The Case Against Valuation-Informed Indexing???

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
elgaeb051
Posts: 333
Joined: Sun Feb 21, 2010 11:23 am

The Case Against Valuation-Informed Indexing???

Post by elgaeb051 »

delete
Last edited by elgaeb051 on Thu Oct 13, 2011 10:58 am, edited 2 times in total.
User avatar
fredflinstone
Posts: 2718
Joined: Mon Mar 29, 2010 7:35 am
Location: Bedrock

Post by fredflinstone »

I do consider valuations. More here:

http://www.bogleheads.org/forum/viewtopic.php?t=75585
Stocks 28 / Gold 23 / Long-term US treasuries 19 / Cash (mainly CDs) 22 / TIPS 8
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 8:51 pm

Re: The Case Against Valuation-Informed Indexing???

Post by bob90245 »

elgaeb051 wrote:Is this approach at all compatible with Buy and Hold? Do all Bogleheads consider valuation? some?
It's just another way of saying Tactical Asset Allocation (TAA). Jack Bogle wrote about TAA in his books. So the concept is not new to Bogleheads. The topic has come up from time to time on this forum.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
User avatar
nisiprius
Advisory Board
Posts: 41937
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

This writer is pushing his personal approach, which he calls "valuation-informed indexing," and chooses to take the rhetorical path of setting up and knocking down straw men.

Notice that even if he were right that indexing is not the best strategy, it would not follow that his own specific strategy is better.

Differences in opinion is what makes horseracing, and difference in opinion on valuation is what makes the stock market. The case against "valuation-informed" anything is that it is hard to value assets correctly. Even in the year 2000, people were arguing dead seriously that Stock Prices Are Still Far Too Low.

I just don't believe that a few simple rules based on numbers that are easily available to everyone will substantially improve your risk-adjusted returns. I mean, really, anyone can think of plausible-sounding simple rules like

--buy whichever ten stocks in the Dow have dividends that are the highest fraction of their price.

--move to cash whenever stocks are higher than the preceding 39-week average, to stocks whenever they are lower

Vanguard has a neat demonstrate that you really should try. Before you go to the site, decide on what values to plug in to each of these three rules:

1) Pull out of the market when my balance has dropped by X%
2) Re-enter the market when the market has risen Y%
3) Pick starting and stopping times anywhere between 1988 and 2009.

Go ahead, pick numbers. Now go to The Truth About Emotion and plug them in. How well did your valuation-informed decision-making work?

Generally, advocates of market timing find that simple rules work most of the time ("i before e except after c") but fail spectacularly on occasion ("weigh"). So they add additional rules ("or when sounded like 'a' is in "neighbor" or "weigh"). Then they say that nobody should apply the rule mechanically when anyone can see that the situation is special ("seize, leisure, science")...

You can find a gazillion... well, scores or hundreds anyway... departures from buy-hold-and-rebalance indexing. "Fundamental indexes," "enhanced indexes," "RAFI indexes," equal-weighted indexes.

You can find asset allocation funds like Vanguard's, which "allocates its assets among common stocks, bonds, and money market instruments in proportions consistent with the advisor’s evaluation of their expected returns and risks. These proportions are changed from time to time as return expectations shift."

They've been doing this stuff for decades. And yet the statistics of failure are just devastating; read Larry Swedroe's The Quest for Alpha, it's an eye-opener.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

These issues are really tricky.

I wouldn't rely on a website in which someone's trying to brand something or, for that matter, on an advisor's book. It's incredibly easy to cherry pick evidence to prove that the approach is either great or terrible.

That doesn't mean that everything that academic economists have written on the topic is great either, but my sense is that those who don't have a dog in the fight (e.g., Brad Delong) find the idea of investing based on valuations among the approaches that a reasonable person might try.

Having said that:

a) small adjustments aren't likely to matter much
b) big moves may matter a lot and for the worse (particularly if you're shifting into bonds at a time when they have valuations issues of their own).

Best,
Pete
Topic Author
elgaeb051
Posts: 333
Joined: Sun Feb 21, 2010 11:23 am

Post by elgaeb051 »

delete
Last edited by elgaeb051 on Thu Oct 13, 2011 10:58 am, edited 1 time in total.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

It's hard to know whether your planner understands the problems with that particular site or not. Having said that, some of the passive advisors on here have previously advocated INCREASING stock allocations when stocks are expensive relative to earnings, and if I had to hire a planner I'd much rather hire one to DECREASE stock allocations when stocks are expensive relative to earnings (as yours seems to recommend).

Best,
Pete
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 8:51 pm

Post by bob90245 »

elgaeb051 wrote:Does it make any sense to go with him? Or does it simply raise a big fat ol' red flag?
Not necessarily a red flag. Many asset managers engage in TAA. Before making your decision to engage this asset manager, ask for a written Investment Policy Statement (IPS). In this IPS, your asset manager should specify the conditions that would trigger buy and sell conditions and by how much. You can then share this IPS with the forum and we can make comments.

One thing you should be careful that would be a red flag. And this is needless trading. You don't want your asset manager to have carte blanche to churn your account and generate a nice commission income stream for himself.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
User avatar
nisiprius
Advisory Board
Posts: 41937
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

elgaeb051 wrote:* He shared that the main goal of this method is to help the investor avoid steep investment losses that can take years to recoup. Examples of this would be 2002-2003 and 2008 market dives and he says that these were quite predictable.
Then I think he's full of it.

I'm not sure how aggressive I would be about challenging someone who said that, but if I were truly going to put myself in his hands I would want to see a complete written record of how he advised clients in the past that would show a) that he predicted them, and b) that he didn't "predict nine of the last five" plunges, to paraphrase a common saw about economist predicting recessions.

There is, of course, a big difference between saying "I see trouble brewing," and making a good timing call. A recent thread mentions that Bill Gross was right about treasuries, yet was "unable to make the right move to profit from being right."
Or does it simply raise a big fat ol' red flag?
Claims that 2002-2003 and 2008 were "quite predictable," and the implication that he can get you the same returns as indexing most of the time while keeping you out of the downturns--that is, give you the good parts of indexing without the bad parts--are suspect as "too good to be true."

A Vanguard 500 Index (VFINX) holder who went to cash during 2002-2003 would have boosted his return by 80%. One who went to cash during 2008-9, by 103%. Combined, 265%. Over a ten-year period, that's an average annualized CAGR of 13.8% above and beyond what VFINX returned. Even if you assume imperfect timing, calling those two periods roughly right would have added, say 50% each, over 8% to VFINX's return.

This is a far cry from the "game of basis points" Rick Ferri says multi-asset investing is, and the 1% extra return Larry Swedroe shows as an illustrative example in The Quest for Alpha.

He's promising he can get you risk premium without your actually needing to take the risk. I don't believe that's possible.
Last edited by nisiprius on Thu Aug 11, 2011 12:54 pm, edited 3 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

I agree with Nisi that that particular line is 100% unadulterated sales BS, but I guess I'd put it in its wider context . . . I've never known an advisor/planner who didn't overstate their pitch, and again, in this case I think you're in less danger than is someone who employs an advisor who concludes that you "need" to take more risk in stocks when stock valuations are already high.

So in descending order of preference, I'd suggest:

1) Buy a Vanguard Target Retirement Fund
2) Take some time to learn about this stuff yourself
3) Hire your person
4) Hire a "need to take risk" advisor.

Best,
Pete
Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Post by Rodc »

How much is this guy going to charge you for this advice?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Post by Rodc »

Oh, anybody recognize the guy in the link?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
User avatar
nisiprius
Advisory Board
Posts: 41937
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

Not quite the same thing, but interesting: a Vanguard research paper on Defensive Equity Investing: Appealing Theory, Disappointing Reality
Conventional wisdom maintains that investors can improve their portfolio’s performance during bad times by shifting their equity exposure defensively toward less-cyclical, lower-beta sectors. This paper investigates the strengths and weaknesses of defensive equity investing by focusing on the historical performance of defensive sectors during two periods: U.S. equity bear markets and U.S. economic recessions.

Using several high-level, intuitive leading indicators of recessions and bear markets, we simulate real-time defensive portfolio decisions from January 1963 through December 2006. We show that implementing a defensive investment strategy based on the leading signals of bear markets and recessions (e.g., forward price/earnings ratios, momentum indicators, and the shape of the U.S. Treasury yield curve) would not have resulted in better results than following a buy-and-hold strategy.

The difficulties in converting historical patterns into real-time defensive portfolio outperformance include the low predictive power of even the best signals of bear markets and recessions, the strategies’ potentially high transaction and tax costs, and the inconsistent performance of sectors over time. Indeed, equity market sectors once defined as “defensive” in the past do not always act defensively in the future (as was true with telecommunication services during the 2000–02 bear market). Moreover, defensive investing comes with a considerable and underappreciated cost—not being fully invested in the entire U.S. equity market when the bad times end.
Last edited by nisiprius on Thu Aug 11, 2011 1:01 pm, edited 2 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Post by Rodc »

peter71 wrote:These issues are really tricky.

I wouldn't rely on a website in which someone's trying to brand something or, for that matter, on an advisor's book. It's incredibly easy to cherry pick evidence to prove that the approach is either great or terrible.

That doesn't mean that everything that academic economists have written on the topic is great either, but my sense is that those who don't have a dog in the fight (e.g., Brad Delong) find the idea of investing based on valuations among the approaches that a reasonable person might try.

Having said that:

a) small adjustments aren't likely to matter much
b) big moves may matter a lot and for the worse (particularly if you're shifting into bonds at a time when they have valuations issues of their own).

Best,
Pete
elgaeb051,

The only thing I would add to Peter's summary is that while valuation based investing certainly sounds good (hey, it is buy low sell high after all!) is that the evidence that one can profitably do this with any reliability is very thin. I can see why someone would do this, though personally the risks seem to outweigh the benefits to me.

One thing buy and hold gives you over valuations based investing is a reduction in complexity (fewer ways to go seriously wrong) and reduced influence of emotions (though that depends a bit on your personality). Many find making and executing a dead simple plan more than they can handle (see posts back in 2008-2009 or if this down turn continue just watch the posts in real-time).
Last edited by Rodc on Thu Aug 11, 2011 1:07 pm, edited 1 time in total.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

Rodc wrote:Oh, anybody recognize the guy in the link?
Hi Rod,

Oh sure, but I think the more important question, as you suggest, is how much the acolyte is charging . . . the sad fact is probably that self-promotion works, and I myself remember innocently stumbling across RB's site about four years ago.

Best,
Pete
Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Post by Rodc »

peter71 wrote:
Rodc wrote:Oh, anybody recognize the guy in the link?
Hi Rod,

Oh sure, but I think the more important question, as you suggest, is how much the acolyte is charging . . . the sad fact is probably that self-promotion works, and I myself remember innocently stumbling across RB's site about four years ago.

Best,
Pete
Hi Pete,

I agree, and the OP is not talking about the fellow in the link as his possible adviser anyway. I just found this tid-bit humorous. I should have spotted him quicker, but some days I'm slow on the up take. :)

Rod
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

A bit off-topic (apologies to the OP) but has anyone else noticed the progression of R48's empire over on M* . . . ?

http://socialize.morningstar.com/NewSoc ... 94E00F0A0D

To RB's credit, I'd love to see even an incoherent 18-point list titled, "The Case Against Pyramiding Up": :D
Topic Author
elgaeb051
Posts: 333
Joined: Sun Feb 21, 2010 11:23 am

Post by elgaeb051 »

Both financial planners we are considering have about the same cost: $1500. And then, we are also considering Vanguard: $250.

- E
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 8:51 pm

Post by bob90245 »

elgaeb051 wrote:Both financial planners we are considering have about the same cost: $1500. And then, we are also considering Vanguard: $250.

- E
I think you are comparing apples to oranges. Vanguard is only going to give you a plan. The onus is on you to implement it.

Now is that the same with the other planners? That doesn't make sense to me because valuations continuously change. In order to implement a plan contingent on market valuations, you need an ongoing asset manager who will monitor the market as well as make real-time changes to your portfolio as valuations change. So is that $1500 an annual fee?
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

elgaeb051 wrote:Both financial planners we are considering have about the same cost: $1500. And then, we are also considering Vanguard: $250.

- E
Those all sound like lower than average flat-fee prices . . . all else equal I'd go with Vanguard, but I guess someone who's adjusting valuations for you is "doing" a bit more for the fee . . . I guess I'm less worried about you, them or anyone else making a huge mistake than is Rod because IMO the statistical evidence that people consistently mistime the market is even more tenuous than the evidence that "buying low" pays off long term, but seems like changing your mind and resisting the sales pitch from the valuations place would be a sign of wise investing in its own right . . .

Best,
Pete
Topic Author
elgaeb051
Posts: 333
Joined: Sun Feb 21, 2010 11:23 am

Post by elgaeb051 »

delete
Last edited by elgaeb051 on Sun Aug 14, 2011 6:29 pm, edited 1 time in total.
pkcrafter
Posts: 14320
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter »

elgaeb051 wrote:Both planners charge a fee by the hour - this project comes in at about $1500 for both.

They both will look at our situation and analyze a pension lump sum versus an annuity situation; review our IPS and basically answer the question how much can we withdraw? give us an analysis of our situation at the current time and analyze what it will look like in the future based on either the lump sum or pension annuity and discuss the nuances involved in various decisions.

Since we are paying a flat fee, we are not expected to go in for check ups, though we could schedule check ups along the way if we desire to do so. On the other hand, we hoped for a plan we can implement ourselves -- so that implies going in for check-ups unless I understand the "rules" of valuation.

I agree with Bob that this doesn't make much sense unless you fully understand the rules that trigger AA changes. you can't go in every month or two to find out if you should be adjusting something. You need to understand these rules before you pay him, but even then it may end up getting you in trouble if you try it on your own. I'd reject any strategy that changed AA by more than 15%.

Interviewing FPs was an interesting experience - they were both so different in temperament. The valuation FP is a stickler for detail and wanted a lot of information ready at hand (but not used unless chosen); the other passive indexing FP was the opposite -- I had to actually ask him what type of information he might want to see during the get acquainted interview.

Vanguard is hard to get a read on - I've called them twice and end up talking to a CFP support person. The last one I talked to had never heard the word "fiduciary".

*Sigh*

Since you have so many doubts about how to handle retirement, perhaps you would be better off putting your assets under professional management.






Paul

- E
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
Topic Author
elgaeb051
Posts: 333
Joined: Sun Feb 21, 2010 11:23 am

Post by elgaeb051 »

delete
Last edited by elgaeb051 on Thu Oct 13, 2011 10:59 am, edited 1 time in total.
peter71
Posts: 3768
Joined: Tue Jul 24, 2007 8:28 pm

Post by peter71 »

Hi Again E,

The passive planner probably doesn't need to know much about you b/c you're paying someone else to "act passively" for you, and that's kind of an oxymoron.

First line phone reps at Vanguard being dumb could well be a problem, but presumably they're just pushing buttons on a computer that will develop/implement a perfectly good passive plan worked out by smarter folks.

IMO the main people who love to talk about how important it is to be a fiduciary are the people who've structured a business brand around that status. It's a legal status that no doubt prevents some of the worst abuses that used to be common out there, but the expanding supply of low fee planners and funds also put pressure on the worst abusers . . . so I think the bottom line is what they're selling you and how much it costs . . . fiduciary or not, be sure to read the fine print and look for hidden costs . . . or, again, just do it yourself or go with an organization like VG whose primary sales pitch is not ripping people off.

Best,
Pete
YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: The Case Against Valuation-Informed Indexing???

Post by YDNAL »

elgaeb051 wrote:Still educating myself, I became interested in knowing more about Valuation Informed Indexing and how it compared to Buy and Hold. I ran across this article, I think it was written in 2007.
Sorry it this is discussed previously, but regardless of what someone calls it, adjusting investments based on valuation is not new, or for that matter, ground-braking.
The purpose of my Valuation-Informed Indexing approach is to provide a means by which middle-class investors can realistically expect not only to talk the buy-and-hold talk but also to walk the buy-and-hold walk. Valuation-informed indexers lower their stock allocations by about 25 percent at times of extremely high valuations (a P/E10 level above 20) and increase their stock allocations by about 25 percent at times of extremely low valuations (a P/E10 level below 12). Valuation-Informed Indexers appreciate the futility of short-term timing. Their expectation is that stocks will perform in the future somewhat as they always have in the past and that long-term timing (changing one’s stock allocation with no expectation of seeing a benefit for doing so for a time-period of up to 10 years) will continue to provide a substantial edge. Valuation-informed indexers are concerned with the value proposition represented by their index purchases and are not willing to commit the same percentage of their portfolios to stocks at times when the 10-year return is likely to be low as they are when the 10-year return is likely to be high.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
User avatar
nisiprius
Advisory Board
Posts: 41937
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

At the risk of setting up a straw man...

There isn't an awful lot in indexing for the people who sell investments or advice. It's not so good for them, which is why it is good for investors. So if you are on the sales side and you are having a problem with people coming in saying they believe in indexing, what are you going to do? Not argue with them, co-opt them.

You say "You're right, you are smart and I admire you and you are a sharp dresser. Indexing is great. And we like it so much that we've developed something much better than that moldy old indexy indexing. It's.... active indexing, yeah! It's Indexing Plus! Or Indexing-X-Treme! Or enhanced indexing or fundamental indexing. It's indexing, but it's better! And because it's better, and only we have it, we get to charge high fees...."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: The Case Against Valuation-Informed Indexing???

Post by YDNAL »

nisiprius wrote:You say "You're right, you are smart and I admire you and you are a sharp dresser. Indexing is great. And we like it so much that we've developed something much better than that moldy old indexy indexing. It's.... active indexing, yeah! It's Indexing Plus! Or Indexing-X-Treme! Or enhanced indexing or fundamental indexing. It's indexing, but it's better! And because it's better, and only we have it, we get to charge high fees...."
You forgot Valuation-Informed Indexing! :)
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
User avatar
fredflinstone
Posts: 2718
Joined: Mon Mar 29, 2010 7:35 am
Location: Bedrock

Post by fredflinstone »

A lot of people on this Forum are skeptical of valuation-informed allocation. I am in the minority. I recently revised my IPS to take into account valuations of both stocks and bonds when making allocation decisions. The algorithm I use is very simple:

% allocated to stocks = 8 x [(1/PE10) - (5 year TIPS yield)]

I rebalance whenever my target % stocks deviates from my actual % stocks by more than 5.0 percent.

My hope (and expectation) is that using this approach will improve risk-adjusted returns relative to, say, a straight 30/70 stock/bond buy-and-rebalance portfolio.
Stocks 28 / Gold 23 / Long-term US treasuries 19 / Cash (mainly CDs) 22 / TIPS 8
Post Reply