Nondiversification Risk - Vanguard 500 Index Fund

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Beensabu
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

gavinsiu wrote: Mon Jul 08, 2024 1:46 pm
Beensabu wrote: Mon Jul 08, 2024 1:23 pm If I told you I had 20% of my equity allocation in 3 stocks, would you consider my portfolio adequately diversified?
Let's flip it around. So you have 80% total stock and 20% of that is in the 3 stock so you have 16% in 3 stock or may be 5% Suppose one of the companny went the ways of the Enron or Lehman Brothers, you would lose 5%, more if that stock is also in the 500 index.
So you would consider me to be adequately diversified as long as no one company was more than 5% of my overall portfolio?
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by beardsicles »

The one that interests me is ESGV. It's almost 40% tech, which probably part of why it's up 1.5% more than VTI YTD.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

beardsicles wrote: Mon Jul 08, 2024 2:12 pm The one that interests me is ESGV. It's almost 40% tech, which probably part of why it's up 1.5% more than VTI YTD.
Top 10 is nearly identical to VOO, and is one-third of both funds.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by gammalaser »

Beensabu wrote: Mon Jul 08, 2024 1:44 pm
Rocinante Rider wrote: Mon Jul 08, 2024 1:33 pm
Beensabu wrote: Mon Jul 08, 2024 1:23 pm
gammalaser wrote: Mon Jul 08, 2024 11:58 am Sounds like regulators (and perhaps folks on this thread) disagree.
If I told you I had 20% of my equity allocation in 3 stocks, would you consider my portfolio adequately diversified?
No if you held the stocks individually, but yes if you held them at that percentage as part of a 100% portfolio of cap weighted total market index funds.
Why does it matter if I hold the stocks individually or as part of a cap weighted index fund?

Either having 20% of your equity allocation in 3 stocks is considered adequately diversified or it is not.

A cap weighted index fund is not diversified just because it is a cap weighted index fund. Either it adequately reduces idiosyncratic risk or it does not.
It doesn't matter if the 20% is inside a fund or outside a fund. But I think it matters whether the rest of the 80% of the portfolio is diversified in the market to overcome the idiosyncratic risk of one or more of the 3 stocks tanking. And by holding a fund, the 80% of rest of portfolio is diversified by default.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Rocinante Rider »

Beensabu wrote: Mon Jul 08, 2024 1:44 pm
Rocinante Rider wrote: Mon Jul 08, 2024 1:33 pm
Beensabu wrote: Mon Jul 08, 2024 1:23 pm
gammalaser wrote: Mon Jul 08, 2024 11:58 am Sounds like regulators (and perhaps folks on this thread) disagree.
If I told you I had 20% of my equity allocation in 3 stocks, would you consider my portfolio adequately diversified?
No if you held the stocks individually, but yes if you held them at that percentage as part of a 100% portfolio of cap weighted total market index funds.
Why does it matter if I hold the stocks individually or as part of a cap weighted index fund?

Either having 20% of your equity allocation in 3 stocks is considered adequately diversified or it is not.

A cap weighted index fund is not diversified just because it is a cap weighted index fund. Either it adequately reduces idiosyncratic risk or it does not.
Because owning the stocks individually introduces additional unsystematic risk associated with factors specific to an individual company or sector. When you own the same stocks as part of a fully diversifed, cap weighted portfolio, the variability in returns from any individual security or sector can be mitigated by complementary variation in the returns from the rest of the market's securities and sectors. It's not that the risk disappears by owning the whole cap-weighted market, but it does get diminished. You still have the unavoidable systemic risk of the market in general, but that's compensated by the potential for greater rewards of owning stocks in general and in aggregate. I think Burton Malkiel explicated this in A Random Walk Down Wall Street, and others have addressed it using the terminology of "compensated risk," which is what you get when you own the whole market, versus "uncompensated risk," which is what you get when you invest in individual stocks.

More practically, is there a better evidence-based alternative to investing other than owning the whole market according to the valuations currently assigned to each of its securities and sectors? Wouldn't any other approach by necessity involve making bets against an overall efficient market? If you don't buy the whole haystack according to it's current valuation, it seems that your alternative is to make skewed bets that, for example, underweight leading companies and sectors and overweight less valuable companies and sectors compared to their currently prevailing valuations. Investors who are smarter and more informed than I am, of which there are many, might feel comfortable making such bets, but I certainly don't. I'm content to just own the entire market despite the fact that a handfull of stocks always comprise a disproportionate percentage of the investment. And when companies A-E inevitably get replaced as leaders by companies U-Z, I'll still own everything according to their then prevailing valuations and I'll get exactly the market returns with no "uncompensated" risk.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by gavinsiu »

Beensabu wrote: Mon Jul 08, 2024 2:09 pm So you would consider me to be adequately diversified as long as no one company was more than 5% of my overall portfolio?
Sort of, the rule of thumb is that if you own company stock, do no more than 4%. However, if you have bunch oif stocks in the same sector, then you are not diversified.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by beardsicles »

Beensabu wrote: Mon Jul 08, 2024 2:38 pm
beardsicles wrote: Mon Jul 08, 2024 2:12 pm The one that interests me is ESGV. It's almost 40% tech, which probably part of why it's up 1.5% more than VTI YTD.
Top 10 is nearly identical to VOO, and is one-third of both funds.
ESGV is 39.10% tech, VOO is 30.60% tech. The categories are broken out slightly differently in each so it's hard to compare exactly, but a 30% difference in exposure is materially different, imo. And it's slightly misleading to say the top 10s are nearly identical--the weightings are quite different.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by gammalaser »

Here's a morningstar article which basically says, not to pay attention to this risk label.

https://www.morningstar.com/funds/how-l ... d-universe
The new descriptions do not indicate these mutual funds have decided to get more aggressive, though. The diversification label—as legally defined by U.S. regulators—is not a particularly useful indicator of a fund’s audaciousness. And at strategies that try to stick closer to their benchmarks’ risk/reward profiles, adhering to the diversification rules can be a hindrance.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by rkhusky »

gammalaser wrote: Mon Jul 08, 2024 2:58 pm Here's a morningstar article which basically says, not to pay attention to this risk label.

https://www.morningstar.com/funds/how-l ... d-universe
The new descriptions do not indicate these mutual funds have decided to get more aggressive, though. The diversification label—as legally defined by U.S. regulators—is not a particularly useful indicator of a fund’s audaciousness. And at strategies that try to stick closer to their benchmarks’ risk/reward profiles, adhering to the diversification rules can be a hindrance.
Right. Would one consider 25 small tech stocks to be diversified, just because each stock is less than 5% of the portfolio?
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

Rocinante Rider wrote: Mon Jul 08, 2024 2:44 pm
Beensabu wrote: Mon Jul 08, 2024 1:44 pm Why does it matter if I hold the stocks individually or as part of a cap weighted index fund?
Because owning the stocks individually introduces additional unsystematic risk associated with factors specific to an individual company or sector. When you own the same stocks as part of a fully diversifed, cap weighted portfolio, the variability in returns from any individual security or sector can be mitigated by complementary variation in the returns from the rest of the market's securities and sectors. It's not that the risk disappears by owning the whole cap-weighted market, but it does get diminished.
The idiosyncratic/unsystematic risk is not a function of the stock (or sector fund) being held individually but of the weighting of the stock/sector.

If I have 7% in an individual stock holding or 7% in that stock in a cap weighted index fund, my holding in that stock will fluctuate the same either way if all I do is hold.

If I have 20% in 3 stocks and the other 80% spread out relatively evenly between 500 stocks, there is not much difference between that and a S&P 500 index fund at the moment.
gavinsiu wrote: Mon Jul 08, 2024 2:48 pm
Beensabu wrote: Mon Jul 08, 2024 2:09 pm So you would consider me to be adequately diversified as long as no one company was more than 5% of my overall portfolio?
Sort of, the rule of thumb is that if you own company stock, do no more than 4%. However, if you have bunch oif stocks in the same sector, then you are not diversified.
And do you also think there is a difference between owning individual company stock and owning company stock via a mutual fund?

If you have a bunch of individual stocks in the same sector, is that different than having a bunch of stocks in the same sector in a mutual fund? Is having a sector fund different than having a significant weighting to that sector in a mutual fund?
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VOO is so concentrated, Vanguard had to issue a notice

Post by yobyot »

[Thread merged into here --admin LadyGeek]

I've been a fan of VOO for decades. Just last week, I bought more. But only after holding my nose because it's so concentrated in tech stocks.

Then in today's mail (yes, I still insist on paper -- but I read 'em), I received a "Supplement Dated June 28, 2024 to the Prospectus and Summary Prospectus Dated April 26, 2024" containing these new risks (emphasis mine):

Nondiversification risk. Because the Fund seeks to closely track the composition of the Fund's target index, from time to time, more than 25% of the Fund's total assets may be more than 5% of the Fund's total assets due to an index rebalance or market movement, which would result in the Fund being nondiversified under the Investment Company Act of 1940. The Fund's performance may be hurt disproportionately by the poor performance of relatively few stocks, or even a single stock, and the Fund's shares may experience significant fluctuations in value.
Sector risk, which is the chance that significant problems will affect a particular sector, or that returns from that sector will trail returns from the overall stock market. Daily fluctuations in specific market sectors are often more extreme or volatile than fluctuations in the overall market. Because a significant portion of the Fund's assets are invested in the information technology sector, the Fund's performance is impacted by the general condition of that sector. Companies in the information technology sector could be affected by, among other things, overall economic conditions, short product cycles, rapid obsolescence of products, competition, and government regulation. Sector risk is expected to be high for the Fund.

IOW, the S&P 500 itself is so overweight on tech that VOO is no longer diversified. It's become a sector fund. The indexer has been concentrated by the index.

I'd be interested hearing what folks are doing for alternatives. What ETF do you buy that costs less than 5bp, indexes large-cap US-based companies and doesn't have MSFT, AAPL, NVDA, AMZN, META and GOOG in the top six holdings? Where's my "Warren Buffett ETF?" The one that costs next to nothing and buys the core of American business but is also diversified?

I'm gonna miss VOO -- it was quality on the cheap.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by LadyGeek »

I merged yobyot's thread into the ongoing discussion.

(Thanks to the member who reported the post and provided a link to this thread.)
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by gavinsiu »

Beensabu wrote: Mon Jul 08, 2024 3:18 pm And do you also think there is a difference between owning individual company stock and owning company stock via a mutual fund?

If you have a bunch of individual stocks in the same sector, is that different than having a bunch of stocks in the same sector in a mutual fund? Is having a sector fund different than having a significant weighting to that sector in a mutual fund?
Yes, most mutual funds are not so concentrated that they have less than 10 stocks. Yes, S&P 500 is less diverse than it used to, but it's still going to be more diverse than a typical stock portfolio. I also don't know if there was another period of time with low-diversity such as right before the Dotcom bubble burst, but if you feel that S&P 500 is not diverse enough, you can buy other assets like international, but then you might start complaining that you are not getting those high return you are used to. Note that I have maintain a roughly 305 international for most of my investment life, so I know how underperforming the index for decades feel like.
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Re: VOO is so concentrated, Vanguard had to issue a notice

Post by abc132 »

yobyot wrote: Mon Jul 08, 2024 3:28 pm [Thread merged into here --admin LadyGeek]

I've been a fan of VOO for decades. Just last week, I bought more. But only after holding my nose because it's so concentrated in tech stocks.

Then in today's mail (yes, I still insist on paper -- but I read 'em), I received a "Supplement Dated June 28, 2024 to the Prospectus and Summary Prospectus Dated April 26, 2024" containing these new risks (emphasis mine):

Nondiversification risk. Because the Fund seeks to closely track the composition of the Fund's target index, from time to time, more than 25% of the Fund's total assets may be more than 5% of the Fund's total assets due to an index rebalance or market movement, which would result in the Fund being nondiversified under the Investment Company Act of 1940. The Fund's performance may be hurt disproportionately by the poor performance of relatively few stocks, or even a single stock, and the Fund's shares may experience significant fluctuations in value.
Sector risk, which is the chance that significant problems will affect a particular sector, or that returns from that sector will trail returns from the overall stock market. Daily fluctuations in specific market sectors are often more extreme or volatile than fluctuations in the overall market. Because a significant portion of the Fund's assets are invested in the information technology sector, the Fund's performance is impacted by the general condition of that sector. Companies in the information technology sector could be affected by, among other things, overall economic conditions, short product cycles, rapid obsolescence of products, competition, and government regulation. Sector risk is expected to be high for the Fund.

IOW, the S&P 500 itself is so overweight on tech that VOO is no longer diversified. It's become a sector fund. The indexer has been concentrated by the index.

I'd be interested hearing what folks are doing for alternatives. What ETF do you buy that costs less than 5bp, indexes large-cap US-based companies and doesn't have MSFT, AAPL, NVDA, AMZN, META and GOOG in the top six holdings? Where's my "Warren Buffett ETF?" The one that costs next to nothing and buys the core of American business but is also diversified?

I'm gonna miss VOO -- it was quality on the cheap.
I would have no issue with someone accumulating AVUV with new additions. It costs more than 5bp but you should be able to invest 1/5th as much and still get as much diversification as a fund excluding the top 6.

You get returns by holding the top 5 stocks not by avoiding the worst 5 stocks. Trying to avoid the best performers isn't a great plan.

Even a small amount of bonds is the best diversifier.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Rocinante Rider »

Beensabu wrote: Mon Jul 08, 2024 3:18 pm The idiosyncratic/unsystematic risk is not a function of the stock (or sector fund) being held individually but of the weighting of the stock/sector...
If I have 20% in 3 stocks and the other 80% spread out relatively evenly between 500 stocks, there is not much difference between that and a S&P 500 index fund at the moment.
Sure. I suppose you could buy and hold proportional to their market caps every individual stock and recreate the S&P 500, or the total market, or any other index and achieve the same result as just buying the index fund. Either way you'd effectively elimate unsystematic/uncompensated risk. Seems like a lot of effort, and probably extra cost, though when you could just buy something like VTI.
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Re: VOO is so concentrated, Vanguard had to issue a notice

Post by yobyot »

abc132 wrote: Mon Jul 08, 2024 3:40 pm ....Even a small amount of bonds is the best diversifier.
Feh! I'm still not over what BND did to me in 2022. So, duration is my sworn enemy plus 2022 proved bond funds can really hurt you due to lack of maturity. (I am experimenting with things like IBDQ but, sheesh, 10bp!)

My renewed interest in VOO is because I've been riding the T-bill tsunami. Consider: I bought a 26-week bill in today's auction with a bond-equivalent rate of 5.286%. But that pahty (Boston, OK?) can't continue. When the Fed cuts rates, I think it will drive equities higher (including, of course, VOO itself) and T-bill zeros' yields down.

I'm trying to pre-position for maybe 100 to 150 bp of rate cuts over the next 18 months. Yes, BND would love that -- but I'm leaving those positions completely as soon as they recover somewhat. Why bother with BND when It's so easy, safe and cheap to buy T-bills at auction. With "auto roll" reinvestment, you essentially build ladders of short term bills with no effort. All you risk is reinvestment risk in ultra-short Treasurys.

But other fixed income? No thanks. You're talking to someone who got burned in the mid Aughts auction rate securities scandal (or freeze-up, if you think the brokers are good guys).

I've tried listening to people (see my sig) who preach fixed income. I may take a beating in equities come the next downturn. But at least it's comprehensible.
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Re: VOO is so concentrated, Vanguard had to issue a notice

Post by abc132 »

yobyot wrote: Mon Jul 08, 2024 4:00 pm
abc132 wrote: Mon Jul 08, 2024 3:40 pm ....Even a small amount of bonds is the best diversifier.
Feh! I'm still not over what BND did to me in 2022. So, duration is my sworn enemy plus 2022 proved bond funds can really hurt you due to lack of maturity. (I am experimenting with things like IBDQ but, sheesh, 10bp!)

My renewed interest in VOO is because I've been riding the T-bill tsunami. Consider: I bought a 26-week bill in today's auction with a bond-equivalent rate of 5.286%. But that pahty (Boston, OK?) can't continue. When the Fed cuts rates, I think it will drive equities higher (including, of course, VOO itself) and T-bill zeros' yields down.

I'm trying to pre-position for maybe 100 to 150 bp of rate cuts over the next 18 months. Yes, BND would love that -- but I'm leaving those positions completely as soon as they recover somewhat. Why bother with BND when It's so easy, safe and cheap to buy T-bills at auction. With "auto roll" reinvestment, you essentially build ladders of short term bills with no effort. All you risk is reinvestment risk in ultra-short Treasurys.

But other fixed income? No thanks. You're talking to someone who got burned in the mid Aughts auction rate securities scandal (or freeze-up, if you think the brokers are good guys).

I've tried listening to people (see my sig) who preach fixed income. I may take a beating in equities come the next downturn. But at least it's comprehensible.
I'm okay with accumulating without fixed income beyond an emergency fund.

Reinvestment risk will show up as sure as duration risk. I personally don't try to time these things and take the lower returns of I-Bonds so I don't have to. If you track all your positions over a career I would guess you will have no benefit vs just choosing your preferred blend of poisons (reinvestment risk, duration risk, return risk).

I see the TIPS crowd that purchased a bunch of TIPS at 1-2% is already behind just keeping things in stocks and rebalancing the portfolio into TIPS. Bond timing doesn't seem to be helpful even when you think you have an obvious advantage. You will of course be correct sometimes.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

Rocinante Rider wrote: Mon Jul 08, 2024 3:56 pm
Beensabu wrote: Mon Jul 08, 2024 3:18 pm The idiosyncratic/unsystematic risk is not a function of the stock (or sector fund) being held individually but of the weighting of the stock/sector...
If I have 20% in 3 stocks and the other 80% spread out relatively evenly between 500 stocks, there is not much difference between that and a S&P 500 index fund at the moment.
Sure. I suppose you could buy and hold proportional to their market caps every individual stock and recreate the S&P 500, or the total market, or any other index and achieve the same result as just buying the index fund. Either way you'd effectively elimate unsystematic/uncompensated risk. Seems like a lot of effort, and probably extra cost, though when you could just buy something like VTI.
The point is that you have not effectively eliminated unsystematic risk when the weightings of individual stocks in the index increase to a particular level / exceed a certain threshold.

A market cap weighted index fund is not diversified because it is a market cap weighted index fund. It is diversified because it has enough holdings that no individual stock/sector has too great a weight - and when that is no longer the case, it is no longer diversified.
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Re: VOO is so concentrated, Vanguard had to issue a notice

Post by Rocinante Rider »

yobyot wrote: Mon Jul 08, 2024 3:28 pm I'd be interested hearing what folks are doing for alternatives.
VTI and VXUS. Own the entire world, with companies and sectors in each segment (US vs international) exactly proportional to their market valuations. My future returns will exactly equal, minus minimal ERs, the overall market returns. I can't think of a better or more cost effective alternative. Anything else and I'd have to engage in active stock and sector picking.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by abc132 »

If Apple buys Google do we suddenly have even more concentration risk in the top six companies because of that additional company? It really doesn't make sense to count companies when declaring concentration risk. Looking at the size of the tech sector also doesn't make sense - if that is where the earnings are happening then they are not riskier because they generate more earnings. We don't suddenly have more personal risk because we got a raise and now have increased our earning potential.

I think people generally understand that these tech companies are going to get a piece of the small company earnings because their platforms are used by almost everyone. This justifies at least some of the higher tech percentage. I can see those that want to diversify away from tech and with SCV over 20% behind this year now is as good a time as any to do so. I wouldn't expect a performance benefit but at least you feel more diversified.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Rocinante Rider »

Beensabu wrote: Mon Jul 08, 2024 4:35 pm
Rocinante Rider wrote: Mon Jul 08, 2024 3:56 pm
Beensabu wrote: Mon Jul 08, 2024 3:18 pm The idiosyncratic/unsystematic risk is not a function of the stock (or sector fund) being held individually but of the weighting of the stock/sector...
If I have 20% in 3 stocks and the other 80% spread out relatively evenly between 500 stocks, there is not much difference between that and a S&P 500 index fund at the moment.
Sure. I suppose you could buy and hold proportional to their market caps every individual stock and recreate the S&P 500, or the total market, or any other index and achieve the same result as just buying the index fund. Either way you'd effectively elimate unsystematic/uncompensated risk. Seems like a lot of effort, and probably extra cost, though when you could just buy something like VTI.
The point is that you have not effectively eliminated unsystematic risk when the weightings of individual stocks in the index increase to a particular level / exceed a certain threshold.

A market cap weighted index fund is not diversified because it is a market cap weighted index fund. It is diversified because it has enough holdings that no individual stock/sector has too great a weight - and when that is no longer the case, it is no longer diversified.
Leaving aside the definition and measure of diversification or a discussion on whether indexing eliminates unsystematic risk, what's the alternative to indexing? Doesn't any approach other than cap weighted indexing involve actively picking and buying stocks or sectors in proportions that differ from prevailing market valuations? How do you determine which stocks and sectors to buy more of because the prevailing market sentiment has wrongly undervalued them? And why is 5% the threshold at which one determines that market sentiment has wrongly overvalued the worth of a company and assigned it "too great a weight"? Would the same nominal valuation be okay if that company split down the financial middle into two companies each valued at 2.5% of the overall market? It all seems like a contemporary argument in favor of active management through stock and sector picking. Although I doubt that I'd have the time or confidence to do anything other than just owning the whole world (VTI + VXUS) as it's currently valued, I am curious how (and why) a thoughtful non-salesperson would approach it otherwise and allocate their investments.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by yobyot »

abc132 wrote: Mon Jul 08, 2024 5:01 pm If Apple buys Google do we suddenly have even more concentration risk in the top six companies because of that additional company? It really doesn't make sense to count companies when declaring concentration risk. Looking at the size of the tech sector also doesn't make sense - if that is where the earnings are happening then they are not riskier because they generate more earnings. We don't suddenly have more personal risk because we got a raise and now have increased our earning potential.

I think people generally understand that these tech companies are going to get a piece of the small company earnings because their platforms are used by almost everyone. This justifies at least some of the higher tech percentage. I can see those that want to diversify away from tech and with SCV over 20% behind this year now is as good a time as any to do so. I wouldn't expect a performance benefit but at least you feel more diversified.
Except...earnings don't determine the S&P 500; market cap does. And market cap is (currently) concentrated so heavily in a single industry that Vanguard risks VOO become "not diversified" according to the law.

Whatever you thinking is about investment choice, for true-blue, OG Bogelheads like me (that is, hard core indexers), you either have to accept that the index accurately represents the market or it doesn't. I think valuation in tech (market cap) has so distorted the index that we're in an unknown Index Galaxy -- where the index doesn't accurately represent the constellations in that galaxy.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by abc132 »

yobyot wrote: Mon Jul 08, 2024 5:27 pm
abc132 wrote: Mon Jul 08, 2024 5:01 pm If Apple buys Google do we suddenly have even more concentration risk in the top six companies because of that additional company? It really doesn't make sense to count companies when declaring concentration risk. Looking at the size of the tech sector also doesn't make sense - if that is where the earnings are happening then they are not riskier because they generate more earnings. We don't suddenly have more personal risk because we got a raise and now have increased our earning potential.

I think people generally understand that these tech companies are going to get a piece of the small company earnings because their platforms are used by almost everyone. This justifies at least some of the higher tech percentage. I can see those that want to diversify away from tech and with SCV over 20% behind this year now is as good a time as any to do so. I wouldn't expect a performance benefit but at least you feel more diversified.
Except...earnings don't determine the S&P 500; market cap does. And market cap is (currently) concentrated so heavily in a single industry that Vanguard risks VOO become "not diversified" according to the law.

Whatever you thinking is about investment choice, for true-blue, OG Bogelheads like me (that is, hard core indexers), you either have to accept that the index accurately represents the market or it doesn't. I think valuation in tech (market cap) has so distorted the index that we're in an unknown Index Galaxy -- where the index doesn't accurately represent the constellations in that galaxy.
Good luck with your market timing. It's not my cup of tea.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

Rocinante Rider wrote: Mon Jul 08, 2024 5:04 pm Although I doubt that I'd have the time or confidence to do anything other than just owning the whole world (VTI + VXUS) as it's currently valued, I am curious how (and why) a thoughtful non-salesperson would approach it otherwise and allocate their investments.
Total world would work. Or just having enough exUS and/or fixed income to reduce the weighting of any individual company (or multiple individual companies in the same industry) in VOO (and eventually maybe even in VTI if it keeps going this way for awhile longer). You know, the three-fund portfolio.

If I have 80% in VTI and 20% in TSMC, NVO and ASML, I wouldn't consider that a diversified portfolio just because I have mostly TSM.

If someone would still consider that diversified, then I guess they're fine with 100% S&P 500 as is today.

But if someone else wouldn't consider that diversified, and they're 100% S&P 500, then that means their portfolio is not currently diversified according to their own personal standards.

In the everlasting US vs. exUS boondoggle, there are people who genuinely see the potential for future US share of global market cap to exceed 80%. And perhaps some of them see the potential for future share of US market cap to be completely dominated by a handful of current tech companies.

My take on that is the future is uncertain so who knows what could happen. Could both of those things happen? Sure. Will it particularly matter how I personally am invested if they do? Not really, at that point. The societal effect of that would matter a whole lot more to my life. If those things don't happen, will it matter how I personally am invested? Yup.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by vv19 »

Not really sure why this is an issue. If you are an index believer, why does this matter if one sector is heavily represented in that index?
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HanSolo
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by HanSolo »

IDpilot wrote: Mon Jul 08, 2024 7:41 am
HanSolo wrote: Mon Jul 08, 2024 3:15 am
IDpilot wrote: Sun Jul 07, 2024 7:55 am
Beensabu wrote: Sat Jul 06, 2024 10:09 pm
IDpilot wrote: Sat Jul 06, 2024 9:33 pm And just because they have now addressed non-diversification when required by a new regulation does not mean that Vanguard feels like they need to address this risk. All we can say for sure is that some government regulator feels like they need to address this risk.
In what alternate universe is the Investment Company Act of 1940 a new regulation?
The relevant law has not changed but how the SEC interrupts and enforces that law has for indexed funds. The Investment Company Act requires a fund declare whether it will operate as a diversified company or not in its registration statement. It also requires that once that fund is registered it can only change its classification from diversified to non-diversified unless authorized by a vote of a majority of its outstanding voting securities. Certain index funds that provided specified notices to their shareholders are now exempt from this requirement.
I'm not seeing anything online that confirms your assertions. If you think Vanguard's wording was caused by some recent change on the part of the SEC or anyone else in the government, please cite the change and when it came into effect.
https://www.sec.gov/investment/stradley-062419

https://www.sec.gov/divisions/investmen ... coming.pdf
The above provides no evidence of any "new regulation" (your words) or change in enforcement (paraphrasing your words). Letters were written, and they didn't say anything about there being a new regulation or change in enforcement. They just confirmed an understanding.

Before 2019: Investment companies are expected to be accurate in their representations.
After 2019: Investment companies are expected to be accurate in their representations.

Also, since the letters were dated 2019, it means that the recent change (OP: "Just over a week ago") was directly caused by something other than those letters... most likely, that the fund crossed the specified thresholds, as others suggested, e.g.:
exodusNH wrote: Sun Jul 07, 2024 10:46 am They didn't have to because the thresholds hadn't been reached.

There are lots of laws that don't apply to companies employing people below certain thresholds. E.g., at 15 people, antidiscrimination laws take effect. If you suddenly see posters in the kitchen talking about this, you can't draw the conclusion that they were discriminating before. They're just reached the threshold dictated by law.

You have to draw a line somewhere. At 17 years and 364 days, you are not a fundamentally different person than at 18 years and 0 days, but a whole new set of laws kicked in.
Apparently, that's all there is to it. The rest is unnecessary speculation and drama. There is no problem here. As long as the representations about the funds are accurate, people can buy what they want as informed consumers.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by IDpilot »

HanSolo wrote: Mon Jul 08, 2024 7:29 pm
IDpilot wrote: Mon Jul 08, 2024 7:41 am
HanSolo wrote: Mon Jul 08, 2024 3:15 am
IDpilot wrote: Sun Jul 07, 2024 7:55 am
Beensabu wrote: Sat Jul 06, 2024 10:09 pm

In what alternate universe is the Investment Company Act of 1940 a new regulation?
The relevant law has not changed but how the SEC interrupts and enforces that law has for indexed funds. The Investment Company Act requires a fund declare whether it will operate as a diversified company or not in its registration statement. It also requires that once that fund is registered it can only change its classification from diversified to non-diversified unless authorized by a vote of a majority of its outstanding voting securities. Certain index funds that provided specified notices to their shareholders are now exempt from this requirement.
I'm not seeing anything online that confirms your assertions. If you think Vanguard's wording was caused by some recent change on the part of the SEC or anyone else in the government, please cite the change and when it came into effect.
https://www.sec.gov/investment/stradley-062419

https://www.sec.gov/divisions/investmen ... coming.pdf
The above provides no evidence of any "new regulation" (your words) or change in enforcement (paraphrasing your words). Letters were written, and they didn't say anything about there being a new regulation or change in enforcement. They just confirmed an understanding.

Before 2019: Investment companies are expected to be accurate in their representations.
After 2019: Investment companies are expected to be accurate in their representations.

Also, since the letters were dated 2019, it means that the recent change (OP: "Just over a week ago") was directly caused by something other than those letters... most likely, that the fund crossed the specified thresholds, as others suggested, e.g.:
exodusNH wrote: Sun Jul 07, 2024 10:46 am They didn't have to because the thresholds hadn't been reached.

There are lots of laws that don't apply to companies employing people below certain thresholds. E.g., at 15 people, antidiscrimination laws take effect. If you suddenly see posters in the kitchen talking about this, you can't draw the conclusion that they were discriminating before. They're just reached the threshold dictated by law.

You have to draw a line somewhere. At 17 years and 364 days, you are not a fundamentally different person than at 18 years and 0 days, but a whole new set of laws kicked in.
Apparently, that's all there is to it. The rest is unnecessary speculation and drama. There is no problem here. As long as the representations about the funds are accurate, people can buy what they want as informed consumers.
Feel free to interrupt anything you want anyway you want. If it makes you feel better, go for it.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by HanSolo »

IDpilot wrote: Tue Jul 09, 2024 8:40 am Feel free to interrupt anything you want anyway you want. If it makes you feel better, go for it.
I just read what's there. No feeling involved (on my part, anyway).

But if this is a feeling-fest, sorry to "interrupt" it!
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by IDpilot »

IDpilot wrote: Tue Jul 09, 2024 8:40 am
HanSolo wrote: Mon Jul 08, 2024 7:29 pm
IDpilot wrote: Mon Jul 08, 2024 7:41 am
HanSolo wrote: Mon Jul 08, 2024 3:15 am
IDpilot wrote: Sun Jul 07, 2024 7:55 am

The relevant law has not changed but how the SEC interrupts and enforces that law has for indexed funds. The Investment Company Act requires a fund declare whether it will operate as a diversified company or not in its registration statement. It also requires that once that fund is registered it can only change its classification from diversified to non-diversified unless authorized by a vote of a majority of its outstanding voting securities. Certain index funds that provided specified notices to their shareholders are now exempt from this requirement.
I'm not seeing anything online that confirms your assertions. If you think Vanguard's wording was caused by some recent change on the part of the SEC or anyone else in the government, please cite the change and when it came into effect.
https://www.sec.gov/investment/stradley-062419

https://www.sec.gov/divisions/investmen ... coming.pdf
The above provides no evidence of any "new regulation" (your words) or change in enforcement (paraphrasing your words). Letters were written, and they didn't say anything about there being a new regulation or change in enforcement. They just confirmed an understanding.

Before 2019: Investment companies are expected to be accurate in their representations.
After 2019: Investment companies are expected to be accurate in their representations.

Also, since the letters were dated 2019, it means that the recent change (OP: "Just over a week ago") was directly caused by something other than those letters... most likely, that the fund crossed the specified thresholds, as others suggested, e.g.:
exodusNH wrote: Sun Jul 07, 2024 10:46 am They didn't have to because the thresholds hadn't been reached.

There are lots of laws that don't apply to companies employing people below certain thresholds. E.g., at 15 people, antidiscrimination laws take effect. If you suddenly see posters in the kitchen talking about this, you can't draw the conclusion that they were discriminating before. They're just reached the threshold dictated by law.

You have to draw a line somewhere. At 17 years and 364 days, you are not a fundamentally different person than at 18 years and 0 days, but a whole new set of laws kicked in.
Apparently, that's all there is to it. The rest is unnecessary speculation and drama. There is no problem here. As long as the representations about the funds are accurate, people can buy what they want as informed consumers.
Feel free to interrupt anything you want anyway you want. If it makes you feel better, go for it.
I'm going to extend my comment ...

The Investment Company Act of 1940 has always required registered investment companies (RIC) to declare if they will operate as a diversified or a non-diversified company and defined what that means. The Act has also always required that if a RIC wants to change from diversified to non-diversified it can only do so by a vote of a majority of its outstanding securities. None of this has changed and this is still what the law requires today. This means that today if a RIC becomes non-diversified without holding this vote it is breaking the law and would be at risk of prosecution.

What did change in 2019 was that the SEC did issue a issued a no-action letter permitting registered open-end and exchange-traded index-based funds to exceed the limits of a “diversified company,” as defined in the Investment Company Act of 1940 without obtaining shareholder approval if that fund took the proposed actions in the incoming letter from Stradley Ronon Stevens & Young, LLP. A SEC no-action letter is nothing more than a promise by the SEC to not prosecute a RIC for breaking the law. This is clearly a change in "how the SEC interrupts and enforces that law" as I stated above.

Given the above your statement that "no evidence of any ... change in enforcement" is clearly wrong.

Now, as to your reasoning as to why Vanguard chose to recently take advantage of the SEC's change in enforcement because they just recently crossed the threshold from diversified too non-diversified, I concur. When crossing this threshold, which just recently occurred for the Index 500 fund, Vanguard had two options to avoid any issues with the SEC. They could have strictly followed the letter of the law in the Investment Company Act of 1940 and held a vote or they could rely on the SEC no-action letter. Following the requirements of the no-action letter is cheaper and easier to do and the letter would provide a strong defense from some wing-nut at the SEC tried to make an issue out of what is technically a violation of the Investment Company Act of 1940.

And now to wrap this up ... In my original post I stated that "just because they(Vanguard) have now addressed non-diversification when required by a new regulation does not mean that Vanguard feels like they need to address this risk. All we can say for sure is that some government regulator feels like they need to address this risk."

Since "regulation" has a define meaning in federal law you are correct that the SEC no-action letter is not a regulation in the strictest sense of the word. Yet a no-action letter does function as a rule or directive made and maintained by an authority on how a RIC must function. Tomayto, tomahto.

But, perhaps, your beef is with the meaning of "new regulation?" 2019 is seventy-nine years after 1940 and only five years ago. Is that old, or new? Perhaps I should have said "newly applicable regulation" but I didn't think such specificity was needed in a forum discussion.

Now with all that said, if you want to stick with your "no evidence of any "new regulation" or change in enforcement", go for it.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by IDpilot »

HanSolo wrote: Tue Jul 09, 2024 8:56 am
IDpilot wrote: Tue Jul 09, 2024 8:40 am Feel free to interrupt anything you want anyway you want. If it makes you feel better, go for it.
I just read what's there. No feeling involved (on my part, anyway).

But if this is a feeling-fest, sorry to "interrupt" it!
See above.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by Beensabu »

IDpilot wrote: Tue Jul 09, 2024 10:25 am Now, as to your reasoning as to why Vanguard chose to recently take advantage of the SEC's change in enforcement because they just recently crossed the threshold from diversified too non-diversified, I concur. When crossing this threshold, which just recently occurred for the Index 500 fund, Vanguard had two options to avoid any issues with the SEC. They could have strictly followed the letter of the law in the Investment Company Act of 1940 and held a vote or they could rely on the SEC no-action letter. Following the requirements of the no-action letter is cheaper and easier to do and the letter would provide a strong defense from some wing-nut at the SEC tried to make an issue out of what is technically a violation of the Investment Company Act of 1940.

And now to wrap this up ... In my original post I stated that "just because they(Vanguard) have now addressed non-diversification when required by a new regulation does not mean that Vanguard feels like they need to address this risk. All we can say for sure is that some government regulator feels like they need to address this risk."
Whoa. Cool info post. Thanks!

Sounds more like "taking advantage of a loophole recently provided in anticipation of this exact scenario" than "abiding by a new regulation" to me.
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Re: Nondiversification Risk - Vanguard 500 Index Fund

Post by HanSolo »

IDpilot wrote: Tue Jul 09, 2024 10:25 am ... A SEC no-action letter is nothing more than a promise by the SEC to not prosecute a RIC for breaking the law. This is clearly a change in "how the SEC interrupts and enforces that law" as I stated above.

Given the above your statement that "no evidence of any ... change in enforcement" is clearly wrong.
First, you need to check the dictionary for the meaning of the word "interrupt" (although as someone in another thread said, "But then who reads dictionaries nowadays"... so there's that).

Second, the information provided didn't specify whether they ever took this kind of enforcement action in the past. Since I haven't seen that information yet, I don't know whether or not there was any actual change in enforcement. I'm not claiming that there was no change, I'm just remaining agnostic on the matter, in absence of that information.
Yet a no-action letter does function as a rule or directive made and maintained by an authority on how a RIC must function.
The above sentence is a new suggestion that wasn't provided upthread or in the cited letters. The letter said that it's a recommendation to the SEC, and not that the SEC adopted that recommendation. In fact, the letter explicitly said, "This letter is not a rule, regulation or statement of the Commission, and the Commission has neither approved nor disapproved its content". I simply took them at their word. I don't know why you think it's "wrong" for me to do that.

Since you've now provided the new suggestion that "a no-action letter does function as a rule or directive", I'm willing to go ahead and take your word for it. Still, everything I said had legitimate reasons, and now you know my reasons.
Beensabu wrote: Tue Jul 09, 2024 10:51 am Sounds more like "taking advantage of a loophole recently provided in anticipation of this exact scenario" than "abiding by a new regulation" to me.
Perhaps the above is more accurate. But since I'm not an expert on legalese, I'll remain agnostic on any question of how to wordsmith it.
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