Bogle on Tactical Asset Allocation

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james22
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Bogle on Tactical Asset Allocation

Post by james22 » Thu Dec 18, 2008 12:54 pm

There is a third option, but only for bold and self-confident investors. It does not abandon the "stay the course" principle, but it allows for a mid-course correction if stormy weather threatens on the horizon. If rational forecasts indicate that one asset class offers a considerably better investment opportunity than another, you might shift a modest percentage of your assets from the class judges less attractive to the class judged more attractive. This policy is referred to as tactical asset allocation. It is an opportunistic, transitory, aggressive policy that - if skill, insight, and luck are with you - may result in marginally better long-term returns than either a fixed-ratio approach or benign neglect.

It's grand to possess skill and insight, though all of us tend to overrate our abilities in both areas. But luck, too, plays a role. Many investors are right, but at the wrong time. It does no good to be too early or too late. Tactical asset allocation, if the strategy is to be used at all, should therefore be used only at the margin. That is, if your optimal strategic allocation is 65 percent stocks, limit any change to no more than 15 percentage points (50 to 80 percent stocks), and implement the change gradually. The prospect of having the skill, insight, and luck to eliminate your stock position overnight and restore it "when the time is right" is, in my opinion, patently absurd. Cautious tactical asset allocation may have a lure for the bold. Full-blown tactical allocation lures only the fool.

What might dictate moderate shifts in tactical asset allocation? One example: concern that stocks are substantially overvalued relative to bonds. Then, investors with conviction, courage, and discipline might benefit from a bow toward caution. I say "bow", not "capitulation." In an inevitably uncertain world, the reduction should not exceed 15 percentage points in your equity position. If you have 65 percent of your portfolio in equities, retain at least 50 percent; if 50 percent, at least 35 percent, and so on. A little caution may represent simple prudence, and, if you are relatively risk-adverse, may enable you to sleep better, a blessing that is hardly trivial. One doesn't have to have investment experience to to recognize the wisdom in this saying, from a remarkably parallel field: "There are old pilots and there are bold pilots, but there are no old bold pilots."

- John C. Bogle, Common Sense on Mutual Funds

http://books.google.com/books?id=KZbOlC ... t#PPA67,M1

SmallHi
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Post by SmallHi » Thu Dec 18, 2008 1:02 pm

All I can say is: YIKES.

sh

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bob90245
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Post by bob90245 » Thu Dec 18, 2008 1:35 pm

For those familiar with Jack Bogle, this is not new.

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Adrian Nenu
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Post by Adrian Nenu » Thu Dec 18, 2008 1:43 pm

One example: concern that stocks are substantially overvalued relative to bonds.
- like 1999 when the S&P 500 index had a P/E of 33 and many NASDAQ stocks/Dot-Coms had P/Es into the hundreds. There was also an inverted yield curve warning of an impending recession. Buffett and Bogle also warned about the equity bubble. Decision time: stay with the plan or reduce equity to a comfortable level. There is nothing magical about a 15% equity reduction limit. Reduce to individual risk tolerance level.

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Post by larryswedroe » Thu Dec 18, 2008 4:36 pm

SH
Do you totally ignore valuations?

HerbertSitz
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Re: Bogle on Tactical Asset Allocation

Post by HerbertSitz » Thu Dec 18, 2008 5:20 pm

james22 wrote:There is a third option, but only for bold and self-confident investors. It does not abandon the "stay the course" principle, but it allows for a mid-course correction if stormy weather threatens on the horizon. . . . This policy is referred to as tactical asset allocation. It is an opportunistic, transitory, aggressive policy that - if skill, insight, and luck are with you - may result in marginally better long-term returns than either a fixed-ratio approach or benign neglect.
I think people should realize that Bogle is not expressing approval for tactical asset allocation generally, just saying that doing it in a very limited way can be okay and not necessarily at odds with his stay-the-course philosophy.

I think that the vast majority of time when you hear people talking about tactical asset allocation, they're talking about something that Bogle wouldn't approve of in any circumstances.

Tactical asset allocation is just a fancy name for one kind of market timing.

I'm not sure if my own response to Bogle's point is to say "YIKES", but I do sort of wish he hadn't said it. I expect many readers will twist it to mean what they want it to mean rather than what Bogle was trying to say, so Bogle's saying it was essentially opening a can of worms

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Post by Roy » Thu Dec 18, 2008 5:43 pm

SmallHi wrote:All I can say is: YIKES.
sh
YIKES indeed. While I read this before my impression remains the same. It is market timing, pure and simple, no matter how softened the suggestion or limited the scope. Funny, there are so many conditionals in this statement of his (above) that I wonder why he suggests it at all.

For me, this seems in opposition to many of his other stay-the-course messages, and likely not helpful to the majority of investors who may be prone to portfolio adjustments anyway.

From an evidence view, studies seem to show that tactical asset allocation is not a good idea, (though I have not parsed the manner of each manager examined). Are there any studies that show more "moderate shifts in tactical asset allocation" is a good idea?

It seems that if one is risk averse, a better initial plan might be a better idea, as has been suggested by some of the authors on this board.

Roy

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Adrian Nenu
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Post by Adrian Nenu » Thu Dec 18, 2008 6:00 pm

YIKES indeed. While I read this before my impression remains the same. It is market timing, pure and simple, no matter how softened the suggestion or limited the scope. Funny, there are so many conditionals in this statement of his (above) that I wonder why he suggests it at all.
How about portfolio adjustments to changing market risk so that risk exposure more closely matches the investor's willingness, ability and need to take risk?

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Post by larryswedroe » Thu Dec 18, 2008 6:02 pm

Just some thoughts

A) valuations must be matter. They determine expected returns and the need to take risk.

B) At some valuations it may seem appropriate that the risks are not worth taking--say P/Es at 40 in a bubble market (can be rationally high in bear markets because earnings are viewed as temporarily depressed)

C) It is a very slippery slope this TAA issue. Where do you draw the line. To me it is this: The vast majority of time I assume prices are rational and efficient. That is within very wide bands of valuations. I cannot tell whether p/es of say 20 or 6 are right or not. But I do know that at 40 in a bull/bubble market is not right. Now I might be wrong timing an exit but I am willing to live with that risk. So where is that line is the tough one. Is it 40 or why not 39? That is the hardest part.

D) even when I made the change in 98 to get all small value I did not change equity allocation, just shifted within equities to assets I thought were rationally priced. Was "wrong" for about two years.

E) to me valuations do matter, just like with TIPS yields. Those that ignore them totally IMO do so at their own peril

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Post by HerbertSitz » Thu Dec 18, 2008 6:42 pm

larryswedroe wrote:to me valuations do matter, just like with TIPS yields. Those that ignore them totally IMO do so at their own peril
Agree, but adding the "at their own peril" goes a little over the top for me. Someone who's determined that 60s/40b is appropriate for the long term might be able to increase return slightly by good limited tactical allocation decisions like those described by Bogle, then again (as Bogle says) they might well lower their return.

In any case the benchmark for that person is still 60s/40b. Over the past eighty years they'd have done fine over long-term by ignoring valuations and staying the course with that allocation. One of the main ideas of indexing is to be happy with the market return, not try to beat it. Adding tactical asset allocation element fosters a "beat the benchmark" attitude that doesn't seem to fit with the overall philosophy. For most people the fight against counterproductive behavioral tendencies is difficult enough without giving in to one of them straightaway.

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wbond
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Post by wbond » Thu Dec 18, 2008 6:58 pm

I pointed out Dr. Bernstein’s (old) post on this topic last week on a thread about “market timing.” He is, of course, an advocate of using the Gordon model to estimate the long, long term returns of equities. I (obviously) am not an active poster, but enjoy the site, and especially enjoy L. Swedroe and SmallHi’s posts. I’m sure it would be interesting to read SmallHi’s response to the Bernstein piece. (And my apologies in advance if you have addressed it before at any length). I am not allowed yet to post links, but it can be found if you Google “efficient frontier: Mamas don’t let your babies grow up to be timers.”

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Post by Roy » Thu Dec 18, 2008 7:25 pm

larryswedroe wrote: C) It is a very slippery slope this TAA issue. Where do you draw the line. To me it is this: The vast majority of time I assume prices are rational and efficient. That is within very wide bands of valuations. I cannot tell whether p/es of say 20 or 6 are right or not. But I do know that at 40 in a bull/bubble market is not right. Now I might be wrong timing an exit but I am willing to live with that risk. So where is that line is the tough one. Is it 40 or why not 39? That is the hardest part.

D) even when I made the change in 98 to get all small value I did not change equity allocation, just shifted within equities to assets I thought were rationally priced. Was "wrong" for about two years.

Many of the people who cried "irrational exuberance" were brutally wrong for the next four years--and they were pretty bright guys.

You're right, Larry. The slope is slippery and I haven't the foggiest as to how and when to make adjustments or shift asset classes consistently well; neither do many portfolio managers, evidentally. I learned this from Bogle's books, and yours, which have impressive academic support.

But, even if using the sort of equity allocation suggestions in your sample portfolios, (in your books), bubble risks are limited somewhat because real diversification is addressed. Then it becomes, for me, how to set an allocation that permits me to sleep well and be a disciplined investor. Otherwise, I fear I'll become too clever by half, and tweak my way to poorer returns.

And if my willingness, need and ability to take risk are now changing, now due to erroneous judgments on my part (on market valuations, crisis assessments, and anything else that supposed to matter beyond the big life issues that affect my finances directly), then I'll likely be just another investor whose returns lag the very funds I'm invested in.


Roy

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Adrian Nenu
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Post by Adrian Nenu » Thu Dec 18, 2008 7:47 pm

- the investing puplic cannot do market timing, portfolio/market risk analysis or buy and hold so I'm not sure what the answer is.

- in 1998-1999, there were warning signs of increased market risk: very high stock valuations, Buffett, Greenspan and Bogle, inverted yield curve, etc. Risk was clearly rising so have to look at your own portfolio risk exposure and determine if it's right for you, stick with it or reduce risk exposure.

- prior to the 2008 bear market and recession, there also were warning signs of increasing risk: RE bubble, mortgage securities with increasing default rates, inverted yield curve. Risk was increasing so again, have to look at your own portfolio and see if you need to make adjustments. Not bail out of stocks completely but check to make sure you can handle it during a storm.

The message is that it is easy to be overconfident and greedy during bull markets and tilt too much towards stocks and then find out the wrong way during a bear market if you ignore the warning signs and do not periodically re-evaluate your exposure to rising market risk and the possibility of a ~50% market decline.

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Post by Prokofiev » Thu Dec 18, 2008 7:58 pm

Using Bogle's "age in bonds" (or age in bonds -10) and rebalancing annually will go a long way to control risk and increased market valuations.

It's 1995 and at age 55 you have a 65/35 portfolio. 5 years later, equities have soared but you are down to a 60/40 AA and have sold a lot of stocks to get down to a 60% level. 2 years later you want 55% equities and have to buy stocks in order to get there . . . etc, etc.

No crystal ball required.
Everything should be made as simple as possible, but not simpler - Einstein

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Post by Robert T » Thu Dec 18, 2008 8:05 pm

.
FWIW - my earlier views on 'valuations matter' http://socialize.morningstar.com/NewSoc ... 90288.aspx

My views have not changed, would only add that a rebalancing strategy is also based on (relative) valuations.

Robert
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Post by tuffy88 » Thu Dec 18, 2008 8:06 pm

This seems very much like John Hussman's method with the Hussman Growth Fund. He adjusts equity market exposure to what he calls valuations and market action. He has done well with his method since he started his fund in 2000. My portfolio of buy & hold index funds is down a little over 14% YTD as of tonight. The Hussman fund is off about 7% YTD.

A question for Larry Swedroe: What do you think of Hussman's method?

Charles

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Post by SmallHi » Thu Dec 18, 2008 8:46 pm

larryswedroe wrote:SH
Do you totally ignore valuations?
Larry, when you target asset classes that "self flush" (ie value portfolios), and you rebalance periodically, you will take care of most of the excessive levels of valuation that need to be worried about. Balanced investors that include fixed income naturally have an added buffer.

Bogle, on the other hand, recommends pure cap weighting (valuation agnostic), excessive allcations to one country -- US (introducing asset class bubble risk), and advises one spend their risk dollars on speculation (ie. sector bets).

I cannot endorse that. Mostly, valuations are helpful in building rational expectations for future results. Not for trading. In studying almost 90 years of historical data and valuations, I have yet to find a period (even with hindsight) where it was obvious to excessively rebalance out of a balanced small/value titled portfolio into cash, or vice versa.

sh

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Post by james22 » Fri Dec 19, 2008 2:13 am

Nonetheless, building an investment portfolio can be exciting, and trying out modern remedies for age-old problems lets you exercise your animal spirits. If you crave excitement, I would encourage you to do exactly that. Life is short. If you want to enjoy the fun, enjoy! But not with one penny more than 5 percent of your investment assets.

That can be your Funny Money account.

Here are [two] Funny Money approaches, and my advice about using them:

Individual Stocks? Yes, Pick a few. Listen to the promoters. Listen to your broker or adviser. Listen to your neighbors. Heck, even listen to your brother-in-law.

Actively managed mutual funds? Yes. But only if they are run by managers who own their own firms, who follow distinctive philosophies, and who invest for the long term, without benchmark hugging. (Don't be disappointed if the managed fund loses to the index fund in at least one year of every three!)

- John C. Bogle, The Little Book of Common Sense Investing

http://www.amazon.com/Little-Book-Commo ... bb_product

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Post by jeffyscott » Fri Dec 19, 2008 8:10 am

larryswedroe wrote:C) It is a very slippery slope this TAA issue. Where do you draw the line. To me it is this: The vast majority of time I assume prices are rational and efficient. That is within very wide bands of valuations. I cannot tell whether p/es of say 20 or 6 are right or not. But I do know that at 40 in a bull/bubble market is not right. Now I might be wrong timing an exit but I am willing to live with that risk. So where is that line is the tough one. Is it 40 or why not 39? That is the hardest part.
A way I have looked at the "line" is that any changes I make need to be something I am willing to stick with indefinitely. An example is a few years ago, it seemed that foreign stocks were significantly cheaper than US. I adjusted my allocation from 25% foreign to 33% (of equities), the new level of 33% was something I was willing to keep as a new permanent allocation. I did not go to 50% or 100% foreign because those are not allocations that I would be comfortable making a permanent commitment to.
Time is your friend; impulse is your enemy. - John C. Bogle

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Post by Roy » Fri Dec 19, 2008 9:50 am

Adrian Nenu wrote:- the investing puplic cannot do market timing, portfolio/market risk analysis or buy and hold so I'm not sure what the answer is.Adrian
anenu@tampabay.rr.com
No question most can not do timing.

I think some self-investors can become converts to a better approach (buy and hold, say). And if the DFA research is accurate, then some who use "good" advisors with "good" funds, also benefit beyond the commissions they pay their advisors. But in both cases, it appears that discipline and consistency are keys.

That said, I do get confused some when experts who are famous for their buy and hold message (either through a Market Cap approach or a more comprehensive diversification), talk about how they change what must have been carefully-planned allocations about. For me, it sounds like: "Buy and Hold. Don't market time, except...."

And I think SmallHi is on-target in his last post regading Bogle's approach, and valuations/trading.

Roy

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Post by Heath » Fri Dec 19, 2008 10:40 am

There are some people who require an absolute, fixed, inflexible set of rules to follow. These people seem to think that the absence of such absolutes is tantamount to no rules at all. Others believe strongly in general principles and rules, but understand that in this context there is no such thing as an absolute. Both Jack Bogle and Larry Swedroe are of the second type, IMO.

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Post by jeffyscott » Fri Dec 19, 2008 11:37 am

Heath wrote:There are some people who require an absolute, fixed, inflexible set of rules to follow.
A current example...suppose one has had an allocation to nominal treasuries using 5 year bonds. These are now yielding 1.26%, meanwhile 5 year TIPS are at 1.37% and 1-5 year FDIC insured CDs are at about 3.5-4.5%. Given this, I can think of no reason why would one would continue to hold the 5 year treasuries.
Time is your friend; impulse is your enemy. - John C. Bogle

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Post by galeno » Fri Dec 19, 2008 12:22 pm

I"m a long-term buy and hold index investor and I agree that small moves with tactical asset allocation is a good move for the very diciplined, knowledgable, and experienced investor.

I will increase my equity allocation by 5% for 2009. If the stock markets take another big dump next year, I'll increase my equity allocation another 5%. And if there is a third market decline in 2010, I'll go 5% higher and max out at 80% stocks.

If the markets go up, I'll be decreasing my stock allocations in the same way I'm going to increase them while markets drop.

Here's my 2009 port:

70% Equities
30% US stocks (16% VTI & 14% VBR)
40% For stocks (16% VEU, 14% SCZ, 10% VWO)

30% Fixed Income in US$ CDs

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Post by Roy » Fri Dec 19, 2008 12:58 pm

jeffyscott wrote:
A current example...suppose one has had an allocation to nominal treasuries using 5 year bonds. These are now yielding 1.26%, meanwhile 5 year TIPS are at 1.37% and 1-5 year FDIC insured CDs are at about 3.5-4.5%. Given this, I can think of no reason why would one would continue to hold the 5 year treasuries.
This seems so. But it depends on what happens next. Though, this is a different order of change than Bogle's suggestions above, where the Stock/Bond ratios change by some arbitrary maximum measure—like up to 15 percentage points—or switching out of one equity class into another based on a valuations guesstimate.

One spiel given by so many portfolio managers is how they are not slaves to a strategy and use their expertise to move money flexibly as the opportunity arises. This always sounds great (I mean, who wants to be robotic, inflexible?) and yet research seems to show it does not work. Maybe constancy has its advantages.

And Bogle himself seems to be saying these adjustments are a crapshoot that can just as easily produce lower returns.

There are no absolutes, but consistently exploiting what are perceived to be inefficiencies seems to be problematic, especially for most investors; research seems to agree—even for the experts.


Roy

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Post by jeffyscott » Fri Dec 19, 2008 3:12 pm

I don't think this particular example is about "exploiting inefficiency". Buying 5 year treasuries over an FDIC insured CD would seem to only make sense if one is speculating that the 5 rates on treasuries will drop even further.
Time is your friend; impulse is your enemy. - John C. Bogle

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Post by Roy » Fri Dec 19, 2008 3:36 pm

jeffyscott wrote:I don't think this particular example is about "exploiting inefficiency". Buying 5 year treasuries over an FDIC insured CD would seem to only make sense if one is speculating that the 5 rates on treasuries will drop even further.
Jeffy
Wasn't talking specifically about this recommendation or about buying 5 year treasuries over CDs at this time. I don't know what the future holds on the rates. Though, I would not be interested in even speculating on whether I should sell my Treasuries for CDs, for several reasons.

My point is I think guesstimations based on valuations, or what one thinks the market will do, seem problematic in general, and research seems to support this.

Roy

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Post by wbond » Fri Dec 19, 2008 6:42 pm

SmallHi wrote: Mostly, valuations are helpful in building rational expectations for future results. Not for trading. In studying almost 90 years of historical data and valuations, I have yet to find a period (even with hindsight) where it was obvious to excessively rebalance out of a balanced small/value titled portfolio into cash, or vice versa.

sh
I agree, and follow the same s/v tilt.

But is there any extreme limit that might give you pause?
For example, in 11/07 the dividend yield in Spain was .57% and the ten-year government bond 4.28%. Regardless of the approximate and long-term nature of valuation models, at some point might this zero or negative expected equity risk premium make you consider a small increase in allocation to fixed income despite an aggressive small/value tilt?

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Down market reallocated my portfolio for me

Post by artthomp » Sat Dec 20, 2008 10:49 am

I started the year with a 40% stock/60% bond allocation which was mostly in index funds. The market results for this down year have altered the allocation to 30% stock/70% bond. I have decided not to rebalance this year based upon my age (68 years) and the following comparison study I made based using historical data available on the Vanguard site.

I simplified the following examples using the Total Stock Market index fund (-37.23% YTD) to represent equity performance and the Total Bond Market index fund (+4.43% YTD) to represent bond performance.

Case 1: While I was still working I maintained a 60% stock/ 40% bond portfolio. That portfolio would be down this year -20.57%. From the average return indicated in the Vanguard table (8.9%) the average return for this portfolio for ten years would be 2.346 times the beginning valuation.

Case 2: I started this year with a 40% stock / 60% bond portfolio. That portfolio would be down this year -12.23%. From the average return indicated in the Vanguard table (7.9%) the average return for this portfolio for ten years would be 2.139 times the beginning valuation.

Case 3: The market results so far this year have reduced my allocation to that of a 30% stock / 70% bond portfolio. If I had started the year with that portfolio, it would be down this year only -8.07%. From the average return indicated in the Vanguard table (7.4%) the average return for this portfolio for ten years would be 2.042 times the beginning valuation.

Case 4: The 100% stock allocation Vanguard portfolio shown below would have resulted in a loss of so far this year of -37.23%. From the average return indicated in the Vanguard table (10.4%) for a 100% stock allocation, the average return for this portfolio for ten years would be 2.690 times the beginning valuation.

Comparison 1: Comparing the results for a 60% stock/ 40% bond and a 30% stock / 70% bond portfolio we see that for an average gain of 15% total (2.346 – 2.042/2.042) over ten years, I would have lost an additional 55% (20.57-8.07/8.07) at this point this year.

Comparison 2: Comparing the results for a 100% stock and a 30% stock / 70% bond portfolio we see that for an average gain of 32% total (2.690-2.042/2.042) over ten years, I would have lost an additional 361% (37.23-8.07/8.07) at this point this year.

Based on these comparisons, I’m going to leave my allocation at 30% stocks / 70% bonds. A younger person would of course want a higher stock allocation because of the longer recovery time from any crashes and the higher return on the average.

Another consideration concerning risk taking with my portfolio is that it’s been a terrible decade for stocks – the total stock market index is down -0.20% on annual basis for the last ten years while the total bond market index has returned an average +5.28% on an annual basis for the last ten years. Of course the past does not predict the future when it comes to markets.

These are just my thoughts on allocation.

Art
Art

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Post by SmallHi » Sat Dec 20, 2008 11:34 am

wbond,

I don't know. At some point? I guess. But in the scenerio you list? I don't think we have enough info to make a qualified judgement. A few thoughts on the matter:

a) there is a difference between the expected equity risk premium and the expected size and value premiums. There are times when one is high, and the other one or two are not. Two great examples are 1983 and 1999. In 1983, small and value stocks had gone through a decade where they were +36% per year, double that of the market (TSM). In 1999, we had a period where TSM was +28% for the previous 5 years, yet SV had not really kept pace.

I would argue, ex ante, that in first case, the expected small/value premiums had fallen somewhat, and in the later, the forward equity premium had declined. Although that is much easier to spot with hindsight. In a portfolio with TSM and SV (if you cannot stomach "all value"), you would have been rebalancing back to TSM pretty heavily in the early 80s, and back to SV in the late 90s. In each case, you did see a lower realized return on the "hot dimension" over the next 10 years, but not dramatically so. And all the while you were "rebalancing back" you were likely choking off what was left of the run...so its no panacea.

I am far less inclined to rebalance my SV allocation for fear of low expected returns than my TSM allocation. First, SV's risk/expected returns far exceed that of TSM, and the payoffs might be spotty. If you were too strict a rebalancer, you may forego some of that premium that continued to accrue in the later stages. A great example of this is the 80s/90s period I mentioned. From 1983-1992, US TSM beat US SV by about 1%. From 1982-1992 (giving SV one more year), SV beat TSM by 1%. Even in a period with diluted size/value premiums, short periods of inclusion/exclusion can make a big difference.

b) the very nature of SV stocks, or a SV index, is "self flushing". Its important to remember, most likely the stocks that drove the SV return from 75-83 were not in the index in 84. SV stocks that do well are sold out of an index annually as they migrate to Mid Value, Mid Blend, or Small Blend. The proceeds are used to buy new stocks that have recently fallen. Its conceivable that the spread between SV stock valuations and LG (or TSM) valuations can be relatively unchanged over a period with a rather large realized SV premium. The period that comes to mind is 1994 and 2006. Valuation spreads between market dimensions were little changed in 06 from where they were in 94, yet we saw about a 5% premium for SV over the Russell 3000 Value. The absolute returns (11% for TSM and 16% for SV) and relative returns (+5% for SV) were almost identical to the realized returns over the previous 60 years:

Code: Select all

Asset Class...............1934-1993..........1994-2006

US TSM......................+11.4%............+10.8%
US SV.......................+16.0%............+16.1%
c) having looked at absolute metrics, relative metrics, and everything in between, I haven't seen a reliable guage of when value or small is over/undervalued relative to LG or bonds. Dividend payout ratios and policies have changed so much over the years, I am very hesitant to rely on those for anything concrete. If we use the spread between Value "valuations" (Large Value + Small Value) and Growth "valuations" on a book to market basis (which is a more common approach), we find it to be almost (2.1) from 1940-1971 than the 1972-2004 period (1.3) <the higher the number, the bigger the value "discount">

The annualized value premium in the first period? 5.4%.
The annualized value premium in the second period? 5.3%

If that significant a difference in value spread over two independent periods produces almost identical results, I am not sure you can really put a lot of weight on shuffling money around to capitalize on perceived under/overvaluations of value v. growth or bonds.

I'd be fine with someone agressively (or entirely) allocating to value permanently after a 5 or 10 year spell where value and small are dreadful assuming they understand the risks and the enormous amount of discipline that will be required. Outside of that, I'd say just rebalance, and use valuation ratios and short term historical returns to manage your expectations.

The thing is, if you stick with your strategy, and we enter a period of lower expected equity or small/value returns...its likely your portfolio will have captured the "run up" that caused these diminished expectations to surface. So you will have lowered needed returns at the same time.

I put "trading" way, way down the list in terms of investment importance (be that adjusting allocations based on valuations, rebalancing bonuses, negative correlations, asset class diversifiers, all that stuff...) relative to keeping your costs relatively low, keeping your asset class choices indexed/structured whenever possible, and targeting equity/size/value risks appropriately.

sh

PS -- in the case you mention, Spain, had that "case" occured in the US market, or International market as a whole (Spain stocks have been up big since 03 <SC stocks +40% per year from 03-07>, and had positive returns in 01-02), I absolutely would be aggressively rebalancing back to the rest of the world equity markets, but not diminishing or eliminating the holding completely.

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Post by wbond » Sat Dec 20, 2008 12:44 pm

SmallHi,

Thank you kindly for such a detailed and thoughtful response. If there is ever a “SmallHi on Investing” I’ll pre-order.

-wbond

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Henry Sadovsky
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The quintessential s/v salesman

Post by Henry Sadovsky » Sat Dec 20, 2008 12:54 pm

.
Hi All.

In retrospect, it seems obvious that there were periods when it would have been wise to excessively rebalance out of a balanced TSM portfolio into cash, or vice versa. (Larry Swedroe himself has done so.) But,
SmallHi wrote:In studying almost 90 years of historical data and valuations, I have yet to find a period (even with hindsight) where it was obvious to excessively rebalance out of a balanced small/value titled portfolio into cash, or vice versa.
So... there you have it. s/v tilting (so goes the theory) has a higher expected return than TSM because it is higher risk, but (wink, wink) tilting really results in more reliable returns!

As Michael Lewis has said, "The promise of something for nothing. It never loses its charm." :)
"What we can't say we can't say, and we can't whistle it either." | Frank P. Ramsey" | | (f.k.a. Zalzel)

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Post by Roy » Sat Dec 20, 2008 12:57 pm

SmallHi wrote:I put "trading" way, way down the list in terms of investment importance (be that adjusting allocations based on valuations, rebalancing bonuses, negative correlations, asset class diversifiers, all that stuff...) relative to keeping your costs relatively low, keeping your asset class choices indexed/structured whenever possible, and targeting equity/size/value risks appropriately.

sh
SmallHi this makes a lot of sense to me and seems more manageable for ordinary investors.

Are you exclusively invested in Value equities or some TSM/ Small Value split?

Also, what do you think of the strategy that has been discussed in past regarding a small allocation to high risk equities (say 30% divided among SV, ISV, EM, etc) and the balance in Treasuries (TIPS or ST bonds)?

While it has done well in this downturn, I suppose any allocation must have periods where it does well and poorly. Or is the "self flushing" nature of SV something that makes this sort of equity/fixed split particularly attractive in a more permanent sense?

Roy

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Post by HerbertSitz » Sat Dec 20, 2008 1:20 pm

SmallHi wrote:I'd be fine with someone agressively (or entirely) allocating to value permanently after a 5 or 10 year spell where value and small are dreadful assuming they understand the risks and the enormous amount of discipline that will be required. Outside of that, I'd say just rebalance, and use valuation ratios and short term historical returns to manage your expectations.

The thing is, if you stick with your strategy, and we enter a period of lower expected equity or small/value returns...its likely your portfolio will have captured the "run up" that caused these diminished expectations to surface. So you will have lowered needed returns at the same time.
sh -- If we apply this to someone with no sv tilt, sounds like same logic could be used to justify someone at 50s/50b changing to higher stock allocation when stocks have become undervalued. But isn't that exactly what prompted you to earlier say, "YIKES"?

I get that you add moving aggressively to "value _permanently_ after after a 5 or 10 year spell where value and small are dreadful. . . .", but I'd still say your statement is a step or two down same slippery slope as Bogle's. What's your justification for approving of the move towards sv once (i.e., permanently) at the "dreadful" bottom, and not approving of any move away from sv at an irrationally exuberant sv top?

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Post by wbond » Sat Dec 20, 2008 3:05 pm

H. Sadovsky,

I think if you consider SmallHi’s “or vice versa” in light of point “c” in his latest post on this thread you will see that he isn’t stating that s/v returns are more reliable, but is, rather, addressing the valuation issue with respect to s/v as opposed to TSM.

Cheers, wb

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Post by johnjtaylorus » Sat Dec 20, 2008 3:49 pm

A very strong efficient mkt theory would forbid the success of Buffett, Munger, Lynch, Templeton, etc.

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Henry Sadovsky
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Not so fast there newbie : )

Post by Henry Sadovsky » Sat Dec 20, 2008 4:15 pm

.
wbond wrote:I think if you consider SmallHi’s “or vice versa” in light of point “c” in his latest post on this thread you will see that he isn’t stating that s/v returns are more reliable, but is, rather, addressing the valuation issue with respect to s/v as opposed to TSM.
Hi wbond.

Why was s/v tilting introduced into this conversation on tactical asset allocation?
SmallHi wrote:In studying almost 90 years of historical data and valuations, I have yet to find a period (even with hindsight) where it was obvious to excessively rebalance out of a balanced small/value titled portfolio into cash, or vice versa.
The sub-text here is that s/v tilting, as compared with TSM investing, decreases the extremes in valuation that the TSM investor is exposed to. A less hectic ride is implied.

You might ask SmallHi (perhaps in a more appropriate conversation in which to do so) what is/are the real world risk(s) an investor who s/v tilts faces that warrant(s) a handsome extra-volatility premium?

I will not contribute further to this conversation getting off track.
"What we can't say we can't say, and we can't whistle it either." | Frank P. Ramsey" | | (f.k.a. Zalzel)

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Re: Bogle on Tactical Asset Allocation

Post by tetractys » Sat Dec 20, 2008 4:33 pm

One thing notable about JB is that he's very cognizant of his audience. So it shouldn't be surprising when he leads them with venturesome statements, only to return to his ground. And I think in this instance he sums up his true view well when he says:
Bogle, J. [u]Common Sense on Mutual Funds[/u]. wrote:One doesn't have to have investment experience to to recognize the wisdom in this saying, from a remarkably parallel field: "There are old pilots and there are bold pilots, but there are no old bold pilots."
Best regards, Tet
RESISTANCE IS FRUITFUL

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Post by wbond » Sat Dec 20, 2008 4:54 pm

Henry S.,

I see this as two related questions and one that is separate.

1. Does it make sense to “over-rebalance” by even a small amount in times where some valuation metric used to predict the expected equity risk premium (e.g. dividend yield, but which can be argued about) is at one extreme or another.
2. For those who “tilt” towards s/v, does this also make sense? (I think this is an interesting correlate to question 1, rather than being terribly off-track).

With respect to question 2 I understand sh as making the point that however imprecise valuation measures are for the long-term expected equity risk premium, they are even more so (or even impossibly futile) for the historical s/v premium.

The separate question, which is, perhaps, a bit off track, is the question of the s/v premium itself. I don’t mean to rehash that here, either.

Have a nice weekend, wbond.

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Post by SmallHi » Sat Dec 20, 2008 6:08 pm

A couple of quick thoughts:

a) there is a "smallhi on investing", it was a series of papers published by Fama and French: "Characteristics, Covariances, and Average Returns"; "Value vs. Growth: International Evidence": "The Anatomy of Value and Growth Returns"; "Migration"; and "The Behavior of Interest Rates"; and "Common Risk Factors in the Returns on Stocks and Bonds" :lol:

b) efficient market theory is fine with the idea that randomly, there will be some Peter Lynch's, Warren Buffetts, and Bill Millers. As a matter of fact, the biggest puzzle yet to be answered by EMH is why isn't there more of them, with the tens of thousands trying?

c) I don't particularly care for the SV/Treasury portfolios that are extremely heavy on the bonds, to be honest. I guess I believe a bit more strongly in the evils of tracking error regret, and the real world realities of building and maintaining a balanced portfolio. To speak nothing of the horrible after tax returns of a portfolio with such high fixed income exposure, I just don't know anyone who could likely maintain a 25%SV/75% T-Note portfolio over an entire cycle (or whatever the % is). There will be periods where stocks do very, very well for long periods, and LGish companies outpace SV stocks by a wide margin for a considerable time. You will hear all sorts of rumors and beliefs that "SV investing is dead", blah, blah, blah...

I don't view one of these low equity, 100% SV portfolios as the "same thing" as say, a balanced global portfolio that has decided to isolate exclusively or mostly value stocks (say Vanguard Value, Vanguard Small Value, iShares EAFE Value, Vanguard Int'l Small, Vanguard EM)...mixed in with some ST bonds.

That too is a relatively extreme allocation, but you are in essense saying: "I get the fact that value stocks are expected to offer higher returns over time, and I am willing to put up with painful periods of tracking error <both on the value side, and on the Int'l side relative to a US bull market> and the likelyhood that when the economy turns down, or we see some sort of financial/military crisis, that my value stocks will probably lose more than a market based portfolio. If you are the rare investor who "gets it", and this doesn't interfere terribly with your human capital, than this is about as far as I'd go. I feel better about at least staying marketwide. Plus, I can still use conventional index funds instead of fundamental weighted index funds, or dividend weighted index funds (technically, in order to own SV stocks internationally, you need Wisdomtree, which I may stay away from).

For the vast majority of everyone else, some combo of TSM/SV or S&P 500/LV/SV is probably a better mix.

...and more specifically in response to Herbert:
sh -- If we apply this to someone with no sv tilt, sounds like same logic could be used to justify someone at 50s/50b changing to higher stock allocation when stocks have become undervalued. But isn't that exactly what prompted you to earlier say, "YIKES"?

I get that you add moving aggressively to "value _permanently_ after after a 5 or 10 year spell where value and small are dreadful. . . .", but I'd still say your statement is a step or two down same slippery slope as Bogle's. What's your justification for approving of the move towards sv once (i.e., permanently) at the "dreadful" bottom, and not approving of any move away from sv at an irrationally exuberant sv top?
Well, my point was: if you have really taken time to understand the research (on 3F), and it resonates with you as an appropriate strategy and you have the access to the right tools (value index funds or asset class funds), and you feel like you have the intestinal fortitude, and small/value investing hasn't been working lately (which first stands to help ensure you aren't performance chasing, and second helps with expected future results)...then I view this as an entirely rational, acceptable change in policy.

If, instead, you are making the changes because you feel:

a) value is safer and will hold up better in the downturn, or
b) value is undervalued

...I would probably say "don't do it".

Not sure if that helps?

sh

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!!!!!!!!!!!!!!!!!!!!

Post by Henry Sadovsky » Sat Dec 20, 2008 7:16 pm

.
Re: "A couple of quick thoughts:" (http://www.bogleheads.org/forum/viewtop ... 386#356386):

Excellent post! Except for the part about Warren Buffett (he is in a class by himself), I agree with all of it.
"What we can't say we can't say, and we can't whistle it either." | Frank P. Ramsey" | | (f.k.a. Zalzel)

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Post by retired at 48 » Sat Dec 20, 2008 9:27 pm

Interesting thread...especially when the source is J. Bogle himself on tactical asset allocation.

Then Herbert professes:
I'm not sure if my own response to Bogle's point is to say "YIKES", but I do sort of wish he hadn't said it.
Shows the power of (Bogle's) stature, for any suggestion by others to tactically change allocations is called nonBoglesque :!:

Smallhi, you make one ponder this topic, but I remain in the camp of james22, Larry and (slight tilt that valuations matter) Robert T.

I went back and reread Bogles litany and it describes me...there is nothing I do at variance with his words.

Just an input.

R48

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Post by james22 » Sun Dec 21, 2008 5:23 am

Vanguard on Tactical Asset Allocation:

TAA can add value at the margin, if designed with the appropriate rigor to overcome significant risk factors and and obstacles unique to the strategy.

https://institutional.vanguard.com/iam/ ... 052006.pdf

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Post by jeffyscott » Sun Dec 21, 2008 8:11 am

SmallHi wrote:there is a "smallhi on investing", it was a series of papers published by Fama and French
...smallhi reveals his true identity is Fama and/or French :wink:
I don't view one of these low equity, 100% SV portfolios as the "same thing" as say, a balanced global portfolio that has decided to isolate exclusively or mostly value stocks (say Vanguard Value, Vanguard Small Value, iShares EAFE Value, Vanguard Int'l Small, Vanguard EM)...mixed in with some ST bonds.

That too is a relatively extreme allocation...
No so extreme as a DFA all value portfolio, since these value funds come from a 50/50 division of the market on the value spectrum, while DFA value comes from a division into three parts. So this all value approach is more like maybe a ~60% value approach using DFA funds.
Time is your friend; impulse is your enemy. - John C. Bogle

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Post by Roy » Sun Dec 21, 2008 8:35 am

SmallHi wrote:... If you are the rare investor who "gets it", and this doesn't interfere terribly with your human capital, than this is about as far as I'd go. I feel better about at least staying marketwide. Plus, I can still use conventional index funds instead of fundamental weighted index funds, or dividend weighted index funds (technically, in order to own SV stocks internationally, you need Wisdomtree, which I may stay away from).sh
Thanks, SH, for all your answers. This thread has been helpful to me.


If "marketwide" makes sense, then those quartile-basket suggested portfolios--plus REITs-- that appear popular in books and online literature (Swedroe, Merriman, et al) seem excellent approaches to global diversity. And they access the "value" component far more than a cap-weighted model. Is this more of what you'd prefer as an approach?

What is wrong with WisdomTree, or dividend weighted funds, in accessing that asset class in an otherwise globally-diversified portfolio. Or is it just that you'd prefer conventional indexes, if they were available? Put another way, is there something so problematic with WT or Fundamentally-weighted indexes such that it would be best avoiding them, even if it meant not accessing the ISV (or IS) asset class?

I was speaking exclusively about tax-deferred portfolios, BTW.

Thanks,

Roy

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Post by SmallHi » Sun Dec 21, 2008 11:22 am

Hey all,

1) R@ 48: I don't set out hoping to change anyone's views, only hoping that, having read "the other side" more carefully, and still disagreeing with it, one may have more confidence in their chosen path. I cannot really expect to change anyones mind, if I haven't come close to changing mine.

As for the cast of characters you mention, I would speculate :shock: that Robert T is pretty close to my views. I guess I need to read his comments on the matter, but I always just assume we are about as close on most topics as two individuals can be.

2) yes, my proposed Vanguard/iShare portfolio is not "deep value" (HmL 0.6 to 0.8 range), but maybe more fairly categorized as "relative value" (HmL 0.35 to 0.5)...but its still helpful. And, why, someone who may draft a 33%/67% Blend/Value DFA style portfolio maybe comfortable with a 100% Vanguard Value allocation.

Given the painful choice of: (a) more diversification, or (b) more value, I'd choose more diversification (and therefore include Int'l Small and EM neutral indexes), but if you want to be a stickler, then Vanguard Value, Vanguard Small Value, and iShare EAFE Value (in something like 20/40/20) would be acceptable so long as you realize you are leaving out about 3,000 publicly traded stocks and about 20 countries.

3) On Widsomtree: I wish they were conventionally weighted and held more stocks, I am concerned about why dividends seem to work better as a metric for value in International Markets than US markets*, and Wisdomtree as a company is not quite up to the standard of Vanguard or Barclays. The EM fund in particular I wish had more stocks in it (about 200 last check), and the Int'l SC fund isn't really that small. But there is research (some by FF and some 3rd party) that says dividend weighting Internationally has been an acceptable value metric...especially outside the US. So for those who want to cover the map, are willing to roll the dice with Wisdomtree, and want to tilt more strongly to value, mixing Wisdomtree ISC and EM with Vanguard and iShares would be fine.

sh

*inside the US, dividend weighting has produced the lowest historical returns of any Price/"flow variable" that I am aware of going back a few decades, results in the greatest concentration, and tends to focus on relatively larger companies in each part of the market ("small stocks" ranked by Dividend/Price tend to be larger than those ranked by Earnings/Price or Book Value/Price)

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Post by larryswedroe » Sun Dec 21, 2008 11:36 am

few thoughts
First re the issue of tax inefficiency for the type of portfolio I recommend because of the high fixed income weight misses the point that if you have to hold fixed income in taxable and are in higher brackets you can own Treasury equivalent in tax efficient manner by purchasing prerefunded bonds. Also a portfolio of AAA munis that is diversiifed while not eliminating credit risk is a very low risk portfolio

Second, if you go with all SV type portfolio it doesnt mean you are not diversified. You have significant exposures to beta, size and value and you own domestic, international and EM stocks, thousands of them.

Third IMO the issue of TE is way overstated once you go to a tilted portfolio anyway. A portfolio with significant tilts to size and value is going to experience significant tracking error. So if you can stand that much TE than a bit more won't hurt, especially if you recognize the benefits of a very low beta exposure. Remember you won't care if the tracking error miss is positive (which will happen the majority of the time) and you wont (or should not) care if the TE is negative but you had positive returns (remember the purpose of the portfolio design was to reduce or minimize the left tail risk), and if the TE is negative and you have negative returns it almost certainly will be because the beta risk shows up in large way. That means your low beta exposure will almost certainly offer more than enough protection to offset the negative TE.

I hopie the above is helpful

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Post by SmallHi » Sun Dec 21, 2008 11:37 am

Just read Robert's comments on valuations. I don't disagree with any of them. Mind you, I have never said to ignore valuations, I have just said we are limited (in my view) in our ability to reposition a portfolio consistently based on perceived valuations (or mis valuations) in a way that will produce superior results beyond a buy/hold global multifactor balanced allocation that is assembled according to your personal goals and refreshed on a set, predetermined schedule .

I never said your portfolio shouldn't change. I am just wary of changes that have more to do with recent market results than actual changes in your circumstances. Sometimes valuations give us the necessary excuse to make changes that are borne out of emotion and not circumstance. As a matter of fact, there is a whole list of rationale that is used to make decisions which, at their root, are based on fear/greed.

I have read many of Robert T's posts in the last 6 months, and I have seen nothing to indicate he is altering his policy based on valuation disclocations.

And, FWIW, I don't view this issue as a slope whatsoever. You either do, or you don't. The magnitude to which you do is of secondary relevance. IMO, better not to do it at all, then if you must, just around the edges.

sh

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Post by HerbertSitz » Sun Dec 21, 2008 11:45 am

retired at 48 wrote:Shows the power of (Bogle's) stature, for any suggestion by others to tactically change allocations is called nonBoglesque
R48 -- I don't really know what my comment shows about Bogle's stature. And didn't I just reply to you in a different thread that one of your particular methods was neither Bogleheady or non-Bogleheady because there was no official Bogle position on the issue?

I said what I said for two reasons:

First, Bogle is so loosey goosey about rebalancing that almost anything meets his approval. Bogle says you can (1) rebalance (and use just about any rules for that you want), (2) use "benign neglect" and never rebalance, or (3) use tactical asset allocation and mildly overbalance in the way he describes. Given that he allows just about any method of rebalancing (or not rebalancing) it's hard to say that there is any Boglehead-advised method of rebalancing at all. Rather, these are all things that he says are okay.

Saying something is "okay" is different from advising people to do it. I think if Bogle thought people would misinterpret as him "advising" them to do tactical asset allocation, that he would also regret having said it. I'll have to check, but I don't believe it is offered as an option at all in his more recent books.

Second, it's true, I'm disappointed that Bogle "okayed" mild tactical asset allocation because it doesn't fit very well with the key elements of his investing philosophy. Yes, he okays it in limited form, but I suspect that people are going to twist those words to mean that Bogle actually "recommends" mild tactical asset allocation, and he doesn't. He doesn't do it himself. He offers it as an acceptable alternative for "bold, agressive" investors who can't resist the "lure" of it. Having done that, he reminds them that it will provide small increase in returns only if they're lucky (and mild decrease if unlucky), that they would be wise to remember that investing is like flying a plane, and "There are old pilots and there are bold pilots, but there are no old bold pilots." So it is obvious Bogle isn't recommending this option, but merely approving it as an option for people who can't resist the lure.
I went back and reread Bogles litany . . . and it describes me...there is nothing I do at variance with his words.
Oh my, you read that quote as a "litany", as a prayer for investors to do tactical asset allocation, rather than as a warning against them doing it and providing absolute limits if they choose to do it despite his advice? That basically proves my point.
. . . and it describes me...there is nothing I do at variance with his words.
That's great. If you have never allocated more than 15 percent away from a target allocation then you may be investing in a way that Bogle doesn't object to, even though he doesn't recommend it. I don't think it's a terrible strategy, either, as practiced by you. My worry is that people will mistakenly take Bogle's comments as enthusiasm for tactical asset allocation and suggest that Bogle wants the average individual investor to do it. That is clearly not the case.

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Tracking Error is a big deal!

Post by SmallHi » Sun Dec 21, 2008 11:50 am

Larry said:
Third IMO the issue of TE is way overstated once you go to a tilted portfolio anyway. A portfolio with significant tilts to size and value is going to experience significant tracking error. So if you can stand that much TE than a bit more won't hurt, especially if you recognize the benefits of a very low beta exposure. Remember you won't care if the tracking error miss is positive (which will happen the majority of the time) and you wont (or should not) care if the TE is negative but you had positive returns (remember the purpose of the portfolio design was to reduce or minimize the left tail risk), and if the TE is negative and you have negative returns it almost certainly will be because the beta risk shows up in large way. That means your low beta exposure will almost certainly offer more than enough protection to offset the negative TE.


I disagree with this. I think TE risk is understated TODAY by most, because we haven't seen it show up in a decade or so. Just like having too much in stocks, or having too much in diversifiers that just don't diversify, if we go through a 5-7 year period of 5% or more value/small underperformance, we will have a whole football stadium full of diehards who tilted for higher returns without a full appreciation of the necessary patience.

Furthermore, I reject the idea that we can predict when small/value "risk" will show up. Yes, sometimes it will come when beta is down and the economy is in the tank. But there are a slew of different scenerious (some we have yet to experience outside of Monte Carlo simulations) which are not tied to beta -- remember, SmB and HmL have negative correlations with the ERP...through thick and thin.

There is a huge difference between some tilt and an "all SV portfolio" as well. I don't know anyone who would say, "well, if I am OK with some tilt, I'll just bet the farm, because...what's the difference?" If we want to look at it in four different grades:

#1 -- MILD = 75% TSM, 25% SV
#2 -- MODERATE = 30% S&P, 30% Large Value, 20% Small, 20% Small Value
#3 -- AGGRESSIVE = 50% Large Value, 50% Small Value
#4 -- EXTREME = 100% Small Value

No one I know can handle #4 (except probably Larry and I), very few can handle #3, #2 is for very well healed investors, and #1 is a pretty good alternative for a total cap-weighted investor who wants some diversity in their equity risk exposure.

Better to adopt #2 or #3, than to find out at the wrong time #4 was a bit more than you could swallow.

sh

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Post by retired at 48 » Sun Dec 21, 2008 11:58 am

Herbert...Fair enough. Good comments and perspective.

R48

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