Asset Allocation Made Difficult #3: REITs and Midcap

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Alf 101
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Asset Allocation Made Difficult #3: REITs and Midcap

Post by Alf 101 » Wed Apr 13, 2011 3:24 pm

As I begin here, the third in the series, I may speak a bit to my defense, in that I'm not a great slice and dicer. As I began my retirement planning it was all the Total Stock Market Index. When that grew I added some Total Bond Market Index. That's been the foundation all along.

At an impressionable point in my life I read Rick Ferri's asset allocation book -- the first edition, right when it came out. He might well wince reading me admit this, but I did go on and try to apply some of what I gleaned. So here's how I have things split right now:

Domestic:
TSM 80%
Small Value Index 15%
REIT Index 5%

Foreign
Europe 45%
Pacific 30%
Emerging Markets 25%

Bonds
TBM 100%

The idea was that splitting among these different funds, some would zig while others zagged, giving me opportunities to benefit from rebalancing. Of course, and this is the siren song for excessively dividing your allocation, it also gave me something to do. Not that I don't have friends and hobbies, but some people just need to fiddle with things.

So here are my current dilemmas. This time I'm actually thinking more in terms of consolidation:

1. REIT Index

I'm considering dropping the REIT Index actually, having gained some appreciation for how REITs are already represented in the index funds I own:

http://www.bogleheads.org/wiki/Percenta ... ndex_Funds

This is particularly true in the Small Value Index. Does anyone see an argument for keeping it? Otherwise I would drop this 5% back in TSM.


2. Mid Caps

My current 401K admittedly has some high expense losers, though there are four low cost index funds, all Vanguard:

Institutional Index Institutional Plus (VIIIX)
Total Bond Index Institutional (VBTIX)
Developed Markets Index Institutional (VIDMX)
Mid-Cap Institutional (VMCIX)

The most I will invest each year will go into my 401K, and with the first two, or three, I can make manage a simple and effective allocation. Basically, as I see it, the first decision is stock % vs. bond %, then within stocks domestic % vs. international %.

What throws me off is this mid-cap index; it's low cost, but what niche does it fill? Maybe, with VIIIX essentially a 500 Index, I would add if my overall portfolio drifted from the 28% mid caps in TSM, but otherwise my sense is this would just be adding a fund and muddying the waters, without adding something especially new or advantageous. Am I missing something here?

As always, thanks...

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Post by Rodc » Wed Apr 13, 2011 3:32 pm

Reits: are a gray area take them or leave them, hard to know.

I suggest now that you have them you keep them simply as an exercise in developing discipline in staying with a plan. At any rate 5% will not make or break your fortune.

Midcaps: don't know what small cap value you have, but for example Vanguard SCV is really more mid-cap that small-cap, so I would not bother if your SCV is similar.
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Random Musings
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Post by Random Musings » Wed Apr 13, 2011 3:43 pm

Personally, I think it makes sense (before adding REIT's to the mix, if you care to) is to base your domestic portfolio with:

TSM
Small-Value Loading

The gamut can run from 100% TSM to 100% SV (the Larry S. method) and all points in between (ZZ Top).

Now, as I vaguely recall, Vanguards SCV fund (which is less valuey and small) has REIT's in it (so does TSM), while the DFA SV fund does not have REIT exposure. TSM does, of course.

But academia does think (well, at least some do) that REIT's are a separate asset class and are a diversifier. Hence, in your case, you are adding "additional exposure to make your REIT holdings statistically more significant" compared to your current REIT holdings embedded in the funds that you currently own.

RM

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Post by Opponent Process » Wed Apr 13, 2011 4:07 pm

REIT fans definitely come and go. there used to be a Yalie called Swensen that everyone thought was a genius but it turned out he was just holding a lot of REITs at the right time. you can play with the numbers and make REITs look like either a free lunch or simply a sector with the same returns but more risk vs. equities. whatever you do, just remember that small investors like us tend to time these things very badly. we get in when everyone is hyping them and don't get out until they are out of favor (maybe like you're wanting to do now). however, being exposed to Rick Ferri during an impressionable period in one's life is not a horrible thing at all.

as far as SV, I would simply recommend spending a great deal of time trying to understand the arguments for and against SV tilting. I don't think this is a waste of time. don't make a decision until you completely understand both sides.

as far as midcaps, they are unloved.
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Post by Noobvestor » Wed Apr 13, 2011 5:56 pm

Opponent Process wrote:REIT fans definitely come and go. there used to be a Yalie called Swensen that everyone thought was a genius but it turned out he was just holding a lot of REITs at the right time. you can play with the numbers and make REITs look like either a free lunch or simply a sector with the same returns but more risk vs. equities. whatever you do, just remember that small investors like us tend to time these things very badly. we get in when everyone is hyping them and don't get out until they are out of favor (maybe like you're wanting to do now). however, being exposed to Rick Ferri during an impressionable period in one's life is not a horrible thing at all.

as far as SV, I would simply recommend spending a great deal of time trying to understand the arguments for and against SV tilting. I don't think this is a waste of time. don't make a decision until you completely understand both sides.

as far as midcaps, they are unloved.
So true :) I see no need to hold midcaps specifically, since other funds I have overlap. Though if I were forced into just one style box forever ... I would probably make it mid-cap value.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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anthau
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Post by anthau » Wed Apr 13, 2011 10:26 pm

Alf,

First of all, thanks for a great series of posts. Seriously.

Second, thanks to Opponent Process in the second post of this series for reminding us we're dancing on the heads of pins.

In no small part thanks to Rick's All About Index Funds and these boards, I came to choose iShares S&P 600 small-value fund (IJS) over Vanguard small-value: Less REITs, so less correlation, at least in theory. Of course, the corollary may be that I'm using two funds where I could use one. But, being a fiddler, it's probably enough to keep me distracted from doing more serious damage to my portfolio (At least I finally gave up on active management and Bridgeway Small-Value for IJS).

Don't know if you've caught Rick's classic post The Core Four, but it may be of interest.

Also, OP's sly reference was to Mel's Unloved Midcaps.
Best, | | Anth

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Post by nbatt » Thu Apr 14, 2011 4:20 pm

They might be unloved (midcaps) but they have performed very well. See recent commentary by John Prestbo on the Index Universe site....http://www.indexuniverse.com/publicatio ... nigma.html


Small investors using dollar cost/Value Averaging need to use a dose of commen sense when fretting over diverging from the all market approach. Run the Gordon equation or Benjamin Graham's value metrics, or even Robert Shillers updated PE/10 numbers to see if it makes any sense to dive into riskier parts of the market. You might end up realizing you have more to loose than gain.

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Post by Index Fan » Thu Apr 14, 2011 4:46 pm

My domestic holdings are TSM and a modest position in REIT Index. I've been a long-term REIT Index investor instead of going into small-cap value and it has served me well, though it's been a wild ride at times. I have no idea if this will work out in the future, but I'm sticking with it.
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Post by abuss368 » Thu Apr 14, 2011 4:53 pm

The older I get, the more I wonder if a separate allocation to REITs (outside of the Total Stock Market) is necessary.

Why not just combine with TSM and have more simplicity and one less fund with overlap?

Roy
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Post by Roy » Thu Apr 14, 2011 5:19 pm

abuss368 wrote:The older I get, the more I wonder if a separate allocation to REITs (outside of the Total Stock Market) is necessary.

Why not just combine with TSM and have more simplicity and one less fund with overlap?
Hi, Abuss,

Given your take on simplicity and Total Markets, I'm surprised you ever thought additional REITs (a tilt to them) necessary, where you seem to think tilting to Small and Value unnecessary.

That said, while I hold no REITs myself, there is some peer-reviewed evidence that they can also be viewed as a separate asset class (as Random Musings said), which returns are not well explained by the 3-Factor model. Also, like RM said, I would consider Small and Value tilts before considering an allocation to REITs. Of course, Total Market equities alone are just fine too.

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Post by staythecourse » Thu Apr 14, 2011 5:23 pm

Opponent Process wrote:REIT fans definitely come and go. there used to be a Yalie called Swensen that everyone thought was a genius but it turned out he was just holding a lot of REITs at the right time. you can play with the numbers and make REITs look like either a free lunch or simply a sector with the same returns but more risk vs. equities. whatever you do, just remember that small investors like us tend to time these things very badly. we get in when everyone is hyping them and don't get out until they are out of favor (maybe like you're wanting to do now). however, being exposed to Rick Ferri during an impressionable period in one's life is not a horrible thing at all.

as far as SV, I would simply recommend spending a great deal of time trying to understand the arguments for and against SV tilting. I don't think this is a waste of time. don't make a decision until you completely understand both sides.

as far as midcaps, they are unloved.
I think you are wrong regarding Swensen. I believe he held real estate NOT REITS. He advices REITS to individual investors as we don't have the access to active management of his real estate.

Swensen is a big fan of active management where they think they can get some extra alpha (i.e. Real estate, hedge funds, timber, oil/ gas exchanges, private equity, etc.)

Please correct me if I'm wrong. Haven't read his book in awhile. Maybe a good time to re-read.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Post by Noobvestor » Fri Apr 15, 2011 12:13 am

staythecourse wrote:
Opponent Process wrote:REIT fans definitely come and go. there used to be a Yalie called Swensen that everyone thought was a genius but it turned out he was just holding a lot of REITs at the right time. you can play with the numbers and make REITs look like either a free lunch or simply a sector with the same returns but more risk vs. equities. whatever you do, just remember that small investors like us tend to time these things very badly. we get in when everyone is hyping them and don't get out until they are out of favor (maybe like you're wanting to do now). however, being exposed to Rick Ferri during an impressionable period in one's life is not a horrible thing at all.

as far as SV, I would simply recommend spending a great deal of time trying to understand the arguments for and against SV tilting. I don't think this is a waste of time. don't make a decision until you completely understand both sides.

as far as midcaps, they are unloved.
I think you are wrong regarding Swensen. I believe he held real estate NOT REITS. He advices REITS to individual investors as we don't have the access to active management of his real estate.

Swensen is a big fan of active management where they think they can get some extra alpha (i.e. Real estate, hedge funds, timber, oil/ gas exchanges, private equity, etc.)

Please correct me if I'm wrong. Haven't read his book in awhile. Maybe a good time to re-read.

Good luck.
I know he likes the TIAA variant because it's cheap, though he bashes private/active REIT stuff on the expense front when warranted. Don't think he likes hedge funds at all, for individuals at least. You might be thinking of things he wrote more for institutional investors?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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abuss368
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Post by abuss368 » Fri Apr 15, 2011 8:51 am

I may have read somehwere that he was not as high on REITs presently and has decreased his position.

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