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Value tilts - anybody use them?
Old 11-13-2008, 10:16 AM   #1
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Value tilts - anybody use them?

I'm in the process of putting together my investment plan. I originally planned on splitting my US allocation equally among 3 Vanguard ETFs:

VB - small cap ETF
VO - mid cap ETF
VV - large cap ETF

But now I'm considering going the value route on each of the 3 instead:

VBR - small cap value ETF
VOE - mid cap value ETF
VTV - large cap value ETF

The thinking is simply that the dividend yield is significantly higher on the value funds than on the blend funds, and the extra dividends sound awfully appealing.

I realize that if I decide to go this route that I increase my exposure to financials..

Any thoughts?
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Old 11-13-2008, 10:26 AM   #2
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Have you included transaction costs in your computations?

My plan is to average into mutual funds then take the whole amount and transfer it into a similar ETF.
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Old 11-13-2008, 10:31 AM   #3
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Of course I use value tilts. Doesn't everybody? Reasons for all this is described in the asset allocation tutorial: Asset allocation tutorial?
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Old 11-13-2008, 10:45 AM   #4
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I try for 50% value, but a portfolio of three value funds is a landslide not a tilt! Growth is OK once in a while.

You may not get much diversification by using the mid-cap fund. You could try a mid-cap growth or blend to even things up a little.

If you really want to go to extremes, employ the small-cap tilt as well and put it all in the small value fund.

Also look at foreign, real estate, emerging markets, and bonds. If you want to stay simple, try a global fund or a retirement date fund.
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Old 11-13-2008, 11:27 AM   #5
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I tilt as well. As animorph points out you are really tilting. I use essentially a total stock market index fund for the bulk of my domestic allocation and then add a little VBR and VTV to tilt it.

DD
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Old 11-13-2008, 12:06 PM   #6
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I use a value tilt as well. I have never been quite enamored with growth investing and as such I don't own a single pure growth fund. But I do have some growth exposure through blend funds which I supplement with value funds.
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Old 11-13-2008, 12:14 PM   #7
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As pointed out, you are not "tilting" by going all value, you are falling over.

Try something like 60-80% Total Stock Market and 40-20% Small Cap Value to tilt towards Small and Value. These are the two classic tilts rolled into one.
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Old 11-13-2008, 12:15 PM   #8
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I have a slight value tilt. The market is doing its best to un-tilt me, though.

For example there's that ever-tinier amount of Vanguard Windsor in my tiny Roth IRA. Windsor is only 40% of its value back in July, 2007. Pretty soon my Windsor shares will be worth less than the minimum, so this is not so tragic as it sounds. But some day I would like for them to grow a little!!
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Old 11-13-2008, 05:57 PM   #9
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At this point, there may not be much difference between growth and value stocks. Intel is now at P/E of 11, and pays 4%. Next year earning is sure to drop, bringing P/E up and reducing dividend. Still, I'd rather buy Intel than any of the stinkin' financials.

Yep, last year the financials made up 25% of S&P 500. Could you believe that? A quarter of the US equities was based on businesses that acted as middle men, shuffling money around. Call me old-fashioned but I think that although middle men are necessary, there is no need for so many. No wonder we got in trouble.
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Old 11-13-2008, 11:09 PM   #10
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I've been thinking about this a bit lately. From what I understand the French Fama model specifies 3 factors which explain most of a portfolio's market returns: exposure to market, small and value. Exposure to market generally equals 1 if you are in equity funds (as opposed to bonds). Some who have done the calculations say that large cap value (like Vanguard's VIVAX) give you value exposure but a slight negative small cap exposure. Midcap value may be the best way to get both value and small exposure (at least not negative small cap exposure). Then couple this with small cap value. One should stay away from small cap growth as it is notorious for disappointing over the long haul (not necessarily in a given year, of course).

There is supposedly a value and small cap premium but it is not easy or practical to time this. HOWEVER, there is extra risk in seeking to capture this premium. The extra risk is thought to show up in particularly strained economic market environments. So you have to decide whether you have a "need to take" this risk. Anyway, that is as far as I've thought this out so far. Recently my risk appetite has receded.

P.S. I like Vanguard Primecap for large cap growth-at-a-reasonable-price exposure. Has worked so far although it is actively managed. Has a lowish ER = .31% for admiral class.
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Old 11-14-2008, 10:51 AM   #11
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Indexes like the S&P 500 tilt growth, due to growth stocks' larger than average P/E. I want a value tilt -- some growth, more value -- so I pair each "plain" index with a corresponding value index, where one is available, and put equal amounts into each. An investor seeking more balance might put, say, 1/2 as much into the corresponding value index.

I agree with NW-Bound that the difference between growth and value is a lot less now than it used to be. For example:

Vanguard S&P 500 (VFINX) p/e = 14.8 yield = 2.76%
Vanguard Value (VIVAX) p/e = 13.8 yield = 3.89%
(according to vanguard.com)
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Old 11-14-2008, 03:14 PM   #12
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Quote:
Originally Posted by lsbcal View Post
There is supposedly a value and small cap premium but it is not easy or practical to time this. HOWEVER, there is extra risk in seeking to capture this premium. The extra risk is thought to show up in particularly strained economic market environments. So you have to decide whether you have a "need to take" this risk. Anyway, that is as far as I've thought this out so far. Recently my risk appetite has receded.
I like to think about as "can I take on the risks associated with small and value stocks?" and "How are the risks associated with small and value stocks correlated with the risks to my job/income?"

- Alec
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Old 11-14-2008, 04:28 PM   #13
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Originally Posted by ats5g View Post
I like to think about as "can I take on the risks associated with small and value stocks?" and "How are the risks associated with small and value stocks correlated with the risks to my job/income?"

- Alec
For those of us in retirement we only have the first question to answer. Unfortunately, I don't know how to quantify those risks. Are we talking about increased volatility or potential for permanent losses? Over what periods? If I'm retired and want to enjoy the age 60 to 70 decade by spending at X% of my portfolio, should I be accepting higher risks now? I have not really seen any analysis that helps me answer "yes" to accepting this risk.

Smart people who have discussed biasing towards small and value say you should have a high tolerance for tracking error. Put another way, if my portfolio has negative tracking error over the years when I'm 60 to 70 what good is it to me if the portfolio recovers when I'm possibly slowing down from 70 to 80? If you are 30 or 40 the picture is different.

Any insights on this are welcome.
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Old 11-15-2008, 08:45 AM   #14
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For those of us in retirement we only have the first question to answer. Unfortunately, I don't know how to quantify those risks. Are we talking about increased volatility or potential for permanent losses? Over what periods?
There are those who think that the value premiums are from behavioral biases, like the guys at LSV. Two [fairly] recent papers from John Campbell at Harvard has an interesting take on the value anomaly:

Bad beta, Good Beta

Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns. [see also Fundamentals and Systematic Risk in Stock Returns].

Quote:
If I'm retired and want to enjoy the age 60 to 70 decade by spending at X% of my portfolio, should I be accepting higher risks now? I have not really seen any analysis that helps me answer "yes" to accepting this risk.

Smart people who have discussed biasing towards small and value say you should have a high tolerance for tracking error. Put another way, if my portfolio has negative tracking error over the years when I'm 60 to 70 what good is it to me if the portfolio recovers when I'm possibly slowing down from 70 to 80? If you are 30 or 40 the picture is different.
IIRC, Larry Kotlikoff has suggested that people within a few years of retirement and in the first few years of retirement should take as little risk as possible. A series of bad returns can permanently reduce your standard of living/income in retirement and you'd have very little wiggle room [either working longer or saving more] to overcome this. Milevsky calls this the "sequence of returns."

Quote:
Any insights on this are welcome.
See Portfolio advice for a multifactor world

Quote:
What are your risks?

Would you be willing to trade some average return in order to make sure that your portfolio does well in particular circumstances? For example, an investor who owns a small company would not want his investment portfolio to do poorly at the same time that his industry suffers a downturn, that there is a recession, or a credit crunch, or that the industries he sells to suffer a downturn. Thus, it makes good sense for him to avoid stocks in the same industry or downstream industries, or stocks that are particularly sensitive to recessions or credit crunches, or even to short them if possible. This strategy would make sense even if these stocks give high average returns, like the value portfolios. Similarly, he should avoid high yield bonds that will all do badly in a credit crunch. If the company will do poorly in response to increases in interest rates, oil prices or similar events, and if the company does not hedge these risks, then the investor should take positions in interest rate sensitive or oil-price sensitive securities to offset those risks as well. We’re just extending the principles behind fire and casualty insurance to investment portfolios.

This logic extends beyond the kind of factors (size, book to market, and so on) that have attracted academic attention. It applies to any identifiable movement in asset portfolios. For example, industry portfolios are not badly explained by the CAPM, as they all seem to have about the same average return. Therefore, they do not show up in multifactor models. However, shorting your industry portfolio protects you against the risks of your occupation. In fact, factors that do not carry unusual risk premiums are even better opportunities than the priced factors that attract attention, since you buy insurance at zero premium. This was always true, even in the CAPM, unpredictable return view. I think that the experience with multifactor models just increases our awareness of how important this issue is.

What are not your risks?

Next, figure out what risks you do not face, but that give rise to an average return premium in the market because most other investors do face these risks. For example, an investor who has no other source of income beyond his investment portfolio does not particularly care about recessions. Therefore, he should buy extra amounts of recessionsensitive stocks, value stocks, high yield bonds, etc., if these strategies carry a credible high average return. This action works just like selling insurance, in return for a premium. This is the type of investor for whom all the portfolio advice is well worked out.

In my opinion, too many investors think they are in this class. The extra factors and time-varying returns would not be there (and will quickly disappear in the future) if lots of people were willing and able to take them. The presence of multiple factors wakes us up to the possibility that we, like the average investor, may be exposed to extra risks, possibly without realizing it.
- Alec
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Old 11-15-2008, 10:27 AM   #15
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Alec, thanks for your thoughts. I'm not too enamored of reading some of the academic papers although some of the conclusions are useful. What I find more interesting is looking at past market behavior of various market segments. Some of this data is nicely compiled in the Simba spreadsheet at the Bogleheads site for years 1972 to present. It shows some of the yearly variations and CAGR's (compound annual growth rates) for various segments. I think this is a great resource, link is here: Bogleheads :: View topic - Spreadsheet for backtesting (includes TrevH's data)

I've also looked at the French-Fama data and done a little munging of it in spreadsheets but not reached any really useful conclusions. Still cannot convince myself that a value tilt is a good way to go given our circumstances. I am sort of convinced that value tilting the small caps is a good idea and so do it with VISVX as my only direct small cap investment. That is partly based on Bertstein's article here: Efficient Frontier

From the data I've fashioned a portfolio I think I can live with for awhile. It is sliced and diced with a distribution not too far off of total stock market but with a few wrinkles thrown in which backtest OK to better then the straight TSM (for the US component). It is a hybrid approach split about 50/50 with active/passive but still the ER=.21%. It will definitely not satisfy the purests but I have to live with the results.
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Old 11-15-2008, 11:52 AM   #16
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Here's another quote from the Cochrane article:

Quote:
Do not forget, the average investor holds the market. If you’re pretty much average, all this thought will lead you right back to holding the market index. To rationalize anything but the market portfolio, you have to be different from the average investor in some identifiable way. The average investor sees some risk in value stocks that counteracts their attractive average returns. Maybe you should too!...
The way you're supposed to get a value tilt is to start with the TSM and then tilt towards or away from small and value. If you want both, then a small value fund does both at the same time. Also, IIRC, the value premium was the highest in small caps vs. large caps.

- Alec
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Old 11-15-2008, 04:35 PM   #17
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I tilt my large cap towards value- then am "even" in mid cap and small cap.

My logic is this-I use managed funds- and my fund manager has a history of buying growth issues (like MSFT, ORCL an INTL) when market drops- meaning it holds growth issues when it can buy on dips.

Rest of portfolio is evenly split because that effect is less evident on mid and small caps.

Funds are
prfdx (t rowe equity income) for large cap
rpmgx (t rowe mid cap growth) for mid cap
prsvx an prnhx (t rowe small cap value and t rowe new horizons) for small cap
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Old 11-15-2008, 04:51 PM   #18
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I tilt my large cap towards value- then am "even" in mid cap and small cap.

My logic is this-I use managed funds- and my fund manager has a history of buying growth issues (like MSFT, ORCL an INTL) when market drops- meaning it holds growth issues when it can buy on dips....
In large caps I've done a similiar thing but not aimed it towards a value tilt. I balance growth holdings in Vanguard Primecap with Vanguard Large Value Index VIVAX. VIVAX 10 top holdings (36%) are:
1 ExxonMobil Corp.
2 General Electric Co.
3 Johnson & Johnson
4 AT&T Inc.
5 Chevron Corp.
6 JPMorgan Chase & Co.
7 Pfizer Inc.
8 Bank of America Corp.
9 Wells Fargo & Co.
10 Philip Morris International Inc

Doesn't sound like stuff that is exactly on the edge does it?
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