Bias toward small cap and value - how much?

[Maurice]

Question for the index-investing asset allocators out there.

Of your US allocation, what % do you have in small vs large, and what % is value vs. growth/market?

I have a bit of a value bias (compared to buying total market) but I'm considering titling that way even more. Same with small (and small value).

Keep in mind, I'm relatively young (39) and can tolerate some extra vol.

 

[tightasadrum]

I don't have a clue about small cap. But I haven't deliberately bought any small cap, but I'm sure some of the funds I own have some. Now I do have some emerging market ETF, but that's probably less than 3%. I may increase that over time. OH, Value fund is at about 4%.

 

[Rich_by_the_Bay]

John Bogle in his "Common Sense" book is lukewarm about both small and value tilts. He acknowledges that they have an historic edge over the TSM but implies that this is no more predictive of future cycles than any other kind of tilt.

He's pretty much a total market guy still.

 

[ziggy29]

Personally I think there is enough noncorrelation between large caps and small caps that I prefer to own them as separate asset classes instead of a "total market" fund which is generally cap-weighted and thus 90-95% large cap.

Out of my U.S. equities allocation, about 2/3 is large cap and 1/3 is small cap and mid cap. This is much heavier in small caps than a cap-weighted total market index. From 2001 to 2006, this proved to be a major boost to my return (especially in '01 through '03). In 2007 and so far in 2008, it is an impediment.

 

[Rich_by_the_Bay]

Out of my U.S. equities allocation, about 2/3 is large cap and 1/3 is small cap and mid cap. This is much heavier in small caps than a cap-weighted total market index. From 2001 to 2006, this proved to be a major boost to my return (especially in '01 through '03). In 2007 and so far in 2008, it is an impediment.

Yep, I think that was Bogle's point. I guess if you anticipated withdrawals in the next 5 years the tilt may increase your odds of having something doing well at that time to take from. If you're letting it run for 10-15 years, it probably doesn't much matter.

 

[Spanky]

U.S. allocation:
1/4 large growth
1/4 large value
1/4 small growth
1/4 small value

 

[jIMOh]

I'm not an index investor, by any stretch. If I get to choose between managed and index, I'll go with managed more times than not.

That being said, the TSM is about 75% large cap, and 25% "other" (mid and small), correct?

There is a clear benefit, in my portfolio to owning pure mid caps and pure small caps. I have also seen a huge edge to small value over time (based on experience of investing for 11 years). One issue though is most small cap funds which are good close before they get to big. Managed ones at least.

My domestic mid cap fund was my best performing fund of 2007 on the domestic side. A couple of my international funds beat it, but none of my domestic stock or bonds funds even came close.

RPMGX was the mid cap fund (don't get too excited- it is closed to new investors). 17% return for 2007.

I believe their is a significant gain holding small caps, and tilting towards value. Most of my portfolio is value oriented to begin with. I sprinkle on some growth, but at this time not much.

 

[Maurice]

THanks for the replies, everyone.

Spanky - thats where I'm headed too, I think - 25/25/25/25.

 

[TickTock]

Relative weights of US equity AA:

Total Stock Market 1.5
Large Value 1.5
Small 1.5
Small Value 1.5
REIT 1.0

 

[Retire Soon]

John Bogle in his "Common Sense" book is lukewarm about both small and value tilts. He acknowledges that they have an historic edge over the TSM but implies that this is no more predictive of future cycles than any other kind of tilt.

He's pretty much a total market guy still.

I agree with this post. I place my trust in John Bogle. Vanguard Total Stock Market Index is the way to go as this fund represents the broader market in its entirety. Any other allocation and you may end up zigging when you should have zagged. The cost of being wrong can be enormous.

 

[Maurice]

I agree with the post too, in that it accurately describes Bogle's view.

My own view, though, is that I'll do better over time with more of a value and small market tilt. The evidence points that way, and the theoretical basis for it seems pretty solid as well.

 

[Rich_by_the_Bay]

I agree with the post too, in that it accurately describes Bogle's view.

My own view, though, is that I'll do better over time with more of a value and small market tilt. The evidence points that way, and the theoretical basis for it seems pretty solid as well.

I have no disagreement with your strategy, but for me the evidence reflects "cycles" -- only time will tell. Really, a small or value tilt may be just another form of market timing, albeit on a macro scale. And the TSM will track small and value as they grow in any event.

Speculation and philosophy either way. I am not looking for an edge, just a fair stake in the market. May we all win.

 

[ats5g]

You can check out Bogle's more recent views of small/value tilting at The Telltale Chart.

In any event, place me squarely in the camp of the contrarians who don't accept the inherent superiority of value strategies over growth strategies. I've been excoriated for my views, but I'm comforted by this reported exchange between Dr. Fama and a participant at a recent investment conference: "What do you say to otherwise intelligent people like Jack Bogle who examine this same data and conclude that there is no size or value premium?" His response: "How far are they from the slide? If I get far enough away, I don't see it either . . . Whether you decide to tilt towards value depends on whether you are willing to bear the associated risk . . . The market portfolio is always efficient . . . For most people, the market portfolio is the most sensible decision." Amen!

Also, I'm not real sure how stable any small or value premia were, or will be in the future. The value premium has definitely been more stable than the small premium. As for me, if I could I'd start with the TSM, and then tilt with a sv index fund until I got the tilt I wanted. But because of retirement plan limitations, I'm just doing a value tilt for now. Smartly, or luckily, my choice of very high quality fixed income [TIPS and VBMFX] nicely offset the recent tanking of my value fund(s).

Edited to add: you should also think about if a value or small tilt could actually be riskier for you personally. For example, you don't want small and/or value to be doing terrible when you could lose your job. Likewise, for all those people that that work(ed) in high tech, their job security was very exposed to similar risks to which growth/tech companies and their stocks were exposed.

- Alec

 

[TromboneAl]

Here's mine, and the Vanguard Robot's opinion of it:

 

[W2R]

I have read in several articles that small caps often do poorly in a recession since it is more likely for a small business to just fold when stressed. The idea is that large caps often do better in a recession, depending on inflation.

Not that I'd figure my AA depending on that, but maybe that explains Bogle's views despite how well small caps have done during some years.

Trying to learn... (thanks for your patience)

Comments?

There are a million articles that seem to imply this, but a couple of them are
Cracking The Small-Cap Code - Forbes.com and
http://www.wachoviasec.com/wachoviasec/WSICommentary/mktcomm09-10-07.pdf

 

[FinanceDude]

I almost never change my AA on small cap and mid cap:

Small cap 15%
Mid cap 15%

I play around a lot more with large cap and global/intl

When the market rebounded from October 2002 to 2005, my small cap and mid caps dragged my portfolio back to even and above faster than anything else.

 

[LOL!]

A small or value tilt is any percentages of small and/or value that are more than the total market weights. From the http://www.early-retirement.org/forums/f28/asset-allocation-tutorial-31324-4.html#post580844 thread, one can see what the Morningstar 9-box style grid looks like for a 'total market' and also for a DFA-style fully-tilted small/value portfolios.

A total market weight appears to have 72% large, 19% mid and 9% small cap.

Anyways, take a look at the link which has specific numbers. You can plug in your own funds into the M* X-ray analysis tool to get your own numbers.

Our portfolio has numbers somewhere in between the total market and the fully-tilted portfolios. What are your numbers?

 

[innova]

More info on this (I love this topic).

It seems not to matter how one gets their tilts. The prevailing theory is that value and small companies are riskier, so if you have two portfolios with the same 'factor loadings' to value and small you should have the same expected return.

In my case, I use only TSM / SV in order to keep things simpler.

There is a lot written about the persistance of small and value premia. Keep in mind that its not guaranteed (otherwise there would be no return premium because there would not be any additional risk), and it may take 10+ years to show up.

It really boils down to how tolerant you are of tracking error, that is, how your investment deviates from your benchmark or market returns. Tilting to S/V will give you a portfolio that acts very differently than the market as a whole, and for a lot of folks it is too gut-wrenching to earn 10% while large growth is on a tear earning 20% per year.

RodC over at the diehards forum is quite the data guy, and he's put together a tracking error study comparing several tilting strategies versus TSM. It gives you a good idea of what to expect from a tilting strategy.
Bogleheads :: View topic - slice and dice tracking error study

 

[Nords]

...a tracking error study comparing several tilting strategies versus TSM.

Tracking error is only an "error" if it reduces your returns.

Imagine if our "indexes" were equal-weighted or fundamentally-weighted instead of cap-weighted.

I remember a study several years ago claiming that the collective returns of the S&P 500, midcap 400, & smallcap 600 outweighed the TSM returns of the S&P1500. It'd be interesting to see a followup.

 

[innova]

Tracking error is only an "error" if it reduces your returns.

Well, not by the actual definition - but I do welcome positive error at any time!

I recall reading that same piece. I'll see if I can find it over at the diehards forums. One explanation that comes to mind is the rebalancing bonus (albeit small) that one would get by holding the parts of the TSM individually rather than the TSM as a whole.

 

[FIREd]

I am about 2/3 Large caps, 1/3 mid and small caps. About 52% value, 48% growth. Pretty close to the Wilshire 5000's composition but with a slight small cap/value tilt.

According to Mornigstar X-ray tool, the break down is as follow:

 

[Spanky]

Of your US allocation, what % do you have in small vs large, and what % is value vs. growth/market?

25% Large growth
25% Large value
25% Small growth
25% Small value

 

[megacorp-firee]

25% Large growth
25% Large value
25% Small growth
25% Small value

Could you give the specific stocks or indices please.
Thanks.

 

[chinaco]

We are 70% stock 30% fixed.

Of the stock allocation, we are a bit heavy domestic large cap. Approximately 45% holdings are in domestic Large Cap (Blend) equity. about 15% is in small and mid cap domestic mix of growth/blend.
10% is foreign.

I am intending to move a bit more of the domestic LC to foreign equity (approx 5% - 10%). But I will move it gradually over several years (5 years). I no longer make big moves all at once if I can avoid it.

My target is:

40% Bonds/fixed
25% Domestic LC
10% Domestic MC
10% Domestic SC
15% Foreign (5% emerging markets) Might adjust down domestic LC/MC/SM and make foreign 20%. But for now I am targeting a boost of 5%.

Most of the reallocations will happen in tax deferred accounts.

 

[Spanky]

Could you give the specific stocks or indices please.
Thanks.

Vanguard 500 Index (VFINX) Vanguard Value Index (VIVAX) Vanguard Small Cap Index (NAESX) Vanguard Small Cap Value Index (VISVX)