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Re: Diversification Sweet Spot
Old 11-10-2006, 08:22 AM   #41
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Re: Diversification Sweet Spot

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Originally Posted by ats5g

What are you saying? Do you really believe that Wellington Management added any value?
I must admit the mix of bonds + value stocks (a la Wellington or Wellesley) does seem to produce interesting results, though nothing you couldn't do on your own.
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Re: Diversification Sweet Spot
Old 11-12-2006, 05:08 PM   #42
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Re: Diversification Sweet Spot


I hate to start a new thread for this, and the topic seems halfway relevant ...

Some of my holdings (JNJ, NT, HPQ) are called "large core" by Morningstar.
Should I consider these "growth" or "value" when I'm trying to allocate
between these ?

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Re: Diversification Sweet Spot
Old 11-12-2006, 05:57 PM   #43
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Re: Diversification Sweet Spot

John -

How about an individual equities category as opposed to style boxes? Such as:

Mutual Funds: 50%
Large G 25%
Large V 25%

Bonds: 40%
etc.

Individual Equities:
10%

When I invest in individual equities, I seek total return and ignore the issue style which I think is irrelevant in this case. After all, even though research suggests our efforts are useless, we are just trying to seek a above avg. return, no? Just my 2 cents of course.
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Re: Diversification Sweet Spot
Old 11-13-2006, 10:57 AM   #44
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Re: Diversification Sweet Spot

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Originally Posted by 3 Yrs to Go
But is it luck or skill that drives the result? Even a pure random walk would produce exceptional winners (Buffett, Lynch, Miller, Cohen, etc) and exceptional losers at the tails of the distribution. Who's to say that the guy who just flipped 50 heads in a row is not a really good coin flipper?
Figure that every manager has a 50-50 shot of beating "their" index (whatever index their fund is compared to), the same odds as a coin flip. After 15 years of flipping, the odds of flipping 15 consecutive heads or tails would be 2^^15 or 32,768. I'm pretty sure that there are fewer mutual funds than 32,000, and I'm sure that the average fund manager's odds of beating their index are lower than 50-50. So I'd say that anything over 14 years (or 13 or 12, depending on your numbers) of beating the index would reflect skill.

Of course Buffett isn't punished for bloat like Lynch & Miller.
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Re: Diversification Sweet Spot
Old 11-13-2006, 01:52 PM   #45
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Re: Diversification Sweet Spot

Quote:
Originally Posted by ats5g
Spanky,

What are you saying? Do you really believe that Wellington Management added any value?

- Alec
Alec,

My message is "simplicity." This is a single fund that holds both value stocks and high quality bonds with reasonable performance and a long track record (since 1929).
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Re: Diversification Sweet Spot
Old 11-13-2006, 02:42 PM   #46
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Re: Diversification Sweet Spot

Quote:
Originally Posted by Nords
Figure that every manager has a 50-50 shot of beating "their" index (whatever index their fund is compared to), the same odds as a coin flip. After 15 years of flipping, the odds of flipping 15 consecutive heads or tails would be 2^^15 or 32,768. I'm pretty sure that there are fewer mutual funds than 32,000, and I'm sure that the average fund manager's odds of beating their index are lower than 50-50. So I'd say that anything over 14 years (or 13 or 12, depending on your numbers) of beating the index would reflect skill.

Of course Buffett isn't punished for bloat like Lynch & Miller.
And, Buffet frequently adds value by directly influencing the operations of the companies in which he buys an interest. Only the biggest investors can do this--and they'd have to know the right thing to do. Because of this post-purchase influence on how his equities perform, I don't think that Buffet's continued outperformance of the market is a slam-dunk repudiation of the efficient market theory.

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Re: Diversification Sweet Spot
Old 11-13-2006, 05:38 PM   #47
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Re: Diversification Sweet Spot


I've got another dumb question that kinda fits this thread ...
(I vaguely remember it disccused awhile back but can't find it).

A lot of "simple" portfolios one sees tend to prefer "value" over
"growth". For example, the "coffee house" portfolio is usually
defined as having 10% large and 10% large growth and ditto
for small (not 10% each of value and growth).

Is this a classic case of "chasing the hot sector", since value has
done better recently ? Doesn't it make more sense to have
equal amounts of growth and value in each equity class (large,
small, foreign) rather than equal amounts of blended and value,
as seems to be trendy these days ?

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Re: Diversification Sweet Spot
Old 11-13-2006, 06:58 PM   #48
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Re: Diversification Sweet Spot

I believe that studies have shown that value slightly outperforms growth in all cap sizes. Now, I have also heard some dispute of this recently.

Sorry I can't remember the names of the studies, etc.

Audrey
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Re: Diversification Sweet Spot
Old 11-13-2006, 08:19 PM   #49
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Re: Diversification Sweet Spot

Quote:
Originally Posted by audreyh1
I believe that studies have shown that value slightly outperforms growth in all cap sizes. Now, I have also heard some dispute of this recently.
Sorry I can't remember the names of the studies, etc.
Audrey
Dimson & Marsh, Triumph of the Optimists
Berstein's Four Pillars
Just about any long-term (20-100 years) chart of returns.

The demise of the small-cap value run has been predicted for at least two of the last four years, but it just hasn't happened yet. Eventually there'll be a reversion to the mean... the trick is figuring out when.
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Re: Diversification Sweet Spot
Old 11-14-2006, 11:24 AM   #50
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Re: Diversification Sweet Spot

Quote:
Originally Posted by JohnEyles
I've got another dumb question that kinda fits this thread ...
(I vaguely remember it disccused awhile back but can't find it).

A lot of "simple" portfolios one sees tend to prefer "value" over
"growth". For example, the "coffee house" portfolio is usually
defined as having 10% large and 10% large growth and ditto
for small (not 10% each of value and growth).

Is this a classic case of "chasing the hot sector", since value has
done better recently ? Doesn't it make more sense to have
equal amounts of growth and value in each equity class (large,
small, foreign) rather than equal amounts of blended and value,
as seems to be trendy these days ?

Hi John,

I guess it depends on what you mean by "equal amounts" of growth and value. Index funds are dominated by larger growth stocks b/c they are weighted by market capitalization (price times shares outstanding). Hence, a TSM fund will be dominated by arge cap growth companies:



[from DFA's website]

So, it could be argued that a 4x25 portfolio, like in the Coffeehouse portfolio, actually weights value + growth, as well as large + small more equally than a TSM fund.

Also, slicing and dicing [or adding SV to TSM] has reduced the standard deviation of the portfolio while it has increased the return, making the portfolio more efficient. Heck, even when large and small had similar returns, the 4x25 portfolio had less standard deviation.

- Alec
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:03 PM   #51
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Re: Diversification Sweet Spot

Quote:
Originally Posted by ats5g
So, it could be argued that a 4x25 portfolio, like in the Coffeehouse portfolio, actually weights value + growth, as well as large + small more equally than a TSM fund.
I remember a similar study claiming that holding equal amounts of the S&P500, S&P400, and S&P600 ETFs had a higher return than an equivalent amount invested in the S&P1500. And that excess return is after the "higher" trading costs plus the index fund's expense & taxes of buying/selling the additional stocks as the index changes.
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:07 PM   #52
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Re: Diversification Sweet Spot

Quote:
Originally Posted by Nords
I remember a similar study claiming that holding equal amounts of the S&P500, S&P400, and S&P600 ETFs had a higher return than an equivalent amount invested in the S&P1500. And that excess return is after the "higher" trading costs plus the index fund's expense & taxes of buying/selling the additional stocks as the index changes.
And since the S&P1500 is market cap weighted, I'd bet that higher return is due solely to the fact that smaller stocks outperformed large stocks.

- Alec
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:21 PM   #53
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Re: Diversification Sweet Spot

Quote:
Originally Posted by ats5g
And since the S&P1500 is market cap weighted, I'd bet that higher return is due solely to the fact that smaller stocks outperformed large stocks.
Exactly. It moves from cap weighting more toward equal weighting.
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:36 PM   #54
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Re: Diversification Sweet Spot

just to throw my gasoline on the fire --

Why should cap weighting be such a holy grail or standard? It is guaranteed to give you lots of big stocks. Instead you would want to hold different segments of the market in proportions that have historically generated good returns for the amount of risk (volatility) incurred, based on your own preferences for risk and return.

Once you think like this, you'll probably be 'overweight' smaller and vaue sectors, but only because they are so under-represented in the index. It doesn't make them 'bad' or 'less-desirable' asset classes. It would be like comparing the total value of Gold in the world to the total value of Stocks in the world in order to try to figure out how much of each to hold. Instead, hold the proportions in your portfolio that have historically generated the best risk/return performance for your taste.
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:43 PM   #55
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Re: Diversification Sweet Spot

Quote:
Originally Posted by ats5g
So, it could be argued that a 4x25 portfolio, like in the Coffeehouse portfolio, actually weights value + growth, as well as large + small more equally than a TSM fund.
I wonder why you call Coffeehouse a 4x25 portfolio ?

The versions I've seen have 10% each in large, large value, small, small value, and foreign.
Then another 10% in REITs, and 40% in fixed income. They seem to ignore commodity
altogether.

I wonder about ignoring mid-cap altogether, as most simple portfolios seem to do.

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Re: Diversification Sweet Spot
Old 11-14-2006, 12:44 PM   #56
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Re: Diversification Sweet Spot

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Originally Posted by ESRBob
Why should cap weighting be such a holy grail or standard?
It's the mutual-fund equivalent of the human appendix-- an organ that aided digestion and was easily implemented but no longer serves a useful purpose as we've evolved.

I think cap weighting was the best way to deal with limited computing power and made more intuitive sense (better marketing & sales) than the DOW's price weighting. Today it's just waiting to be replaced with something better, although (like the appendix) it's expensive to remove yet can still kill you.
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Re: Diversification Sweet Spot
Old 11-14-2006, 12:46 PM   #57
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Re: Diversification Sweet Spot

Quote:
Originally Posted by Nords
The demise of the small-cap value run has been predicted for at least two of the last four years, but it just hasn't happened yet. Eventually there'll be a reversion to the mean... the trick is figuring out when.
I've tried to figure out why the small-cap value premium would ever end.

I get that small cap value may be "overvalued" today by, say, 25%. I've just assumed that is true, for the sake of argument.

But what is going to happen over the next 30 years? I've read the small cap value premium may be 2%. So the total market grows at 8%, and the SCV grows at 10%. 30 years out, the total market has gone up 906%, while the SCV has gone up 1645%. Even if the SCV drops in value (ie - becomes "fairly valued" over 30 years) by the 25% by which it is currently overvalued, you'd still get a 1209% return in SCV.

In other words, given a sufficiently long period of time to allow compound growth, the premium, if any, you pay for SCV today will be trumped by the higher rate of growth of SCV. Using the numbers I assumed, the breakeven point would be around 15.5 years.

Implicit in this analysis is that the SCV will grow at a rate greater than the total market (primarily the large caps). This premium makes intuitive sense, since it should be easier for a company with $100 million in revenue and a 1-2% market share in their industry to double their revenue and market share than a corporate giant with tens of billions in revenue and a 40% market share.
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Re: Diversification Sweet Spot
Old 11-14-2006, 01:02 PM   #58
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Re: Diversification Sweet Spot

Interesting analysis, Justin.

One more point is that 'small cap' is what most of us would consider to be pretty large companies -- Vanguard's index has a median market cap of 1.6 Billion. It isn't as though owning small caps is like somehow betting on little venture-backed startups or the grocery store down on the corner. I think realizing the size and sophistication of what gets classified as a small cap helps people get comfortable owning more of them.
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Re: Diversification Sweet Spot
Old 11-14-2006, 01:10 PM   #59
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Re: Diversification Sweet Spot

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Originally Posted by justin
I've read the small cap value premium may be 2%.
Your logic seems predicated on this assumption. What if the "premium" is simply an artifact of data mining? In that case, you might expect ScV to underperfom in the future as much as it has recently outperformed the total market.

If the premium really exists, and it hasn't been rationalized away by its wide publicity, then there should be no reason to hold any other asset class, right? 100% ScV for everybody! Hmm, what would that do to the Total Market?
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Re: Diversification Sweet Spot
Old 11-14-2006, 01:42 PM   #60
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Re: Diversification Sweet Spot

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Originally Posted by wab
Your logic seems predicated on this assumption. What if the "premium" is simply an artifact of data mining? In that case, you might expect ScV to underperfom in the future as much as it has recently outperformed the total market.

If the premium really exists, and it hasn't been rationalized away by its wide publicity, then there should be no reason to hold any other asset class, right? 100% ScV for everybody! Hmm, what would that do to the Total Market?
My logic is predicated on the assumption that SCV will grow at a faster rate than total market over the long term. Whether that will hold true, I don't know.

What I'm trying to understand (and rebut) is the argument that "everyone knows about the small and value premium, so it's too late to exploit it". If the small and value segments of the market continue to grow at a faster rate than the market overall, then this continued outperformance year after year will make small and value a better proposition long term, even if the extra cost you pay today gets washed out in a correction to "fairly" value the small and value segments.

Small caps and value indexes are imperfectly correlated to the total market. Basic portfolio theory says that a mix of multiple imperfectly correlated asset classes will have lower volatility than what you would get by taking a simple weighted arithmetic average of the constituent asset classes. The goal of including a tilt towards small and value is to capture those small and value premiums, while at the same time incorporating multiple imperfectly correlated assets with the goal of reducing the overall portfolio volatility.
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