The case against small cap value

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Streptococcus
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The case against small cap value

Post by Streptococcus »

A few months ago, I reached the point in my investing life where my IPS authorizes me to tilt. I started out as a lazy portfolio investor. I was initially planning to tilt towards small cap value but I have been seriously rethinking the strategy, after research, partly thanks to this awesome forum. This is actually an odd thing to say since many posters here are happy SCV tilters.
I now have a pause regarding SCV tilt owing to the following considerations:

1.
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. ...
... 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...
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.
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...
So what do I understand here?
The basis of SCV higher expected return compared to the market is its extended periods of underperformance. As Larry swedroe recently put it in a post:
larryswedroe wrote:staythecourse
The logic is that assets that do poorly in bad times should carry big premiums. So it should be no surprise that these risky assets do poorly in bad times. Note that this is also one of the risk explanations for the value premium.
As to volatility it tends to jump in bad times, so it's during periods of high vol that these stocks would likely do poorly, not after. After the period of high vol they would likely have very high expected returns
Larry
So in order to catch the SCV premium, the investor needs to be ready to ride along 10, 20, even 40 years of underperformance, like between 1926-1959. And more importantly, the investor must have the fortitude to stay the course as SCV is underwater and other funds are over performing. Worse, he/she needs to rebalance, buying into funds that have been underperforming for years or decades, and at the same time, hear experts declare the death of the SCV premium because it was overvalued, too popular and everyone was into it. And they will possibly be right, because nothing guarantees that the SCV premium will persist.

So am I ready to ride that SCV roller coaster under water for possibly more than my time horizon (30 years), and stay the course and rebalance into possible eternal underperformance? That's a tough sell. Who is buying it and why?
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TimeRunner
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Re: The case against small cap value

Post by TimeRunner »

Frans made his case yesterday for SCV for equities. See: http://www.bogleheads.org/forum/viewtop ... 0&t=135625

It's an interesting read.
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Random Musings
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Re: The case against small cap value

Post by Random Musings »

Regardless of which way you invest, either market cap weighted or all small-value load or somewhere in between, there will always be periods of time where your mettle is tested. Sometimes, these gut checking moments occur at the same time, like in the 2008 bear market and 73-74. However, the magnitude of the gut check may be slightly different.

Other times, these moments occur in longer cycles where the other methodology is working better and the urge to switch may rear it's ugly head. I believe these moments are more dangerous to the investor who is knowledgable about these choices. Correlation is one thing, but deviation is another animal.

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Re: The case against small cap value

Post by sunnywindy »

Here's the Morningstar chart of all three of the oldest share classes of Vanguard Small Cap Value, Growth, and Blend (note: they are using their third index since inception: S&P, MSCI, CRSP). Since 1998, all three had their day in the sun, but value slightly beats growth.

http://quote.morningstar.com/fund/chart ... %2C0%22%7D
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LH
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Re: The case against small cap value

Post by LH »

1) I basically believe French fama factors likely will end up a footnote.

2) I believe scv MAY outperform in my investing lifespan.

3) I believe scv WILL fall out of favor, such that maybe even French, fama, or both say it no longer works.....

I tilt scv anyway.

1) it's one part of four corners, it's likely to have correlation benefits with tsm. Even if it sucks, it still has rebalancing benefit expectantly. Instead of lcv scv lcv scg, I just do tsm and scv. Along with land, geo stocks, bonds, and some gold.

2) since I do not really think scv is going to be great per se, I have lower capitulation risk if scv sucks x 20 years.

3) since I do not believe factors per se anyway, if they fall out of favor, so what? Again less capitulation risk.

4) maybe I m wrong, and FF right, and if one does NOT have scv, then per the factors, which in this future reality path continue to pan out, be better than sliced bread etc, one is/was NOT actually diversified.


So basically, why not throw some in? I see little downside, it may well suck, but anything can suck.

At minimum, it can be expected to jump around a bit relative to tsm. Which should be good expectationally. At maximum, if you don't include it, you are simply NOT diversified according to the factor Maths.
berntson
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Re: The case against small cap value

Post by berntson »

Streptococcus,

I'm glad that you're being cautious with your investment approach. Many investors just starting out jump feet-first into small cap value funds because "someone somewhere" said that small value stocks have higher returns than other stocks. Such investors likely won't be able to weather the storms necessary to actually carry out such a strategy. I think this is especially prudent at the current moment. The high valuations for small stocks make me nervous, but I buy them anyway.

It's good to keep in mind that the value premium and small premium are different things. You can invest in one and not the other and you can diversify between them. The small and value premiums across countries are also not all that correlated. So it could be that in a given year, US small is down, international value is down, US value is up, and international small is up.
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Streptococcus
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Re: The case against small cap value

Post by Streptococcus »

sunnywindy wrote:Here's the Morningstar chart of all three of the oldest share classes of Vanguard Small Cap Value, Growth, and Blend (note: they are using their third index since inception: S&P, MSCI, CRSP). Since 1998, all three had their day in the sun, but value slightly beats growth.

http://quote.morningstar.com/fund/chart ... %2C0%22%7D
berntson wrote:Streptococcus,

I'm glad that you're being cautious with your investment approach. Many investors just starting out jump feet-first into small cap value funds because "someone somewhere" said that small value stocks have higher returns than other stocks. Such investors likely won't be able to weather the storms necessary to actually carry out such a strategy. I think this is especially prudent at the current moment. The high valuations for small stocks make me nervous, but I buy them anyway.

It's good to keep in mind that the value premium and small premium are different things. You can invest in one and not the other and you can diversify between them. The small and value premiums across countries are also not all that correlated. So it could be that in a given year, US small is down, international value is down, US value is up, and international small is up.
I do believe that a SCV premium will (or may) show up in the future. But as you say, I worry about valuation. I remember Bill Bernstein saying "valuation matters". And I respect the man.

But the thing that gives me more pause is the fact that to carry out this strategy, and maybe the basis of SCV over performance is it's very long period of underperformance during which it expected return increases. Am I ready to ride it for 30 years of underperformance? I'm not sure about that.

And I feel like many people don't really ponder the magnitude of investing in an underperforming asset for decades. To Stay the course and rebalance after years of underperformance when experts tell you that the SCV premium is dead and they could be right. That is really difficult.

On the other hand, am I ready to ride along with the market during decades of underperformance? Of course! I believe in the market. It would be much easier to stay the course and rebalance into a global broadly diversified portfolio that is under water. It is easier to believe that the global economy is not going to sink forever than to believe in a SCV premium.

And I believe that even if you tilt just a little bit, you still need to keep rebalancing and funding when things go south for decades. If you jump the ship, you will have done a disservice to your portfolio even if your tilt was small.
Waba
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Re: The case against small cap value

Post by Waba »

There was a posting recently that showed that compared to historic P/E ratios, the P/E ratio of large cap value has seen a smaller expansion than the P/E ratio of small cap value.
So in good market timing tradition I figured this week is a good time to rotate out of small cap and into RPV.
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Re: The case against small cap value

Post by livesoft »

SCV has been doing just fine. It has outperformed Total US Market Index (TSM) quite nicely over the past year (30% vs 26%). One can use the relative performance between SCV and TSM to help one decide whether to add to one or the other or both during the accumulation phase and whether/when to rebalance. I don't think one should ever have a mind set to buy and hold and never rebalance. If one never rebalances (buys low, sells high) among equity classes, then one might as well just use TSM.

As for long-term underperformance and how that might affect an investor, please take a look at emerging markets. There seem to be quite a number of folks who like to overweight emerging markets on the forum. Unlike SCV, EM has underperformed TSM and developed foreign markets for the past 3 years. It has certainly been a drag on one's portfolio. There are now discussions about EM getting "cheap" and maybe this is the year EM recovers. Maybe one should overweight EM now? But what about those folks who have been oveweight in EM for the past 3 years? How do they feel? How about EM small-cap value? I think there is a lesson there.
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Re: The case against small cap value

Post by packer16 »

The case for small cap value is the market is inefficiently pricing these assets. The reason they outperform is folks realize the market has underestimated their performance versus subsequent actual performance as companies. There are a few times when large portions of the market are cheap (2008) but in most case it is going to be a few sectors or stocks where this is the case. Now the SCV is going to include those securities but it is also going to hold alot of not so mispriced securities also as a part of its "diversification" strategy that is why it does not outperform all the time.

I think the best way to capture this is to holds the cheapest stocks that are not in terminal decline and to focus on the cheap industry or companies. This may incur more risk in volatility and lack of diversification sense but less risk in the valuation sense. Since the factor folks are from the return=risk camp, the idea of valuation risk is beyond there thought framework. I think what they miss using the return=risk framework is the micro reason for the effect. It would be interesting to see if the so-called "lottery tickets" they describe were just undervalued securities that there framework blinded them to this fact. I think in reality there is valuation risk and you can take advantage of this fact.

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Re: The case against small cap value

Post by larryswedroe »

FWIW
The small value premium has been at least as persistent as the equity premium over whatever horizon you want to look. SV is very different than small stocks in general. Also the value premium has been much larger in small than in large. There are very logical risk explanations for the small value premium and there are some good behavioral ones as well.
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in_reality
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Re: The case against small cap value

Post by in_reality »

Streptococcus wrote: So am I ready to ride that SCV roller coaster under water for possibly more than my time horizon (30 years), and stay the course and rebalance into possible eternal underperformance? That's a tough sell. Who is buying it and why?
Given what research shows about the small value premium, I doubt if anyone can really say for certain that the Fed's QE won't have an effect. Here is why I say that...

http://www.bogleheads.org/forum/viewtop ... 0#p2014187

I personally wouldn't do a drastic overweighting. There is too much risk of the small value premium not persisting...IMHO.
RNJ
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Re: The case against small cap value

Post by RNJ »

A couple of thoughts, offered in part as a check on my own thinking.

1) When tilting to small cap value, one is making a choice to tilt towards a riskier asset class, with risk here defined as greater volatility. M* shows the 10 year SD for VBR to be 19.6 and the beta 1.27, but "only" 15.29 and 1.04 for VTI. Their Sharpe ratios are essentially identical: VBR .47, VTI .48. Note also that VBR is a relatively "watered down" offering as SCV goes. So if one were to go with these offerings there is no free lunch to be had. If we use this albeit very brief historical record, in exchange for the possibility of higher returns, one will have to live with the certainty of a lot more volatility. And, by the way, the risk adjusted returns of these holdings in isolation has been exactly the same. BUT . . .

2) Is it reasonable to look at them in isolation? If one is tilting, then the question is not just, "Will SCV outperform?", but what will the effect of blending these assets (TSM and SCV) have on the portfolio as-a-whole. AND . . .

3) What else will you own? Looking at the bond side, I own Treasuries and the highest quality muni fund I could find (I have limited tax-advantaked space and no desire to shop for individual issues) in part because I tilt pretty significantly to SCV (VIOV and PXSV) and have a healthy slug of EM, and in part because the correlations are a bit lower than using Total Bond. Then there is the rest of the portfolio. OF COURSE . . .

4) There are other considerations: cost, time, willingness to rebalance, tracking error regret, willingness to "stay the course". This last piece is, to my mind, by far the biggest risk, as we are no longer talking about volatility, but the permanent loss of capital.

We pay to tilt. No free lunch.

Thoughts?
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Re: The case against small cap value

Post by livesoft »

in_reality wrote:I personally wouldn't do a drastic overweighting. There is too much risk of the small value premium not persisting...IMHO.
What really is the risk of the small value premium not persisting? I don't think it is really that much. If SCV premium does not persist, then that does not necessarily mean that one loses money. I can see the SCV premium turning into the SC premium, so that SCV holdings would perform no better than a small-cap blend or an extended market fund.

As for volatility, consider this personal example: I bought a large dose of VBR in early April 2009. It's 13% of our total portfolio now. I have neither added to that account, nor sold anything from that account, but I have not reinvested dividends either. This VBR position is practically in set-and-forget mode. In other words, I simply have not noticed nor cared about any volatility in those particular shares. So if a share is volatile in the woods and nobody notices, does it matter?

OTOH, I buy in another account some VBR every now and then. I buy on a RBD, that is, after a relatively big one-day drop. I generally sell within a month whether it does up or down. I want volatility and I am acting on volatility. (Note: "generally sell within a month" is NOT "sell exactly one month later"!!) I don't do this with total stock market index fund shares because TSM is not volatile enough.

I guess I am saying that buy-and-hold doesn't always capture the premium for one. One has to buy low and sell high occasionally. If one doesn't do this, then they won't notice a premium. And studies that don't do this, won't notice one either.
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in_reality
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Re: The case against small cap value

Post by in_reality »

livesoft wrote:
in_reality wrote:I personally wouldn't do a drastic overweighting. There is too much risk of the small value premium not persisting...IMHO.
What really is the risk of the small value premium not persisting? I don't think it is really that much. If SCV premium does not persist, then that does not necessarily mean that one loses money. I can see the SCV premium turning into the SC premium, so that SCV holdings would perform no better than a small-cap blend or an extended market fund.
Yeah exactly ... my thinking too ... if the premium doesn't continue it's still has the performance of small.

Still, I wouldn't do a barbell Larry type portfolio thinking that since small value will outperform, I can overweight on the long term treasuries and get the same returns will less risk. If the small value premium ceased, you'd be at risk of underperformance since you lowered your stock allocation. I meant I wouldn't do a drastic overweighting, reduce my stock allocation and increase my bonds. I think that is suspect planning ... and not a real way to reduce risk. You are just lowering your NAV fluctuation with the possibility that a ceased small value premium doesn't make up for your lowered stock %.
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Re: The case against small cap value

Post by LH »

livesoft wrote:SCV has been doing just fine. It has outperformed Total US Market Index (TSM) quite nicely over the past year (30% vs 26%). One can use the relative performance between SCV and TSM to help one decide whether to add to one or the other or both during the accumulation phase and whether/when to rebalance. I don't think one should ever have a mind set to buy and hold and never rebalance. If one never rebalances (buys low, sells high) among equity classes, then one might as well just use TSM.

As for long-term underperformance and how that might affect an investor, please take a look at emerging markets. There seem to be quite a number of folks who like to overweight emerging markets on the forum. Unlike SCV, EM has underperformed TSM and developed foreign markets for the past 3 years. It has certainly been a drag on one's portfolio. There are now discussions about EM getting "cheap" and maybe this is the year EM recovers. Maybe one should overweight EM now? But what about those folks who have been oveweight in EM for the past 3 years? How do they feel? How about EM small-cap value? I think there is a lesson there.
I guess I overweight em, I have 13 percent em I think.

To answer your question on my part, I really don't feel anything.

Something has to suck if one is diversified.
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Re: The case against small cap value

Post by pkcrafter »

Streptococcus, it should be pointed out that you and Frans are making the same mistake. You both are taking a selected small portion of the small cap data and using only that to form an erroneous conclusion. Frans insists in only looking at very long term data while ignoring the possibility of rather long stretches of significant deviation from that data. You are taking only very short term data and drawing an opposite conclusion.

The reality is correlations, performance, volatility, etc. do not, and never will, provide a nice dependable straight line. Deviation from anticipated behavior is completely normal and that's what should be expected. If we do not acknowledge the fact that stretches of disappointing results will be part of our experience, we will never be understand the risks in investing. This is precisely why we diversify.

Paul
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Re: The case against small cap value

Post by berntson »

Streptococcus wrote: I do believe that a SCV premium will (or may) show up in the future. But as you say, I worry about valuation. I remember Bill Bernstein saying "valuation matters". And I respect the man.
I've been thinking about precisely this issue the last few weeks. I consider myself a value investor. My goal is to systematically buy equities at a discount to their present value. This means that I'm not especially excited about owning Vanguard small value at the moment. If we think of value as book value, VBR is only 20% cheaper than the total US stock market. Using cash flow, it is no cheaper than the total market.

On the other hand, international funds are a much better deal. Developed large international value (PXF in particular) is 45% cheaper than the US total market using either book value or cash flow. Small developed international (SCZ) is about 40% cheaper.

The idea behind value investing is that valuations matter. So when domestic valuations are unfavorable, a value investor should be willing to focus her investments internationally. My own plan is to send a greater portion of future contributions to international value and international small until domestic stocks (including domestic small value) are a better deal.
Streptococcus wrote: But the thing that gives me more pause is the fact that to carry out this strategy, and maybe the basis of SCV over performance is it's very long period of underperformance during which it expected return increases. Am I ready to ride it for 30 years of underperformance? I'm not sure about that.
Let's see what the historic returns have looked like in the US. These graphs were generated using the Fama and French data set, so they represent hypothetical performance, not the performance of any actual investor. So take everything with a grain of salt. But let's see how a small portfolio did against the market as a whole. (In particular, this the difference in performance between a portfolio with smb .8 and hml 0 and the market portfolio.)

Image

As you can see, there were indeed long periods of underperformance. The 1950s and early 1960s were tough for small investors. So were the late 1980s and all of the 1990s. But now let's see what happens when we add some value to the mix (smb .8 and hml .5).

Image

Now the 1950s and 1960s don't look so bad. The portfolio tilted towards value and small actually comes out ahead. The 1980s also turned out fine. The 1990s were rough overall, but the mid 1990s provided some welcome relief.

My own view is that we should be skeptical of claims that a value and small investor "might suffer through thirty-year performance droughts." Small stocks have underperformed for as long as twenty years. But that's why the prudent investor doesn't just invest in small stocks. She invests in small stocks and value stocks to diversify her tilts. Together, they make for a much smoother ride.

You are being careful and cautious and paying attention to valuations. This is precisely the right way to proceed. In fact, this is exactly how the best value investors think about the markets. The intelligent investors knows that price matters and that the best investment decisions are made slowly and carefully. And if you decide to just buy the market, there's nothing wrong with that! :beer
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Streptococcus
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Re: The case against small cap value

Post by Streptococcus »

RNJ wrote:A couple of thoughts, offered in part as a check on my own thinking.

1) When tilting to small cap value, one is making a choice to tilt towards a riskier asset class, with risk here defined as greater volatility. M* shows the 10 year SD for VBR to be 19.6 and the beta 1.27, but "only" 15.29 and 1.04 for VTI. Their Sharpe ratios are essentially identical: VBR .47, VTI .48. Note also that VBR is a relatively "watered down" offering as SCV goes. So if one were to go with these offerings there is no free lunch to be had. If we use this albeit very brief historical record, in exchange for the possibility of higher returns, one will have to live with the certainty of a lot more volatility. And, by the way, the risk adjusted returns of these holdings in isolation has been exactly the same. BUT . . .

2) Is it reasonable to look at them in isolation? If one is tilting, then the question is not just, "Will SCV outperform?", but what will the effect of blending these assets (TSM and SCV) have on the portfolio as-a-whole. AND . . .

3) What else will you own? Looking at the bond side, I own Treasuries and the highest quality muni fund I could find (I have limited tax-advantaked space and no desire to shop for individual issues) in part because I tilt pretty significantly to SCV (VIOV and PXSV) and have a healthy slug of EM, and in part because the correlations are a bit lower than using Total Bond. Then there is the rest of the portfolio. OF COURSE . . .

4) There are other considerations: cost, time, willingness to rebalance, tracking error regret, willingness to "stay the course". This last piece is, to my mind, by far the biggest risk, as we are no longer talking about volatility, but the permanent loss of capital.

We pay to tilt. No free lunch.

Thoughts?
This is a great point.
pkcrafter wrote:Streptococcus, it should be pointed out that you and Frans are making the same mistake. You both are taking a selected small portion of the small cap data and using only that to form an erroneous conclusion. Frans insists in only looking at very long term data while ignoring the possibility of rather long stretches of significant deviation from that data. You are taking only very short term data and drawing an opposite conclusion.

The reality is correlations, performance, volatility, etc. do not, and never will, provide a nice dependable straight line. Deviation from anticipated behavior is completely normal and that's what should be expected. If we do not acknowledge the fact that stretches of disappointing results will be part of our experience, we will never be understand the risks in investing. This is precisely why we diversify.

Paul
I agree with you. But I don't think I'm taking only short term data. I'm just saying that it is easy to underestimate the difficulty to stay the course when you overweight an asset class (SCV) that may not show its premium for more than your own investment horizon (20-30 years).
berntson wrote:
Streptococcus wrote: I do believe that a SCV premium will (or may) show up in the future. But as you say, I worry about valuation. I remember Bill Bernstein saying "valuation matters". And I respect the man.
I've been thinking about precisely this issue the last few weeks. I consider myself a value investor. My goal is to systematically buy equities at a discount to their present value. This means that I'm not especially excited about owning Vanguard small value at the moment. If we think of value as book value, VBR is only 20% cheaper than the total US stock market. Using cash flow, it is no cheaper than the total market.

On the other hand, international funds are a much better deal. Developed large international value (PXF in particular) is 45% cheaper than the US total market using either book value or cash flow. Small developed international (SCZ) is about 40% cheaper.

The idea behind value investing is that valuations matter. So when domestic valuations are unfavorable, a value investor should be willing to focus her investments internationally. My own plan is to send a greater portion of future contributions to international value and international small until domestic stocks (including domestic small value) are a better deal.
Streptococcus wrote: But the thing that gives me more pause is the fact that to carry out this strategy, and maybe the basis of SCV over performance is it's very long period of underperformance during which it expected return increases. Am I ready to ride it for 30 years of underperformance? I'm not sure about that.
Let's see what the historic returns have looked like in the US. These graphs were generated using the Fama and French data set, so they represent hypothetical performance, not the performance of any actual investor. So take everything with a grain of salt. But let's see how a small portfolio did against the market as a whole. (In particular, this the difference in performance between a portfolio with smb .8 and hml 0 and the market portfolio.)

Image

As you can see, there were indeed long periods of underperformance. The 1950s and early 1960s were tough for small investors. So were the late 1980s and all of the 1990s. But now let's see what happens when we add some value to the mix (smb .8 and hml .5).

Image

Now the 1950s and 1960s don't look so bad. The portfolio tilted towards value and small actually comes out ahead. The 1980s also turned out fine. The 1990s were rough overall, but the mid 1990s provided some welcome relief.

My own view is that we should be skeptical of claims that a value and small investor "might suffer through thirty-year performance droughts." Small stocks have underperformed for as long as twenty years. But that's why the prudent investor doesn't just invest in small stocks. She invests in small stocks and value stocks to diversify her tilts. Together, they make for a much smoother ride.

You are being careful and cautious and paying attention to valuations. This is precisely the right way to proceed. In fact, this is exactly how the best value investors think about the markets. The intelligent investors knows that price matters and that the best investment decisions are made slowly and carefully. And if you decide to just buy the market, there's nothing wrong with that! :beer
Another great point
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Re: The case against small cap value

Post by garlandwhizzer »

I think that streptococcus makes a good case of questioning the wisdom of SCV tilting. I also think that Larry and Frans among others have made a good case for SCV tilting. In short, it isn't entirely clear which way for an investor to proceed. It is likely that if SCV outperforms TSM going forward that it will do so with greater volatility, greater downside risk, greater fund cost structure and less tax efficiency. Personally, I believe in the SCV premium but believe also that the case for low cost, tax efficient TSM is compelling. Hence, feeling this uncertainty, I tilt modestly to SCV but TSM remains the core of my US equity portfolio. Hopefully that covers all bases.

Garland Whizzer
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Re: The case against small cap value

Post by larryswedroe »

Here's what's missing from the thinking, By owning SV and then more high quality bonds you are able to hold less BETA risk. And because the correlation of high quality bonds to stocks tends to move in the right direction at the right time, the combination of those two cuts the left tail risk way back. Also you diversify across three factors instead of having exposure to just beta, so you gain some other diversification benefits IMO.
My book Reducing the Risk of Black Swans will discuss the strategy of low beta, high tilt in great detail. Should be out in about 30 days or so
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deikel
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Re: The case against small cap value

Post by deikel »

For what its worth:

a) if you are looking for a small cap VALUE - you automatically end up with a more actively managed fund (someone has to make the call what is valued or not) and hence the respective fees seem to be higher on average. I have no interest in such approach.

b) personally I think small caps are the only true market left (in the sense that these are companies with product ideas that are seeking capitalization to go about their business). For that reason alone I am tilting to small cap. Whereas large caps are basically 'just' a reflection of general market behaviour - breakthrough innovation by definition comes from small companies, never large ones - large are good at re-engeneering and defending an idea.

c) since eventually a successful small cap will not fall under the small cap definition anymore and needs to be sold off for the index fund - does that not somewhat defeat the purpose of hoping for one successful company in a see of failures and this one paying for all the failures ? You would have to read the prospectus of the underlying fund pretty closely to see how this is handled.

d) I believe small caps are successfull whenever there is a technology (or technological area) that causes many companies to form and lots of innovation to happen (computer 80s, pharma 90s, healthcare 00s, biotech/genomics 10s (?) - this leads itself to rather sector specific success as is reflected in sector funds vs capitalization funds.

e) although the financing and risk arguments are valid for small caps, the added return is somehwat small (see Main Street Money from Mark Matson for example) - its one of these: 'lets squeeze out half a percentage point more by doing this cool thing' - the financial industry will never cease to present us the next cool thing to keep on talking and making new products to leach money into....few will survive the test of time.
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.
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Re: The case against small cap value

Post by hoops777 »

I am certain this has been asked and answered before but how does a stock weighting of 1/3 each small,mid and large value do vs the total market?
K.I.S.S........so easy to say so difficult to do.
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Re: The case against small cap value

Post by grabiner »

deikel wrote:a) if you are looking for a small cap VALUE - you automatically end up with a more actively managed fund (someone has to make the call what is valued or not) and hence the respective fees seem to be higher on average. I have no interest in such approach.
There is no need for specific active management; most value index funds use a mathematical definition such as price/book ratio, just as most small-cap index funds use a mathematical formula such as the smallest X% of the market or all stocks except the N largest.

Any specialized index does tend to have a slightly higher cost; Vanguard's small-cap indexes are more expensive than the total-market index, and the value and growth indexes are more expensive than the blend indexes for each cap size.
c) since eventually a successful small cap will not fall under the small cap definition anymore and needs to be sold off for the index fund - does that not somewhat defeat the purpose of hoping for one successful company in a see of failures and this one paying for all the failures ? You would have to read the prospectus of the underlying fund pretty closely to see how this is handled.
The CRSP index (used by Vanguard's index funds) uses bands to reduce turnover; a small-cap stock which does well and moves over the boundary into the mid-cap range is not dropped from the index, and even if it moves further into the mid-cap range, it is not dropped immediately. The bands also allow small-cap indexes to capture any momentum effect.

The S&P 600 (used by Vanguard's Tax-Managed Small-Cap, and some ETFs) doesn't officially use bands, but it is designed by a committee; stocks are not immediately moved from one S&P index to another when they change cap ranges.
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Re: The case against small cap value

Post by protagonist »

Streptococcus wrote:A few months ago, I reached the point in my investing life where my IPS authorizes me to tilt. I started out as a lazy portfolio investor. I was initially planning to tilt towards small cap value but I have been seriously rethinking the strategy, after research, partly thanks to this awesome forum. This is actually an odd thing to say since many posters here are happy SCV tilters.
I now have a pause regarding SCV tilt owing to the following considerations:

1.
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. ...
... 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...
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.
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...
So what do I understand here?
The basis of SCV higher expected return compared to the market is its extended periods of underperformance. As Larry swedroe recently put it in a post:
larryswedroe wrote:staythecourse
The logic is that assets that do poorly in bad times should carry big premiums. So it should be no surprise that these risky assets do poorly in bad times. Note that this is also one of the risk explanations for the value premium.
As to volatility it tends to jump in bad times, so it's during periods of high vol that these stocks would likely do poorly, not after. After the period of high vol they would likely have very high expected returns
Larry
So in order to catch the SCV premium, the investor needs to be ready to ride along 10, 20, even 40 years of underperformance, like between 1926-1959. And more importantly, the investor must have the fortitude to stay the course as SCV is underwater and other funds are over performing. Worse, he/she needs to rebalance, buying into funds that have been underperforming for years or decades, and at the same time, hear experts declare the death of the SCV premium because it was overvalued, too popular and everyone was into it. And they will possibly be right, because nothing guarantees that the SCV premium will persist.

So am I ready to ride that SCV roller coaster under water for possibly more than my time horizon (30 years), and stay the course and rebalance into possible eternal underperformance? That's a tough sell. Who is buying it and why?
As an outsider looking in, I neither buy any long-range predictions of future performance based on very limited past historical data, nor does it really matter what the experts think unless you are going to critically evaluate it yourself (part of genius often means making colossal mistakes....most of them have). This is why I don't tilt....I could....maybe I would do better....maybe I would do worse....in my mind it would be a crap-shoot, and it would involve extra work and probably a lot of extra research on my part (you've already done that given the above post) plus anxiety if I am wrong. And for what? Who knows. In my humble opinion, the one equation that seems to me to usually work, whether applied to finance, sports, romance, career path, and just about anything else, is that risk is proportional to reward (that could be one of the few fundamental truths in the universe, if there are any). If there is a premium in small value to be had, I imagine it likely comes with increased risk, regardless of what some experts might say. If I was willing to take bigger chances in hopes of making more money, I would prefer just increasing my equity allocation. It's easier, less controversial, and more comprehensible to me.
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grap0013
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Re: The case against small cap value

Post by grap0013 »

OP, since you had to ask you are not ready to tilt. I don't believe you will have enough conviction to hold on. Here's my personal 2010 post about tilting: http://www.bogleheads.org/forum/viewtop ... 10&t=59145

Also, please note that one has to be willing to wait 20+ years for tilting to work out, but the probability of having to wait that long is low. One may construe a plausible story about how SCV will underperform in the future, but it is not probable. Do not confuse plausibility with probability. If you have read enough of this strategy, you know this already.

FWIW: all my tilts have payed off very quickly. For instance, my tilt to international developed ex US small cap value passed its large cap weighted counterpart in less than a week's time and hasn't looked back. Lower standard deviation to boot.

Keep reading. You might do well with the agnostic Trev H's portfolio http://www.bogleheads.org/forum/viewtopic.php?t=38374 or a simple target date fund.
There are no guarantees, only probabilities.
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Streptococcus
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Re: The case against small cap value

Post by Streptococcus »

Finally, considering all options, I decided to switch from my 3 fund lazy portfolio to a tilted one:
AA 75/25
1. Total stock market
2. Small cap value (VBR, IJS, VIOV)
3. Total international
4. VSS

Ultimately, I agree with Larry's idea of a portfolio with high quality bonds and small cap value. I also like Trev H "elegant" tilt although I will not go as far as 25/25/25/25. More like 35/15/35/15. What got me convinced is the fact that I plan to leave some money to my kids and if my small cap value funds underperform by the time I need the money (say for more than 30 years) I will just leave the shares to my kids.
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Re: The case against small cap value

Post by staythecourse »

Boy, the thread started not to tilt then ended up okay let's tilt.

Either way let me throw my two cents in. Don't assume those who tilt are avid SCV fanatics. If they were they would be 100% SCV. I think most on here who do tilt, they might not even be aware of why, do it to crease a poor mans equal weighted index. It isn't they are proponents of TSM OR SCV. They want a more balanced/ equal weight in equity investing. A lot of the anti TSM crowd say the reason other indexes perform better is just because the minimize the amount invested in the LCG arena (The corner box with the highest P/E valuations).

Who know if SCV will do best going forward. I, personally, am not any more convinced of it doing best going forward then the TSM (which is 70% LC). I tilt because I know at one point one will do better then the other, but just don't know when.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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Re: The case against small cap value

Post by Rodc »

staythecourse wrote:Boy, the thread started not to tilt then ended up okay let's tilt.

Either way let me throw my two cents in. Don't assume those who tilt are avid SCV fanatics. If they were they would be 100% SCV. I think most on here who do tilt, they might not even be aware of why, do it to crease a poor mans equal weighted index. It isn't they are proponents of TSM OR SCV. They want a more balanced/ equal weight in equity investing. A lot of the anti TSM crowd say the reason other indexes perform better is just because the minimize the amount invested in the LCG arena (The corner box with the highest P/E valuations).

Who know if SCV will do best going forward. I, personally, am not any more convinced of it doing best going forward then the TSM (which is 70% LC). I tilt because I know at one point one will do better then the other, but just don't know when.

Good luck.
FWIW: I tilt some to scv and have no interest in a poor man's equal weight index.

I much prefer a lower cost to implement a tilt to a higher cost to implement to tilt strategy.

And at any rate equal weight only works with large cap companies. You can't have a large fund that equal weights Apple and micro cap company Z. Not enough shares of Z.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Re: The case against small cap value

Post by Clearly_Irrational »

My take is that the small premium is definitely risk based and will persist. All my analysis & reading suggests that BOTH the small value and the small growth categories beat small blend and the weight of evidence seems to be in small value's favor. Even if I'm wrong about small value though I'll only lose the difference between small value and small growth, which isn't that big to begin with.
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Re: The case against small cap value

Post by LH »

Clearly_Irrational wrote:My take is that the small premium is definitely risk based and will persist. All my analysis & reading suggests that BOTH the small value and the small growth categories beat small blend and the weight of evidence seems to be in small value's favor. Even if I'm wrong about small value though I'll only lose the difference between small value and small growth, which isn't that big to begin with.
If you were in circa 1959 would you be saying the same thing about the stock/bond yield ratio?

Great risk explanation then, stocks more risky, must payout more than bonds to get people to take risk, lots of history behind it then, had pretty much always reverted, sounded great. eminently reasonable.

Then it was not true for 50 years going forward.

Markets are funny things.
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Re: The case against small cap value

Post by nedsaid »

This is precisely the reason I have made changes to my portfolio slowly over time. It is the concern that I might give up on something right before things turn around and returns improve. So as I have grown as an investor, I still have kept things from my investing past.

For the record, I tilt towards small cap value and have been doing so since 2007 after attending a couple of Merriman seminars. I got educated about Dimensional Funds and the academic research regarding market returns and the "small" and "value" performance factors. I try to keep my stocks about 40% small caps and mid-caps. I have always been value oriented.

So if you are a small value tilter and have concerns about valuations of small value stocks, I sure wouldn't make sudden changes. If you choose a good strategy, it is best to stick with it. Otherwise, you will have a lifetime of going in and out of investment strategies at the wrong time. People normally pick strategies that have worked recently. Not too many people say, Gee whiz, let's pick a strategy that has recently been really disappointing. Don't get caught in the trap of chasing strategies which is pretty much performance chasing.

If you have concerns about valuation, it might be better to steer new investment money towards those asset classes that might have better values. I am pretty cautious and whatever changes I make are slowly and over time.
A fool and his money are good for business.
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Clearly_Irrational
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Re: The case against small cap value

Post by Clearly_Irrational »

LH wrote:If you were in circa 1959 would you be saying the same thing about the stock/bond yield ratio?

Great risk explanation then, stocks more risky, must payout more than bonds to get people to take risk, lots of history behind it then, had pretty much always reverted, sounded great. eminently reasonable.

Then it was not true for 50 years going forward.

Markets are funny things.
Sorry, you lost me there. Are you suggesting that big companies may suddenly become more risky than small?
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Re: The case against small cap value

Post by steve_14 »

I think any hidden free lunch in value stocks has been soundly disproven by both actual fund data and common sense. As to the small premium, I think a lot of people loading up on small caps today were the same ones overweighting the S&P 500 circa 2000, after it had crushed small caps during the preceding two decades. Small caps were cheap then, they're expensive now.

Tip: buy low, sell high.
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Re: The case against small cap value

Post by berntson »

steve_14 wrote:I think any hidden free lunch in value stocks has been soundly disproven by both actual fund data and common sense.
Image
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Re: The case against small cap value

Post by steve_14 »

Oh, if we get to cherry pick funds, we can prove whatever we want. But let's be fair and compare all value funds. M* reports, growth of $10K over the past 20 years:

S&P 500: $63,351
All Value Funds: $53,717

DFA did have a good run in its early value years (just as its early small cap years were a disaster), but that was when it had $30B, not $300B in assets. If you're wondering what happens to fund companies that have a run and see their asset base explode, see [any fund company in history]. The result is always the same.
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Re: The case against small cap value

Post by berntson »

steve_14 wrote:Oh, if we get to cherry pick funds, we can prove whatever we want. But let's be fair and compare all value funds.
Why are we comparing actively managed value funds to the S&P index? Obviously, actively managed funds underperform the market. We knew that already.

I picked the DFA funds because they are the oldest passive value funds with the strongest value tilt. But we can also look at the oldest value tilted ETFs from iShares instead. Here is their performance since inception.

Image

In fact, it turns out that over over the lifetime of the iShares ETFs, large value beat large growth, midcap value beat midcap growth, and small value beat small growth. The full chart is here.

I just see no reason to think that "real fund performance" shows that there is no small or value premium. Perhaps real fund performance shows that active value managers are not very good at what they do (rather like active managers in general). But that's a different issue.
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Re: The case against small cap value

Post by LH »

Clearly_Irrational wrote:
LH wrote:If you were in circa 1959 would you be saying the same thing about the stock/bond yield ratio?

Great risk explanation then, stocks more risky, must payout more than bonds to get people to take risk, lots of history behind it then, had pretty much always reverted, sounded great. eminently reasonable.

Then it was not true for 50 years going forward.

Markets are funny things.
Sorry, you lost me there. Are you suggesting that big companies may suddenly become more risky than small?
Prior to 1959, there was a long history of stock yielding more than bonds, I dunno, say 50 to 100 years.

Now, CLEARLY this was because stocks were riskier than bonds, and investors needed to be paid to take the risk.


This is a "risk story"

That particular risk story
1) made sense, felt good intuitively
2) coincided with long market history that verified it.

It was such that when the relationship became inverted, with bonds paying out more than stocks, well by gosh, stocks were riskier, and one KNEW the ratio would normalize, because it had a risk story.

This was in fact, true, until it was not for roughly the past 50 years.....

Now I ask you..... Did stocks become more risky than bonds for that 50 year period?

Or was the story, simply a story, and the market, the market?

I think it was a nice story, that stocks remained riskier, but the 50 year pattern simply ceased to exist for 50 years.

I think FF is a nice story. It may hold true during my investing time, it may not.

One the scv pattern may cease to exist for reasons non omnipotent will never know, and if it does cease to exist, well to make up a risk story or a behavioral story about why it ceased to exist is trivial.
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Re: The case against small cap value

Post by JoMoney »

berntson wrote:
steve_14 wrote:Oh, if we get to cherry pick funds, we can prove whatever we want. But let's be fair and compare all value funds.
...and don't forget about cherry-picking time periods...
berntson wrote:...it turns out that over over the lifetime of the iShares ETFs, large value beat large growth, midcap value beat midcap growth, and small value beat small growth...
The iShares ETF "lifetime" period starts towards the peak of the 2000 bubble. A significant chunk of that small and value beating large and growth can be explained better by the miserable performance of the market in general rather than some superior quality of small-value. In fact, as John Bogle was suggesting to people at the time, owning more bonds was a better tilt to control the risks of the market at the time:
John Bogle, April 6, 2000 wrote:...What if you share my misgivings about the real protection available by diversifying into what may be riskier asset classes in the paradoxical quest to reduce the volatility risk of the equity portfolio? One major option remains: Controlling risk by reducing equity exposure. I conclude that the single most effective way to control risk is by controlling equity exposure...
...I believe that this situation will prove transitory, not eternal. Nonetheless, fixed-income investments are not only our only real means of controlling risk, they are now our only real means of generating income. In a world of box-car total returns on stocks, risk is often ignored, bonds deemed irrelevant, and income old-fashioned. But when the going gets tough, all three—risk, bonds, and income—will come into their own again.
http://johncbogle.com/speeches/JCB_NE_Pension_4-00.pdf
Image
In the period following the early 2000's, when the market got it's footing again, it's growth that shined...
Image
..but if you could go back further you'd see it's just a trade off of growth and value taking turns..
... and similar trade-offs can be shown for large and small over time.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: The case against small cap value

Post by steve_14 »

LH wrote: Prior to 1959, there was a long history of stock yielding more than bonds, I dunno, say 50 to 100 years.

Now, CLEARLY this was because stocks were riskier than bonds, and investors needed to be paid to take the risk.


This is a "risk story"

That particular risk story
1) made sense, felt good intuitively
2) coincided with long market history that verified it.
Keep in mind we invest for total return, which has been stable over those periods. And stocks aren't just riskier because of historical data, or because it feels good - they are because the law dictates they are. Bondholders must be paid before stockholders get a dime.

However, your point is well taken, and the case of small vs large caps is very different from stocks vs bonds. The only way we'd expect small caps would return more than large caps is is if their cost of capital is higher. But when we say "small caps" we're really talking about large companies with upwards of $1B in market value. I, as an individual investor can already get a very favorable cost of capital if I need to borrow money. So it's doubtful that a $1B company has to offer much more return than a $100B company to attract investors. A $25M pink sheets stock might be a different story.

The reality, as you note, is that random variation (future events) will determine whether large outperforms small, or tech outperforms finance, or Texas companies outperform those in Florida.
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Re: The case against small cap value

Post by berntson »

Thanks Jo. Surprisingly, perhaps, I mostly agree. I don't think that the performance of the iShares ETFs shows that there is a small or value premium. The observation period is simply too short. My point was that there is no evidence for steve_14's claim that real fund returns show that there is no small or value premium. At best, real fund returns show that actively managed value funds, like other actively managed funds, are a bad bet. Well run passive funds have done a good job tracking the academic small and value premiums over reasonably long periods of time.

I also agree that it's a coin flip whether growth or value outperforms in any given year.The import point is that it's a slightly biased coin flip. This table is from Shaughnessy's book What Works on Wall Street.

Image

This chart compares large value returns to large total market returns, but it makes roughly the same point. In any single year, the odds of large value beating the total market are basically a coin flip, with a slight bias in favor of large value. Over time, the small edge adds up. This is one reason that it is foolish to think that value stocks are a road to quick riches. At best, they can only be expected to have an edge on large time scales. Even then, the total market still beat large value in almost 10% of rolling 10-year periods. If the value premiums persists, it will likely be because investors continue to focus on short-term returns.
Last edited by berntson on Thu Apr 10, 2014 11:02 am, edited 1 time in total.
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Re: The case against small cap value

Post by Clearly_Irrational »

LH wrote:Prior to 1959, there was a long history of stock yielding more than bonds, I dunno, say 50 to 100 years.

Now, CLEARLY this was because stocks were riskier than bonds, and investors needed to be paid to take the risk.
Sure, and you still get paid more for owning stocks. Dividends payments were replaced by share buybacks as the tax laws shifted to favor capital gains.
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grap0013
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Re: The case against small cap value

Post by grap0013 »

berntson wrote:This chart compares large value returns to large total market returns, but it makes roughly the same point. In any single year, the odds of large value beating the total market are basically a coin flip, with a slight bias in favor of large value. Over time, the small edge adds up. This is one reason that it is foolish to think that value stocks are a road to quick riches. At best, they can only be expected to have an edge on large time scales. Even then, the total market still beat large value in almost 10% of rolling 10-year periods. If the value premiums persists, it will likely be because investors continue to focus on short-term returns.
65% vs. 35% is much different than 50:50 odds and you are only showing the value premium. If you start stacking up risk premiums such as small + value + profitable vs. TSM I think you'll find that the dice are loaded.
There are no guarantees, only probabilities.
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Re: The case against small cap value

Post by berntson »

grap0013 wrote:
berntson wrote:This chart compares large value returns to large total market returns, but it makes roughly the same point. In any single year, the odds of large value beating the total market are basically a coin flip, with a slight bias in favor of large value. Over time, the small edge adds up. This is one reason that it is foolish to think that value stocks are a road to quick riches. At best, they can only be expected to have an edge on large time scales. Even then, the total market still beat large value in almost 10% of rolling 10-year periods. If the value premiums persists, it will likely be because investors continue to focus on short-term returns.
65% vs. 35% is much different than 50:50 odds and you are only showing the value premium. If you start stacking up risk premiums such as small + value + profitable vs. TSM I think you'll find that the dice are loaded.
I do think that small and value are a good bet! The chart doesn't come with error bars, though, so we have to read it with "fuzzy" statistical glasses. 65% is really probably more like 55%-75%. So a cautious investor will think that the historic results are consistent with value having only a slightly edge in any given year. But that's all the value investor needs, since small edges compound over time. :beer
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Re: The case against small cap value

Post by JoMoney »

I have issues with the idea of selecting a time period of the past, showing the returns of that period (even rolling periods) and deciding that shows a conclusive "edge" that should be expected going forward. I can flip a coin 50 times and the results most likely won't be a 50/50 split. We don't have enough independent periods of data to draw those kind of conclusions from stocks. There have been plenty of previous time periods where the same types of arguments have been made for Blue-Chip stocks and other market anomalies including best days of the week or times of the year to invest. It's not an actuarial table, the past isn't necessarily prologue, results are easily skewed by recent performance. One style of stock could be ahead in 3 out of 5 periods but the next period might make it 3/6, and there's a lot of history that shows that type of RTM happening.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: The case against small cap value

Post by berntson »

JoMoney wrote: There have been plenty of previous time periods where the same types of arguments have been made for Blue-Chip stocks...
Examples?
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Re: The case against small cap value

Post by JoMoney »

I may have overstated. What I was thinking of though, was the Nifty-Fifty boom of the 60's-70's, which ended in the bull market in the mid-70's and was followed by a small-cap boom that busted in the early 80's and was followed by a large-cap boom in the late 90's that busted in early 2000, followed by small-caps again leading us to today with small-caps leading but doing so with seemingly excessive valuations relative to where they were when large-caps were in vogue. To me, it seems like a Soros-esque "Reflexivity Theory" cycle...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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grap0013
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Re: The case against small cap value

Post by grap0013 »

berntson wrote:I do think that small and value are a good bet! The chart doesn't come with error bars, though, so we have to read it with "fuzzy" statistical glasses. 65% is really probably more like 55%-75%. So a cautious investor will think that the historic results are consistent with value having only a slightly edge in any given year. But that's all the value investor needs, since small edges compound over time. :beer
I just casually looked at the past 10 years for DFSVX (DFA SCV) vs. TSM. DFSVX outperformed in 8 of the 10 years = 80% of the time.

I also looked at SFSNX (Fundamental mid/small with value tilt) vs. TSM. SFSNX has only been around for 6 years and it outperformed 4 of 6 years = 66%.

SFILX vs. VEA = 3 of 5 years = 60%

DGS vs. VWO = 4 of 5 years = 80%

Real life returns suggest premiums are alive and kicking. :sharebeer
There are no guarantees, only probabilities.
Browser
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Re: The case against small cap value

Post by Browser »

Probably a good idea to spread your bets around: some bonds, some commodities, some gold, some real estate, some baklava, even some stocks. My guess is that splitting the stock portion into yellow, blue, and orange stocks won't have the bang of splitting between stuff that is from different species. So, I'm more concerned about cross-species diversification than within-species diversification and don't think it's worth worrying that much about how much to put in yellow, blue, and orange stocks. Put some in each color (or not) and let it go.
We don't know where we are, or where we're going -- but we're making good time.
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nedsaid
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Re: The case against small cap value

Post by nedsaid »

This is a great thread. Two of my favorite posters, Bernston and JoMoney making their case for and against the small cap value tilts. A very interesting and enlightening discussion.

I am a small value tilter myself. Will I get outperformance? I think so. I think it is worth the effort to reach for a bit more return. If it turns out that I am wrong, I won't be wrong by very much. So the academic research, patience, and frankly a bit of faith is my formula for possible outperformance. But it is important to pick a good strategy and stick with it. I have found from experience that investing strategies tend to work really well right after you have given up on them.
A fool and his money are good for business.
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