Small/Mid Cap Exposure

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McNewton
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Small/Mid Cap Exposure

Post by McNewton »

Hi All,

I am in the midst of moving my portfolio to index-based investing. I currently have adequate pure large cap exposure through index funds. I recently terminated a manager who was supposedly investing in the small and mid cap sectors. It turns out that there was substantial style drift both to larger and international stocks in the portfolio causing significant underperformance in 2013.

I am considering investing in the Vanguard Extended Market Index which gives about a 50/50 exposure to mid and small stocks. Is this a reasonable approach or should more emphasis be given to small stocks over mid stocks in an indexed strategy?

Should I look at a separate funds for each of small and mid cap exposure instead?

Should I even consider skipping the mid sector since the overall portfolio performance would likely be close to the results of a blended large and small exposure?

Mid caps don't seem to get much emphasis in most investment discussions. Just wondering if they are worth an allocation or if I should just put more into small caps instead.
livesoft
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Re: Small/Mid Cap Exposure

Post by livesoft »

These are frequently asked questions on the forum. There are 2 major camps of investors here:

1. The total market weights folks who believe that one should be satisfied with the same weighting as the total US market index for US stocks. That is, there are large, mid, and small caps. See, e.g.: http://www.bogleheads.org/wiki/Approxim ... ock_market

2. The small cap and value tilted folks who believe that one should overweight small caps and value equities. Generally, it is hard to just overweight small caps because plenty of mid-caps come along for the ride.

Do you know how to use the Morningtar instant X-ray tool? You should use it to take a look at Extended Market index (I own it) and Vanguard Small-cap Value Index (I own it). Both are fine funds and I don't think one can seriously argue that either one is a bad choice for folks that want to overweight away from large-caps.

I do not own a separate mid-cap fund because the small cap funds have plenty of mid-caps. The net result is that I am overweighted in mid- and small-caps without having a fund with "mid" in its name.
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in_reality
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Re: Small/Mid Cap Exposure

Post by in_reality »

McNewton wrote:Hi All,

I am in the midst of moving my portfolio to index-based investing. I currently have adequate pure large cap exposure through index funds. I recently terminated a manager who was supposedly investing in the small and mid cap sectors. It turns out that there was substantial style drift both to larger and international stocks in the portfolio causing significant underperformance in 2013.
Hi,

My advisor did the same trick and the first thing I did was get VEXAX (extended market admiral shares).

This is what Morningstar writes:
Vanguard Extended Market Index Admiral is a suitable portfolio holding for those looking to counterbalance an S&P 500 Index fund or a portfolio overweight in large-cap stocks.

Search in this forum or google Mel's unloved midcaps

People say things like:

I would recommend looking at both risk and reward and realize that the small-cap stocks have greater volatility along with the higher returns. That is why I emphasize the mid-caps in my portfolio to find the "sweet-spot" which gives higher returns without adding significant risk.

Others say meh go small.
Ex. http://www.bogleheads.org/forum/viewtop ... 10&t=11153
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Re: Small/Mid Cap Exposure

Post by rkhusky »

If by large cap, you mean that you own an S&P 500 fund, then the Extended Market fund at about a 4/1 ratio with the S&P 500 would give you approximately the Total US Stock Market.
If you already own the Total US Stock Market and want to overweight small/mid cap stocks than you would add the Extended Market to the Total Stock Market index. Keep in mind that you will be increasing your portfolio volatility in order to try and achieve higher returns. For this to work you need to stick with it when small stocks have their occasional decline in relation to the larger cap stocks.
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Re: Small/Mid Cap Exposure

Post by The Wizard »

I see no reason to assume that owning the total stock market in proportion to market weights is an optimal approach.
It's fine to overweight mid/small caps using the VG Extended Market fund.
I do that to a degree...
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harmony
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Re: Small/Mid Cap Exposure

Post by harmony »

You could try googling this article entitled: "Morningstar Stock Research The Perfect Mix of Large-, Mid-, and Small-Cap Stocks".
Maybe it could help you clarify some options regarding risk tolerance and time horizon for a mid- small- tilt for your portfolio.
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in_reality
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Re: Small/Mid Cap Exposure

Post by in_reality »

harmony wrote:You could try googling this article entitled: "Morningstar Stock Research The Perfect Mix of Large-, Mid-, and Small-Cap Stocks".
Maybe it could help you clarify some options regarding risk tolerance and time horizon for a mid- small- tilt for your portfolio.
I found that useful reading too.

Still, after x years of outperformance, aren't small valuations relatively high.

Morningstar also notes:
Those seeking to exploit the size premium should be warned that it is volatile and only reliably appears over periods of a decade or more. Since 2000, the size premium has averaged 3.6% and the Russell 2000 Index of small-cap stocks has returned 6.5% per year versus 2.8% per year for the S&P 500 Index. This stretch of strong performance has caused small caps to look expensive relative to large caps. Stocks in the S&P 500 Index trade at a P/E ratio of roughly 14.6 times, while stocks in the S&P Completion Index trade at a more pricey 17.7 times.

The premium valuation of smaller-cap stocks could be justified if they were lower-risk or offered superior growth rates, they are more volatile. Over the past five years, the S&P Completion Index had a standard deviation of 23.7% versus 18.8% for the S&P 500 Index. In the current lower-growth economic environment, it's hard to envision small caps growing at a rate fast enough to justify their valuation.
harmony
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Re: Small/Mid Cap Exposure

Post by harmony »

When I read the article (Morningstar Stock Research The Perfect Mix of Large-, Mid-, and Small-Cap Stocks) my take away from it was that the right percentage of mid-caps over time can reduce risk and and increase performance, as opposed to only balancing between large and small caps to some optimum ratio. Retirees, espeically may want/need to reduce risk because of a shorter time horizon. Because of higher volatility, small caps do bring higher risk, but this can be mitigated by increasing the %age of mid-caps.
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JoMoney
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Re: Small/Mid Cap Exposure

Post by JoMoney »

As others pointed out, Small-cap index usually have a hefty dose of what's considered "mid-cap".... Large-cap indexes also have a hefty dose of "mid-cap"... Where you draw the line on what's considered "mid-cap" is a grey area somewhere between the Micro-caps and the $60billion+ Mega-caps.

Vanguard Extended Market Index (VXF) is a great way to get exposure to everything that's not in the S&P 500. This may include larger $60billion+ market cap companies that just don't meet the liquidity, profitability, or other suitability requirements to be included in the S&P500.

Vanguard Mid-Cap Index (VO) fund is a great way to get exposure to "mid-caps" including those companies that are in the S&P 500 up to around the $20billion market cap.

Vanguard S&P Mid-Cap 400 Index ETF (IVOO) is a great way to get exposure to "mid-caps" that are not included in the S&P 500 and meet S&P's selection criteria. The average market-cap is smaller than what you'd find in the the above VO index but not small enough to fit into the S&P Small-Cap 600 index.

Whether or not you want to split your small-caps and mid-caps into separate funds might depend on how actively you want to manage or re-balance. If you're happy to accept the market as it is, one fund should be fine. If you're hoping to gain some sort of "rebalancing bonus", or tactically trade between the different sizes based on some other criteria, or maybe do some sort of tax-loss harvesting... that might drive your decision on whether or not you need different funds and how many different funds.

My opinion, it seems a lot of people are caught up in a smaller-cap investing fad based on some recent outperformance, and various period dependent results looking only at very specific time periods of past results. I haven't seen any compelling reason to believe smaller-caps will outperform going forward. I think valuations suggest the opposite. If you're going to develop a strategy that deviates from the market portfolio (e.g. Total Stock Market by market-cap weight) I think you need to be very careful how you develop that strategy so that you have a strong understanding of what you're betting on and not persuaded by other "stories"... and can "stay the course" with your plan when the market, popular opinion, or the latest pseudo-science researcher doesn't agree with what you think it should be.
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joe8d
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Re: Small/Mid Cap Exposure

Post by joe8d »

Just set up nephews NYS 457b:

VG Institutional Index ( S&P 500 ) 50%
VG Mid Cap Index 10%
VG small Cap Index 20%
International Index 20%

I factored in the Mid Cap expousure from the 500 ( highest end) and Small cap ( lowest end ) with the actual Mid Cap covering the middle.
All the Best, | Joe
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Kevin M
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Re: Small/Mid Cap Exposure

Post by Kevin M »

There is quite a bit of academic research indicating that there is a small-cap premium (and a value premium), and according to Larry Swedroe there's convincing evidence that these are risk stories. So small and value (and momentum and profitablity) are considered risk factors in addition to the overall market risk factor (often referred to as "beta"). You don't read about a mid-cap premium--at least I don't see it.

So, a good starting point for your US stocks is a Total US Stock Market index fund. The purpose of an extended index fund is to get exposure to the US stocks not in the S&P 500, so as others have said, you can roll your own Total US Stock market by combining these two funds. If you have sufficient access to a Total Stock fund there is no reason to do so.

If you believe in the small-cap risk factor story, you can then add a small-cap fund to "tilt" your portfolio toward small caps, or you could add a small-cap value fund to tilt to both small and value. Since the S&P 500 stocks dominate Total US stock market, you probably will achieve similar results using just a large-cap fund like S&P 500 and a small-cap or small-value fund.

Finally, if you look at a 5-year chart of the Vanguard small-cap, mid-cap, and 500 index funds, you can barely see the difference in the performance of the small and mid funds, so either one seems to give you about the same diversification effect. One way to understand this is to look at the median market capitalization of the small-cap and mid-cap funds compared to that of that S&P 500 index fund--$3B, $10B, $70.5B, so there's a much larger gap between mid and large than between small and mid. Market cap for extended market is $3.7B, so much closer to small-cap.

If all you have access to is extended market, then it's just fine to add to large-cap, either to bring you closer to total market or to go further and tilt to small-cap. If you believe in the small-cap risk premium, then might as well go to the smaller-cap fund if you have access. Other non-Vanguard funds are even more heavily loaded on the small-cap factor, and some prefer those funds for that reason.

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berntson
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Re: Small/Mid Cap Exposure

Post by berntson »

McNewton wrote: Should I look at a separate funds for each of small and mid cap exposure instead? Should I even consider skipping the mid sector since the overall portfolio performance would likely be close to the results of a blended large and small exposure?
I use three funds myself. A microcap fund (BRSIX), a small value fund (VBR), and a midcap value fund (VOE). If you're set on using just a single fund and you want to only tilt towards small, I would lean towards using VB or IJR.
Kevin M wrote:There is quite a bit of academic research indicating that there is a small-cap premium (and a value premium), and according to Larry Swedroe there's convincing evidence that these are risk stories. So small and value (and momentum and profitablity) are considered risk factors in addition to the overall market risk factor (often referred to as "beta"). You don't read about a mid-cap premium--at least I don't see it.
Keep in mind that even if small and value represent genuine risk factors, it does not follow that the corresponding premiums will persist going forward. Certain classes of investors are risk seeking and (some would say) irrationally bid up the price of assets with higher risk and expected return. If the prices get bid up high enough, the risk remains and the higher expected returns go away.
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JoMoney
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Re: Small/Mid Cap Exposure

Post by JoMoney »

berntson wrote:...Keep in mind that even if small and value represent genuine risk factors, it does not follow that the corresponding premiums will persist going forward. Certain classes of investors are risk seeking and (some would say) irrationally bid up the price of assets with higher risk and expected return. If the prices get bid up high enough, the risk remains and the higher expected returns go away.
Eugene F. Fama, Market efficiency, long-term returns, and behavioral Finance wrote: ...We shall find, however, that the long-term return anomalies are sensitive to methodology. They tend to become marginal or disappear when exposed to different models for expected (normal) returns or when different statistical approaches are used to measure them. Thus, even viewed one-by-one, most long-term return anomalies can reasonably be attributed to chance...
...If a reasonable change in the method of estimating abnormal returns causes an anomaly to disappear, the anomaly is on shaky footing, and it is reasonable to suggest that it is an illusion...
...Moreover, the doubts about these anomalies are the result of replication and robustness checks that followed publication of the original studies. Other anomalies will likely fall prey to the same process...
William Sharpe , Investors & Markets wrote:…the superiority of small stock returns diminished substantially after 1980 following widespread attention to the phenomenon. More recently, the superiority of value stocks has been broadly publicized. If this truly reflected a market inefficiency, some future diminution might be anticipated. Methods for beating the market carry the seeds of their own destruction...
T. Rowe Price Small-Cap Stock Fund, Annual Report wrote:We believe small-caps will face a significant challenge in outperforming larger-cap shares. Estimates for 20% small-cap earnings growth in 2013 certainly appear optimistic given our economic environment. Valuations remain at premium levels on most relative measures, including the price-to-book and price-to-earnings ratios...
John Bogle & Burton Malkiel, Turn on a Paradigm wrote:...But to the extent that investors are persuaded by these data, the premiums offered by such stocks may well now have been "arbitraged away" in the stock market, as price-earnings multiples have become extremely compressed.
Jeremy Siegel, Stocks for The Long Run wrote:...the cumulative total return on small stocks (measured by the bottom quintile of market capitalization) did not overtake large stocks once between 1926 and 1959. Even by the end of 1974, the average annual compound return on small stocks exceeded large stocks by only about 0.5 percent per year, not nearly enough to compensate most investors for their extra risk and trading costs.
But between 1975 and the end of 1983, small stocks exploded. During these years, small stocks averaged a 35.3 percent compound annual return, more than double the 15.7 percent return on large stocks. Total returns in small stocks during these nine years exceeded 1,400 percent.
After 1983, small stocks hit a long dry period and underperformed large stocks. In fact, Figure [pic] shows that if the nine-year period from 1975 through 1983 is eliminated, the total accumulation in small stocks over the entire period from 1926 through 1997 falls nearly one-third below that in large stocks. ...
In 1975, money managers were able to find many undervalued stocks among these smaller issues. But by 1983, many of these stocks became overpriced and significantly underperformed large stock in subsequent years.
Some might object to drawing conclusions from return data where some of the best or worst years have been removed, since such a procedure can significantly distort returns. Yet that criticism is not applicable here. Computer simulations were performed that randomized the historical returns on small and large stocks, and then the nine best consecutive years were removed from the small stock series. Reversals of the magnitude that were found in the actual data were very rare and occurred in less than 10 percent of the cases analyzed. Even when the nine best consecutive years for large stocks (which ran from 1950-58) and the best nine consecutive years for small stocks have been removed, large stocks still outperformed small stocks over the past 70 years...
John C. Bogle, The Telltale Chart wrote:...place me squarely in the camp of the contrarians who don’t accept the inherent superiority of value strategies over growth strategies. I’ve been excoriated for my views, but I’m comforted by this reported exchange between Dr. Fama and a participant at a recent investment conference:
“What do you say to otherwise intelligent people like Jack Bogle who examine this same data and conclude that there is no size or value premium?”
His response:
“How far are they from the slide? If I get far enough away, I don’t see it either . . . Whether you decide to tilt towards value depends on whether you are willing to bear the associated risk . . . The market portfolio is always efficient . . . For most people, the market portfolio is the most sensible decision.”
Amen!
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Re: Small/Mid Cap Exposure

Post by YDNAL »

McNewton wrote:I currently have adequate pure large cap exposure through index funds. <snip>

I am considering investing in the Vanguard Extended Market Index which gives about a 50/50 exposure to mid and small stocks. Is this a reasonable approach or should more emphasis be given to small stocks over mid stocks in an indexed strategy?
1. What is your reason to say "pure large cap" and what are you trying to accomplish (goal) ?
2. Can you provide details/example of the large cap Index funds you mentioned ?

For *total market exposure* at market weights, a combo 80% LC + 20% Extended is what you would want. Is this what you want ?
McNewton wrote:Mid caps don't seem to get much emphasis in most investment discussions. Just wondering if they are worth an allocation or if I should just put more into small caps instead.
Ask Mel Lindauer and you get a different take.
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Re: Small/Mid Cap Exposure

Post by Call_Me_Op »

The Op uses the expression "should I" a lot. There are no hard rules in investing. You can tilt toward small-caps to your hearts content. Just understand that small-cap stocks, in addition to their higher expected return, come with higher volatility and tracking error. There is not even a law against 100% small-caps.
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Re: Small/Mid Cap Exposure

Post by YDNAL »

Call_Me_Op wrote:The Op uses the expression "should I" a lot. There are no hard rules in investing.
Agree. OP "should" say what (s)he is looking to do.

If (s)he doesn't know, Forum posters will handle confusing the hell out of him/her. :)
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IFKC
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Re: Small/Mid Cap Exposure

Post by IFKC »

YDNAL wrote:
Call_Me_Op wrote:The Op uses the expression "should I" a lot. There are no hard rules in investing.
Agree. OP "should" say what (s)he is looking to do.

If (s)he doesn't know, Forum posters will handle confusing the hell out of him/her. :)
Agreed. I'll toss out my approach though, as one potential option.

I'm young(ish) :) , strong job security (unless I leave), will receive a small pension at retirement, and have "guaranteed" (backed by NY Life) $ coming in 5 years. I tilt heavily toward small and value: it makes up nearly 50% of my portfolio, and I may increase this amount slightly. It's comprised mostly of VSMAX, VSIAX, VVIAX.

It may sound simplistic, but using the sample portfolios in A Random Walk and William Bernstein's book, and then modifying it based on what YOU think you should do given your specific circumstances, seems to ensure you don't go nuts for the doughnuts.
Last edited by IFKC on Sun Feb 02, 2014 10:51 am, edited 1 time in total.
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nedsaid
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Re: Small/Mid Cap Exposure

Post by nedsaid »

Pairing a US Total Market Index with the Extended Market Index is a great idea. This would enhance your allocation to both mid-cap and small-cap stocks. The US Total Stock Market Index has just over half of its market capitalization in the largest 100 companies!

I am a big fan of the mid-cap area of the market. My favorite mutual fund company calls this the "sweet spot" of the market. These behave a lot like small caps but with a bit less risk. In fact, many "small cap" funds have a lot of mid-cap stocks in their portfolios.

One caution though. Small-caps have done well recently and many folks believe that this sector of the market is getting overvalued. So please don't do this for the sake of performance chasing.
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Re: Small/Mid Cap Exposure

Post by Garco »

nedsaid wrote:Pairing a US Total Market Index with the Extended Market Index is a great idea. This would enhance your allocation to both mid-cap and small-cap stocks. The US Total Stock Market Index has just over half of its market capitalization in the largest 100 companies!

I am a big fan of the mid-cap area of the market. My favorite mutual fund company calls this the "sweet spot" of the market. These behave a lot like small caps but with a bit less risk. In fact, many "small cap" funds have a lot of mid-cap stocks in their portfolios.

One caution though. Small-caps have done well recently and many folks believe that this sector of the market is getting overvalued. So please don't do this for the sake of performance chasing.
I agree totally. In my taxable account, VTI (the ETF form of TSM) and VXF (ETF form of extended market) are the cornerstones of my equity holdings. The rest are mainly FI in one form or another.
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Re: Small/Mid Cap Exposure

Post by garlandwhizzer »

I think the extended market index is a great addition to TSM which is of by the necessity of cap weighting dominated by mega-cap and large cap stocks. Getting more exposure to small and mid cap stocks has historically increased both returns and volatility. However I tend to agree with some others on the forum that small caps are presently overvalued relative to large and mega-caps and that this valuation disparity is likely to reduce their expected outperformance going forward. So small caps and small cap value are not the slam dunk they were in 2000 when large cap growth was the hugely overvalued sector. One would expect, however, that small and mid-cap stocks, being more volatile and risky than large and mega-cap, would rationally be expected to have higher long term returns if one remains a patient long term investor through market declines. But that is not a free lunch.

Mid caps may indeed be a sweet spot as Mel has pointed out, not as popular for the factor chasing crowd as small and micro-caps, not quite so volatile during market downdrafts, but with higher potential earnings growth rates and more upside potential than large well-established companies. Holding both small and mid-cap stocks might be a net plus for the extended market index going forward relative to pure small cap exposure.

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Re: Small/Mid Cap Exposure

Post by Clive »

One would expect, however, that small and mid-cap stocks, being more volatile and risky than large and mega-cap, would rationally be expected to have higher long term returns if one remains a patient long term investor through market declines
A single stock might start as a small cap and progressively grow up through mid cap and into large cap. Ultimately it fades, often quickly. Which indexes (small, mid, large) benefit the most from that single stock?

Both small and mid can see entry/exit from above and below. Large cap however has no top out. One way to reduce that large cap effect is to equal weight each stock and reduce a stock by a third if its weighting grows to 1.5 times the median weighting.

The structure of cap weighted indexes is that a few single stocks can be much more heavily weighted than the average weighting. Sometimes a number of those outsized weighted stocks can be in the same sector (tech during late 1990's, banks in the lead up to 2008), such that if that sector gets hit so also can the index be dragged down. Small and mid are much less prone to such sector based issues.

Equally however as a sector strengthens then a relative overweighting to that sector can uplift the entire index.
Mid caps may indeed be a sweet spot as Mel has pointed out
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Re: Small/Mid Cap Exposure

Post by Kevin M »

Lots of comments are not supported by viewing the chart of 500 index, small-cap and mid-cap that I referenced earlier. I mentioned the 5-year chart, but here's the 10-year chart so we can evaluate the comments about mid-caps holding up better in downturns, as well as my main point that there just isn't that much difference between mid-cap and small-cap performance, at least with the Vanguard funds.

(Blues is 500 index, red is small-cap, yellow-orange is mid-cap):

Image

This chart also shows that the small-cap premium as been realized over the last 10 years. Next 10 years--who knows?

Mid-caps performed slightly better than small-caps from 2005 to mid-2008. Looks mid actually fell more than small during the crash, and since then they are almost indistinguishable. Of course mid and small both fell more than large during the crash, which is consistent with viewing small as a risk factor with more risk than the market (beta).

Seems to me that this graph helps answer most of the OP's questions, except that we don't know how the small-cap risk factor will be expressed in the next N years; i.e., will the risk be rewarded as it has been over the last five years (and also was in 2005-2007) or will it show up as it did from 2008 to early 2009?

With respect to the small-cap premium disappearing after it was widely recognized, the last 10 years seems to contradict that. With respect to earlier decades when large outperformed small, even strong proponents of multi-factor investing, like Larry Swedroe, acknolwedge that there can be decades-long periods of time when a particular risk factor is not rewarded. Because of this reason, one should try to do an honest assessment of one's potential tracking-error regret before tilting away from total market. Several reflective forum-members have indicated that for exactly this reason they stick with total market. How many of us would stick with a small-cap tilt through 20 years of small-cap under-performance?

Back to the OP, if by current pure large-cap you mean something like S&P 500, then adding the appropriate percentage of extended market is the cleanest way to simulate total US market. As an exercise, add VG extended market to the chart above; do you see much difference between it and small or mid? Hint: you are likely to do about the same by adding a given proportion of any of these three funds to your large-cap dominated portfolio. Whether you go beyond total market and tilt to small (or small/mid if you prefer) is a personal preference. Whether or not to do so has been discussed in numerous threads on this forum for longer than I've been participating, and there never will be an answer that we all agree on.

Kevin
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JoMoney
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Re: Small/Mid Cap Exposure

Post by JoMoney »

Kevin M wrote:Lots of comments are not supported by viewing the chart of 500 index, small-cap and mid-cap that I referenced earlier. I mentioned the 5-year chart, but here's the 10-year chart so we can evaluate the comments about mid-caps holding up better in downturns....
Morningstar shows a lower standard deviation for the Vanguard's Mid-cap Index (VIMSX) over the Small-cap Index (NAESX) for the past 3, 5, 10, and 15 year periods.
Trailing 10 Year Standard Deviation:
NAESX: 19.61
VIMSX: 17.74

Larger-cap stocks have historically been less volatile than smaller-caps. Which fund appears to have fallen lower or grown higher on a price/growth chart is period dependent on the starting point (and end point) you choose for the chart.
Kevin M wrote:...With respect to the small-cap premium disappearing after it was widely recognized, the last 10 years seems to contradict that. With respect to earlier decades when large outperformed small, even strong proponents of multi-factor investing, like Larry Swedroe, acknolwedge that there can be decades-long periods of time when a particular risk factor is not rewarded. Because of this reason, one should try to do an honest assessment of one's potential tracking-error regret before tilting away from total market. Several reflective forum-members have indicated that for exactly this reason they stick with total market. How many of us would stick with a small-cap tilt through 20 years of small-cap under-performance?...
20 years? How'about 30 or more! Possibly never realizing a "premium", and just hoping for a "return to the mean" average performance of the larger market
Jeremy Siegel, Stocks for The Long Run wrote:...the cumulative total return on small stocks (measured by the bottom quintile of market capitalization) did not overtake large stocks once between 1926 and 1959...
Image
and the nature of this recent so-called "premium" comes with a high expansion of the P/E multiple for those smaller "riskier" companies. If this were a "risk" story, the small companies should sell at a discount on earnings relative to the comparably "safer" ones. The only way to justify the higher P/E multiple is from an expectation of higher growth, and in recent years that growth hasn't been coming from reasonable growth in earnings and dividends it's been primarily further expansion of the P/E.
Image
John Bogle, The Telltale Chart, June 26, 2002 wrote:...Virtually the entire small-cap advantage took place during the first 18 years. Then large-cap dominates small-cap from 1945 through 1964; small-cap through 1968 ; large-cap through 1973 . Then small-cap through 1983, large through 1990, and so on. On balance, these to-and-fro reversions have cancelled each other out, and since 1945 the returns of large-cap stocks and small-cap stocks have been virtually identical. So ask yourself whether the evidence to justify the claim of small-cap superiority isn’t too fragile a foundation on which to base a long-term strategy...
http://johncbogle.com/speeches/JCB_Morningstar_6-02.pdf
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rkhusky
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Re: Small/Mid Cap Exposure

Post by rkhusky »

The Wizard wrote:I see no reason to assume that owning the total stock market in proportion to market weights is an optimal approach.
A market weight portfolio is optimal in terms of an asset allocation for lowest trading costs. It is also optimal in terms of taking advantage of whatever wisdom there is in the market. No one knows the optimal portfolio for future returns.
garlandwhizzer
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Re: Small/Mid Cap Exposure

Post by garlandwhizzer »

Although I modestly tilt to small and value, I believe Jo Money's post is timely and insightful. Timely because we have had SC significant outperformance relative to LC for 14 years running now. No one knows when exactly this trend will reverse but we do know that pendulums don't swing just one way. Valuation disparities have built up as a result of that long term SC outperformance and reversion to the mean could start at any point from here. Personally due to valuation concerns, I recently decreased my SC exposure a bit and increased my LC exposure to 60% with MC at and SC at 20% each. The future is by definition unknown and I want to cover all cap bases. TSM is also in my opinion a very good option now as it is always.

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Mel Lindauer
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Re: Small/Mid Cap Exposure

Post by Mel Lindauer »

Here's what I posted on the recent Mid-Cap thread regarding "Mel's Unloved Mid-Caps":
Mel Lindauer wrote:Standard and Poors article on Mid-Caps as the "sweet spot".

http://us.spindices.com/documents/educa ... rmance.pdf
Mel Lindauer wrote:And here's some more reading on Mel's Unloved Mid-Caps for those interested.

https://www.google.com/search?q=mel%27s ... 2&ie=UTF-8
Best Regards - Mel | | Semper Fi
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Re: Small/Mid Cap Exposure

Post by garlandwhizzer »

Mel wrote;by Mel Lindauer » Mon Feb 03, 2014 1:18 pm

Here's what I posted on the recent Mid-Cap thread regarding "Mel's Unloved Mid-Caps":

Mel Lindauer wrote:
Standard and Poors article on Mid-Caps as the "sweet spot".

http://us.spindices.com/documents/educa ... rmance.pdf


Mel Lindauer wrote:
And here's some more reading on Mel's Unloved Mid-Caps for those interested.

https://www.google.com/search?q=mel%27s ... 2&ie=UTF-8
Best Regards - Mel | | Semper Fi

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These posts mentioned by Mel are ones that I think all serious investors should read. As for the size question, our forum discusses every aspect of SC vs. LC, the relative merits of each, whether to tilt, and if so, by how much. Rarely (other than Mel) does anyone mention the case for MC which is indeed a strong one as a reading of the above posts will demonstrate. It may be the very fact that investors, like many of our forum posters, tend to ignore the MC segment that is the secret to MC's success. Unloved MCs seem to offer a nice tradeoff between risk and volatility on the one hand and long term return on the other.

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Kevin M
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Re: Small/Mid Cap Exposure

Post by Kevin M »

If you use Vanguard funds, and if you look at the last ten years, the mid-cap and small-cap funds have performed almost the same, both in terms of returns and volatility (see the chart I posted above). Holding only the mid-cap fund has been much more like holding only the small-cap fund than like holding something between large-cap and small-cap. Either mid-cap, small-cap, or for that matter extended-market blended with a large-cap fund would have produced about the same results.

I would not hold only the Vanguard mid-cap fund unless I also was comfortable holding only the VG small-cap fund, which I am not.

It looks like the VG small-cap and mid-cap funds would make good TLH pairs. I'm going to keep that in mind.

Kevin
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joer1212
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Re: Small/Mid Cap Exposure

Post by joer1212 »

JoMoney wrote:
Kevin M wrote:Lots of comments are not supported by viewing the chart of 500 index, small-cap and mid-cap that I referenced earlier. I mentioned the 5-year chart, but here's the 10-year chart so we can evaluate the comments about mid-caps holding up better in downturns....
Morningstar shows a lower standard deviation for the Vanguard's Mid-cap Index (VIMSX) over the Small-cap Index (NAESX) for the past 3, 5, 10, and 15 year periods.
Trailing 10 Year Standard Deviation:
NAESX: 19.61
VIMSX: 17.74

Larger-cap stocks have historically been less volatile than smaller-caps. Which fund appears to have fallen lower or grown higher on a price/growth chart is period dependent on the starting point (and end point) you choose for the chart.
Kevin M wrote:...With respect to the small-cap premium disappearing after it was widely recognized, the last 10 years seems to contradict that. With respect to earlier decades when large outperformed small, even strong proponents of multi-factor investing, like Larry Swedroe, acknolwedge that there can be decades-long periods of time when a particular risk factor is not rewarded. Because of this reason, one should try to do an honest assessment of one's potential tracking-error regret before tilting away from total market. Several reflective forum-members have indicated that for exactly this reason they stick with total market. How many of us would stick with a small-cap tilt through 20 years of small-cap under-performance?...
20 years? How'about 30 or more! Possibly never realizing a "premium", and just hoping for a "return to the mean" average performance of the larger market
Jeremy Siegel, Stocks for The Long Run wrote:...the cumulative total return on small stocks (measured by the bottom quintile of market capitalization) did not overtake large stocks once between 1926 and 1959...
Image
and the nature of this recent so-called "premium" comes with a high expansion of the P/E multiple for those smaller "riskier" companies. If this were a "risk" story, the small companies should sell at a discount on earnings relative to the comparably "safer" ones. The only way to justify the higher P/E multiple is from an expectation of higher growth, and in recent years that growth hasn't been coming from reasonable growth in earnings and dividends it's been primarily further expansion of the P/E.
Image
John Bogle, The Telltale Chart, June 26, 2002 wrote:...Virtually the entire small-cap advantage took place during the first 18 years. Then large-cap dominates small-cap from 1945 through 1964; small-cap through 1968 ; large-cap through 1973 . Then small-cap through 1983, large through 1990, and so on. On balance, these to-and-fro reversions have cancelled each other out, and since 1945 the returns of large-cap stocks and small-cap stocks have been virtually identical. So ask yourself whether the evidence to justify the claim of small-cap superiority isn’t too fragile a foundation on which to base a long-term strategy...
http://johncbogle.com/speeches/JCB_Morningstar_6-02.pdf
Mr. Bogle has unintentionally convinced me of the reason we should invest in small-caps: diversification.
Viewed in isolation (or even in comparison) with large-cap stocks, there doesn't seem to be a compelling enough reason to own small-caps. But the fact that large and small-cap stocks have outperformed/underperformed in different time periods throughout history proves that they would work very well together in a portfolio to stabilize it.
Last edited by joer1212 on Mon May 12, 2014 10:28 pm, edited 1 time in total.
Aesthetics
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Re: Small/Mid Cap Exposure

Post by Aesthetics »

livesoft wrote:These are frequently asked questions on the forum. There are 2 major camps of investors here:

1. The total market weights folks who believe that one should be satisfied with the same weighting as the total US market index for US stocks. That is, there are large, mid, and small caps. See, e.g.: http://www.bogleheads.org/wiki/Approxim ... ock_market

2. The small cap and value tilted folks who believe that one should overweight small caps and value equities. Generally, it is hard to just overweight small caps because plenty of mid-caps come along for the ride.

Do you know how to use the Morningtar instant X-ray tool? You should use it to take a look at Extended Market index (I own it) and Vanguard Small-cap Value Index (I own it). Both are fine funds and I don't think one can seriously argue that either one is a bad choice for folks that want to overweight away from large-caps.

I do not own a separate mid-cap fund because the small cap funds have plenty of mid-caps. The net result is that I am overweighted in mid- and small-caps without having a fund with "mid" in its name.
I never understand when people say that the Vanguard small cap index fund has a bunch of mid caps in them.

The definitions of mid-caps and small-caps is whatever you want them to be. Where you draw the cutoff point is merely a matter of preference. The Vanguard Small Cap Index Fund uses the CRSP Small Cap Index, which contains the companies that make up the 85-98% in market cap. It will also contain some that are somewhat smaller and larger because of the way the index is constructed, but its intention is the 85-98% market cap. The CRSP Index's definition of small cap is between 85 and 98%, with microcap being 98-100%. So if you agree with their definition of small cap, then you are mostly in small cap if you use this fund. The M* X-Ray will show 44% mid-cap if you look at it today, but the reason is because M*'s definition of small cap are companies in the 90-100% range, while mid-cap are those in the 70-90% range. Therefore, since the CRSP index contains companies in the 85-90% range, those will be categorized by M* X-Ray as mid-caps, which is why you see such a large % being mid-caps in this fund. But to say that the Vanguard Small Cap Index Fund is 44% mid-caps is wrong if you believe that CRSP's categorization is correct, while M*'s categorization is wrong. But that is merely a matter of preference.

I personally just wish CRSP would change their index to make it so their Mid-Cap Index tries to capture companies in the 70-90% range, and they should add in micro-caps into their Small Cap Index and try to capture companies in the 90-100% range. Then, people would stop considering the Vanguard Small Cap Index Fund as a mid/small blend.
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Re: Small/Mid Cap Exposure

Post by jrbdmb »

harmony wrote:You could try googling this article entitled: "Morningstar Stock Research The Perfect Mix of Large-, Mid-, and Small-Cap Stocks".
Maybe it could help you clarify some options regarding risk tolerance and time horizon for a mid- small- tilt for your portfolio.
First, apologies for resurrecting an old thread. But I want to point out that the conclusions from the Morningstar report quoted earlier in the thread seem heavily dependent on the time frame selected. While small caps handily beat large caps in a comparison starting in 1975, a quick check on Yahoo Finance shows that the Russell 2000 (^RUT) has lower returns than the S&P 500 (^GSPC) over the last 18 years, 10 years, 5 years, 2 years, 1 year, and YTD (as of 12/11/15). It makes me wonder whether the conclusions drawn have any validity at all.
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Re: Small/Mid Cap Exposure

Post by wije »

jrbdmb wrote:a quick check on Yahoo Finance shows that the Russell 2000 (^RUT) has lower returns than the S&P 500 (^GSPC) over the last 18 years, 10 years, 5 years, 2 years, 1 year, and YTD (as of 12/11/15). It makes me wonder whether the conclusions drawn have any validity at all.
How about the S&P 500 compared with the S&P SmallCap 600?
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