some very good points in this piece:
http://www.fooledbyrandomness.com/FT-Nobel.pdf
Anyway, since I now have market cap weighted ETFs, I am sticking with them even though I don't agree with much of the rationale behind them, and I tell myself that they are allright after all because of the low turnover anD minimal costs.
However, as far a my geographical allocation is concerned, it's much close to EW (ie I roughly equally weight Europe, US, Pacific+Japan and EM).
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by JoMoney » Sat Jul 28, 2018 10:58 am

Lauretta wrote:
Sat Jul 28, 2018 10:44 am
JoMoney wrote:
Sat Jul 28, 2018 9:35 am

Because I'm not interested in increasing expenses that comes with the trading involved with other weighting schemes.
Yes I agree with this point. In fact I do use market cap weigthted index funds; I must confess that the reason is that when I started investing I just relied on the theories of famous academics like Sharpe - after all they got the Nobel prize so I thought that those theories must be respectable... Since then, as I have given some thought to the matter, I have personally become more and more convinced that Taleb is making some very good points in this piece:
http://www.fooledbyrandomness.com/FT-Nobel.pdf
Anyway, since I now have market cap weighted ETFs, I am sticking with them even though I don't agree with much of the rationale behind them, and I tell myself that they are allright after all because of the low turnover anD minimal costs.
However, as far a my geographical allocation is concerned, it's much close to EW (ie I roughly equally weight Europe, US, Pacific+Japan and EM).
When it comes to 'Modern Portfolio Theory' and 'Efficient Market' theory, I don't agree with a lot of that rationale either, but none of that is really necessary for "The Arithmetic of Active Management" to hold true. A real world cap-weighted index does have to trade from time to time, but the model should caution one to avoid trading or differing much from the market (unless you believe you're the one who is going to be able to beat the other guy, and by more than enough to compensate for expenses).
"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: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Dottie57 » Sat Jul 28, 2018 7:10 pm

How would equal weighting work? Wouldn’t the smallest companies limit the size of a fund by having fewer stocks and less value?

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by nisiprius » Sat Jul 28, 2018 7:55 pm

Equal-weighting isn't really a feasible option.

If you check, you will find that the so-called "Guggenheim S&P 500 Equal Weight ETF," RSP, does not actually invest in those stocks with anything close to equal weight. And the so-called "Invesco Russell 2000 Equal Weight ETF," EQWS doesn't even try (you may be surprised if you look up the actual description of the Russell 2000 Equal Weight Index. I sure was.)

So while one might have thought that you could invest equally weighted by means of an allocation of 20% RSP and 80% EQWS... you can't.

The fact is that equal weighting the stock market isn't feasible, and the product names that include the phrase 'equal weight" are misnomers.

I cannot think of a good rationale for investing $100 in ExxonMobil and $100 in TakeTwo Software, yet investing $100 in Take Two software and zero dollars in Lithia Motors. The seeming neutrality of treating the in-group of stocks equally is contradicted by the arbitrariness in treatment betwen the in-group and the out-group.

Of course there are alternatives other than cap weighting and equal weighting.
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Valuethinker » Sun Jul 29, 2018 7:27 am

Lauretta wrote:
Sat Jul 28, 2018 10:44 am
JoMoney wrote:
Sat Jul 28, 2018 9:35 am

Because I'm not interested in increasing expenses that comes with the trading involved with other weighting schemes.
Yes I agree with this point. In fact I do use market cap weigthted index funds; I must confess that the reason is that when I started investing I just relied on the theories of famous academics like Sharpe - after all they got the Nobel prize so I thought that those theories must be respectable... Since then, as I have given some thought to the matter, I have personally become more and more convinced that Taleb is making some very good points in this piece:
http://www.fooledbyrandomness.com/FT-Nobel.pdf
Anyway, since I now have market cap weighted ETFs, I am sticking with them even though I don't agree with much of the rationale behind them, and I tell myself that they are allright after all because of the low turnover anD minimal costs.
However, as far a my geographical allocation is concerned, it's much close to EW (ie I roughly equally weight Europe, US, Pacific+Japan and EM).
I think you want to tinker -- your posts are very much along that line? Straight market weight indexing is too "easy"? You experience regret when that straight indexation strategy underperforms? You will know that Kahneman, Thaler and Tversky (& Ariely) have observed these human behavioural biases and in fact predict them. The tendency to see patterns in numbers where they do not necessarily exist ie where the reality is one of randomness, to attribute causation where there is none; the tendency to frame average performance as a "loss" for which you experience regret, etc. Also you feel you do not deserve investing success if all you do is index to global markets with a market cap weighting? Financial markets, you feel, is like physics, we should be able to divine the underlying physical principles?

If you believe Taleb, then you should hold mostly safe fixed income, as well as option strategies which exploit large moves (up or down) in markets, which Mandelbrot tells you are much more common than the assumption of Gaussian distribution of returns would predict?

That is the strategy I believe Taleb has pursued via his hedge fund. I also understand that that fund has shut down?

You are aware that a small number of super stocks has driven much of the last part of this rally -- big cap stocks which have done very well? They happen to be US listed. If you were not in those stocks, you underperformed. So much for a 1/ N strategy. Given the different sectoral weightings of different stock markets, a 1/N strategy is not a 1/N strategy. At the very least, it's an anti technology tilt.

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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by Lauretta » Mon Jul 30, 2018 2:02 am

Valuethinker wrote:
Sun Jul 29, 2018 7:27 am
you feel you do not deserve investing success if all you do is index to global markets with a market cap weighting? Financial markets, you feel, is like physics, we should be able to divine the underlying physical principles?
You are quite right in the first sentence of the quote above. I don't think that financial markets are like physics - though people like Jean-Philippe Bouchaud do use methods of statistical physics to manage their funds (and do that successfully - I know his wife, also a physicist with an interest in acting - and sometimes ago he just bought her a theatre in Paris as a gift...).
But you are right in the first sentence I quoted: psychologically there seems to be something in me that feels I don't deserve high returns if I just do something as simple as invest in an MSCI World ETF. It's really quite odd because I already made quite a lot of effort when earning the money; but there you go, that's indeed how I feel...
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Re: FCA stock drops 15% following Marchionne's death: another argument against market cap weighting?

Post by UpperNwGuy » Mon Jul 30, 2018 6:04 am

Valuethinker wrote:
Sun Jul 29, 2018 7:27 am
I think you want to tinker
This is my favorite sound-bite from Bogleheads.org for the entire month of July. It applies to numerous threads that appear in this forum.

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