Matter/scatter, part 8: Small-caps

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nisiprius
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Matter/scatter, part 8: Small-caps

Post by nisiprius » Fri Aug 03, 2018 7:28 pm

Part 1: Introduction, Part 2: Bond fund choices,, Part 3, International bonds, Part 4: Bond allocation. Part 5: International stocks Part 6: Expense ratios Part 7: Bonds during the financial crisis Brief notes: 1) In these Monte Carlo simulations, the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of simulated outcomes. 5) The actual data source is PortfolioVisualizer.com, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.

It's often suggested that Vanguard Total Stock Market Index should be preferable to Vanguard 500 Index, because of 500 Index lacking small-caps. The first chart in this series showed that comparison. Here it is again.

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For years, the Vanguard Total International Stock Index Fund did not include small-caps. In 2011, Vanguard revamped the fund, and, among other things, linked it to an all-cap index which includes small-caps. This allows a direct comparison between it and the Vanguard FTSE All-World Ex-US fund, which is very similar but tracks an index without small-caps. In the forum, when people asked about the difference, the usual answer was that, since the revamp, VGTSX ought to be preferable because it included small-caps, and VFWIX did not. Here is how they have behaved from 2011 on:

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And here it is in the context of a 60/40 portfolio: the green portfolio is 42% VFINX + 18% VFWIX / 40% VBMFX, and thus lacks small-caps; the red portfolio, 42% VTSMX + 18% VGTSX / 40% VBMFX, and has them.

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Small-caps, however, are not a large part of the market. Morningstar classifies only 6% of Total Stock, and only 6% of Total International as small caps. Advocates of factor investing usually advocate overweighting small-caps, not just including them at market cap weight. For example, one model factor-based portfolio published in 1998 allocated a third of the stock allocation to small-caps.

Our next illustrations compare a 60/40 portfolio with all large-cap stocks to one with 40% large-caps, 20% small-caps, and 40% bonds. In order to get the longest possible time range within PortfolioVisualizer, I chose VFINX, the Vanguard 500 index fund for large-cap stocks, and FBNDX, the Fidelity Investment-Grade Bond fund, for bonds. In the first illustration, I used a 20% allocation to the Vanguard Small-Cap Index Fund, NAESX:

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The DFSCX, the DFA US Micro Cap Portfolio, invests in smaller-cap stocks than NAESX, and is sometimes suggested as being superior to NAESX for that reason.

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Let's see whether a 20% allocation to DFSCX would have made more difference than NAESX made:

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petulant
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Re: Matter/scatter, part 8: Small-caps

Post by petulant » Sat Aug 04, 2018 2:39 pm

Very interesting analysis! It seems like stock/bond allocation remains the king of the castle on what choices materially impact long-term portfolio returns.

Many of these graphs still show consistent standard deviation differences even when outcomes are not very different. Is there any way to distill that analysis more helpfully?

heyyou
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Re: Matter/scatter, part 8: Small-caps

Post by heyyou » Sat Aug 04, 2018 5:32 pm

Not a request for Nisi, but the real question is how much more VG small cap is needed to equal the returns of the higher cost DFA small cap fund? 5% more VG small cap vs. the DFA small cap in the stock portion, isn't much difference in a 60/40 allocation.

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David Jay
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Re: Matter/scatter, part 8: Small-caps

Post by David Jay » Sat Aug 04, 2018 6:14 pm

heyyou wrote:
Sat Aug 04, 2018 5:32 pm
Not a request for Nisi, but the real question is how much more VG small cap is needed to equal the returns of the higher cost DFA small cap fund? 5% more VG small cap vs. the DFA small cap in the stock portion, isn't much difference in a 60/40 allocation.
I think the final 2 scatter-plots above provide your answer. Exactly the same percentages of NAESX and DFSCX provided the same range of returns, at least to the nearest thousand (148K-292K).
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

HEDGEFUNDIE
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Re: Matter/scatter, part 8: Small-caps

Post by HEDGEFUNDIE » Mon Aug 06, 2018 3:40 am

How about the choice of small cap funds tracking Russell 2000 vs. S&P 600? That issue seems to get a lot of play here, with the S&P index the consensus winner given backtesting. I’m curious whether this holds up in the simulations.

jbinpa59
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Re: Matter/scatter, part 8: Small-caps

Post by jbinpa59 » Wed Aug 28, 2019 3:01 am

nisiprius wrote:
Fri Aug 03, 2018 7:28 pm
Quote edited down for brevity
THANK YOU !! For taking the time and effort to do the matter/scatter series

At least now I can see the effects or lack thereof of my undereducated / unconscious biases in my investing :confused
And now understand better how lucky some of my choices along the way have been. :oops:

Again, Thank You for the effort! :beer

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