Author Topic: AA by Sectors  (Read 9957 times)

tooqk4u22

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AA by Sectors
« on: May 16, 2013, 10:19:39 AM »
There is a lot of discussion about AA with various iterations but typically including a mix of cash/bonds/equities/REITS/commodities/Gold.  REITs are technically equities but many times it is an accepted individual bucket for AA for good reason. 

But lets focus on the equity part - typical convention is to buy an index fund that is total market or S&P500 - all good.

What about buying sector ETFs for the equity bucket and doing AA by sector, which there are 10 of but REITS fall under the financial sector. 

Pick your mix but lets say spread equally so 10% each then then rebalance by sector. 

Anybody think about this or know of any research - look over the last year the overall market is up but certain sectors have under/overperformed.

grantmeaname

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Re: AA by Sectors
« Reply #1 on: May 16, 2013, 08:50:30 PM »
I'm tired, so I'm reading this a second time -- are you suggesting that the rebalancing between sectors is what would theoretically drive an excess return, not the investor's ability to pick the over- and underperforming sectors specifically?

tooqk4u22

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Re: AA by Sectors
« Reply #2 on: May 17, 2013, 08:17:43 AM »
I'm tired, so I'm reading this a second time -- are you suggesting that the rebalancing between sectors is what would theoretically drive an excess return, not the investor's ability to pick the over- and underperforming sectors specifically?

Yes - I mean that is what I am asking but not sure if it works or not.  So if you invest 10% in each sector (or whatever sector AA that works for you) then each year (or whatever measurement/balancing interval you choose) you rebalance to 10% in each sector.

So here is the mix for the S&P 500 - so if use 10% for each sector you would be equal weighted across sectors vs. being over/underweighted in sectors in the S&P500.   

Consumer Discretionary        11.80%
Consumer Staples                 11.10%
Energy                                   10.60%
Financials                               16.10%
Health Care                           12.60%
Industrials                               9.80%
Information Technology          17.80%
Materials                                   3.40%
Telecommunication Services      3.10%
Utilities                                      3.70%

Roland of Gilead

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Re: AA by Sectors
« Reply #3 on: May 17, 2013, 09:01:44 PM »
not a bad question.  I wonder if rebalancing by sector might work.  There are certainly rotations and cycles in certain sectors.

grantmeaname

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Re: AA by Sectors
« Reply #4 on: May 18, 2013, 07:33:02 AM »
But consumer staples and utilities aren't equally important to our economy -- I'd argue that with 10% in each you're over- and underweighted in sectors, because your proportions are arbitrarily determined by your classification rules. What if you called IT two sectors, hardware and software, and held 9% in each?

rjack

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Re: AA by Sectors
« Reply #5 on: May 18, 2013, 10:35:23 AM »
But consumer staples and utilities aren't equally important to our economy -- I'd argue that with 10% in each you're over- and underweighted in sectors...

Why does being over- or under-weighted matter?

I think his approach could work. Sectors do become over- or under-valued:

http://www.mebanefaber.com/2013/04/16/countries-sectors/

grantmeaname

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Re: AA by Sectors
« Reply #6 on: May 18, 2013, 11:35:02 AM »
Why does being over- or under-weighted matter?
Because it introduces sector risk that you don't have with a broad market index.

rjack

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Re: AA by Sectors
« Reply #7 on: May 18, 2013, 12:10:44 PM »
Why does being over- or under-weighted matter?
Because it introduces sector risk that you don't have with a broad market index.

By analogy, most investors don't weight their stocks based on world market capitalization. They tend to over-weight U.S. stocks. Would you say that all of them are exposing themselves to country risk?

arebelspy

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Re: AA by Sectors
« Reply #8 on: May 18, 2013, 12:13:13 PM »
Why does being over- or under-weighted matter?
Because it introduces sector risk that you don't have with a broad market index.

By analogy, most investors don't weight their stocks based on world market capitalization. They tend to over-weight U.S. stocks. Would you say that all of them are exposing themselves to country risk?

Of course.  How large you think that risk is depends on your thoughts about the future of that country, but clearly if they are overweighting on one country's stocks they are exposing themselves to risks related to that country.
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rjack

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Re: AA by Sectors
« Reply #9 on: May 18, 2013, 01:00:34 PM »
Why does being over- or under-weighted matter?
Because it introduces sector risk that you don't have with a broad market index.

By analogy, most investors don't weight their stocks based on world market capitalization. They tend to over-weight U.S. stocks. Would you say that all of them are exposing themselves to country risk?

Of course.  How large you think that risk is depends on your thoughts about the future of that country, but clearly if they are overweighting on one country's stocks they are exposing themselves to risks related to that country.

I agree and I'm doing a really crappy job of making a point that I'm sure many here will disagree with.

[Rant]
My point is that market cap weighted countries, sectors, or whatever is not necessarily the best approach. Fundamentally weighted may make more sense, but because it will deviate from the cap-weighted returns, it is considered more risky. Deviation from some artificial benchmark like cap-weighted returns does not equal risk - it just equals deviation.
[/Rant]

Sorry for hijacking the thread.

To make up for it and try to get back on the OP question, here is one fund that is using sector allocations based on CAPE weighting of the sector:

http://finance.yahoo.com/q/pr?s=CAPE+Profile

I think this is an interesting approach.



« Last Edit: May 18, 2013, 01:05:29 PM by rjack »

tooqk4u22

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Re: AA by Sectors
« Reply #10 on: May 18, 2013, 01:36:45 PM »
But consumer staples and utilities aren't equally important to our economy -- I'd argue that with 10% in each you're over- and underweighted in sectors, because your proportions are arbitrarily determined by your classification rules. What if you called IT two sectors, hardware and software, and held 9% in each?

That has nothing to do with asset allocation.....buying a total market index is not an AA (well it could be I guess).  PP is an AA (not one I agree with), 60/40 equities/bonds is an AA, some people will choose 25% US, 25% international, 25% bonds, 25% REITs, some will go with just S&P 500 for US and iNternational exposure......point is there are numbers of different ways to approach an AA and how much any one thing accounts for the economy is somewhat irrelavent.   REITS account for very little of the economy, and stock market for that matter, but a lot of people a good with 25% of them in their AA.

I know I keep referring to REITS but that is because that is the most prevelant use of adjusting an AA for a sector. 

grantmeaname

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Re: AA by Sectors
« Reply #11 on: May 18, 2013, 02:58:53 PM »
By analogy, most investors don't weight their stocks based on world market capitalization. They tend to over-weight U.S. stocks. Would you say that all of them are exposing themselves to country risk?
Well, you don't just live in the world, you live in your country. I would think you would want your investment results to be overweight in securities from the country you're living in, relative to the world, if anything.

But yes, I would say that having no international allocation exposes you to country risk. What are you getting at with this analogy?

grantmeaname

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Re: AA by Sectors
« Reply #12 on: May 18, 2013, 03:00:23 PM »
That has nothing to do with asset allocation.....buying a total market index is not an AA (well it could be I guess).
Deliberately choosing to hold 10% of each of 10 artificial categories is an asset allocation, but deliberately choosing to hold each of 10 artificial categories in proportion to their market capitalization is not an asset allocation because Vanguard does it for you?

tooqk4u22

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Re: AA by Sectors
« Reply #13 on: May 18, 2013, 04:45:25 PM »
That has nothing to do with asset allocation.....buying a total market index is not an AA (well it could be I guess).
Deliberately choosing to hold 10% of each of 10 artificial categories is an asset allocation, but deliberately choosing to hold each of 10 artificial categories in proportion to their market capitalization is not an asset allocation because Vanguard does it for you?

First of all they are not artificial...there are actual sectors.  Second of all, as I suggested above, market cap is irrelevant.  Apple was the largest market cap company and account for 3% of S&P 500 and 2.4 % of total US stock market (this is after its fall and rise of broader market).  Personally, I don't like this but according to you I should be ok with this concentration because it is afterall the market cap. 

MMM has an individual AA, JL Collins has his own, there is the PP, and there are many more.....are they all artificial?

Basically it seems you are against it purely because it is an AA you personally don't like.
« Last Edit: May 18, 2013, 04:50:46 PM by tooqk4u22 »

grantmeaname

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Re: AA by Sectors
« Reply #14 on: May 19, 2013, 07:54:15 AM »
First of all they are not artificial...there are actual sectors.
What if I decide that defense is a sector, and food is a sector, and then have twelve sectors with 8% each and so my portfolio weights are dramatically different than yours? What if I decide my old employer, Frisch's Big Boy, with a market cap of $86M, should be a sector? The selection of what's a sector is totally arbitrary and dramatically changes portfolio composition.

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Second of all, as I suggested above, market cap is irrelevant.  Apple was the largest market cap company and account for 3% of S&P 500 and 2.4 % of total US stock market (this is after its fall and rise of broader market). Personally, I don't like this but according to you I should be ok with this concentration because it is afterall the market cap. 
The entire utilities sector is also 3% of the S&P500. Why would you be okay with holding 10% utilities but not okay with holding 3% Apple?

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MMM has an individual AA, JL Collins has his own, there is the PP, and there are many more.....are they all artificial?
Yes, clearly.

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Basically it seems you are against it purely because it is an AA you personally don't like.
No, I'm just not sure what advantages you gain by dramatically overweighting your portfolio in equities for companies in some industries and dramatically underweighting it in equities from other industries, relative to an index, and whether they outweigh the disadvantages.

tooqk4u22

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Re: AA by Sectors
« Reply #15 on: May 19, 2013, 05:37:05 PM »
First of all they are not artificial...there are actual sectors.
What if I decide that defense is a sector, and food is a sector, and then have twelve sectors with 8% each and so my portfolio weights are dramatically different than yours? What if I decide my old employer, Frisch's Big Boy, with a market cap of $86M, should be a sector? The selection of what's a sector is totally arbitrary and dramatically changes portfolio composition.

Sectors are actually defined so there is no grey area, what you are referring to is the industries within the sectors or the companies within the industries. Also there are sector specific funds available from most firms (including vanguard) so clearly some think there may be value in the strategy, but I don't know if it is valid or not


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Second of all, as I suggested above, market cap is irrelevant.  Apple was the largest market cap company and account for 3% of S&P 500 and 2.4 % of total US stock market (this is after its fall and rise of broader market). Personally, I don't like this but according to you I should be ok with this concentration because it is afterall the market cap. 
The entire utilities sector is also 3% of the S&P500. Why would you be okay with holding 10% utilities but not okay with holding 3% Apple?

Why? Because the utilities sector includes hundreds of companies, not just one.


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MMM has an individual AA, JL Collins has his own, there is the PP, and there are many more.....are they all artificial?
Yes, clearly.

So do you view them as foolish?  Also, what would you say is an acceptable AA then that can't be refuted as artificial? Keep in mind that the bond market accounts for about 75% of capital markets and stocks at about 25% therefore by your rationale to be appropriately indexed and weighted based on capitalization you would need an AA of 75% bonds and 25% stocks to match the market.....most would not agree with this but it is another form of AA.

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Basically it seems you are against it purely because it is an AA you personally don't like.
No, I'm just not sure what advantages you gain by dramatically overweighting your portfolio in equities for companies in some industries and dramatically underweighting it in equities from other industries, relative to an index, and whether they outweigh the disadvantages.
[/quote]

Good, you have brought the discussion back on topic, which is are the advantages or disadvantages based on actual data or intelectual perspective. 

grantmeaname

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Re: AA by Sectors
« Reply #16 on: May 19, 2013, 06:09:34 PM »
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Quote
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MMM has an individual AA, JL Collins has his own, there is the PP, and there are many more.....are they all artificial?
Yes, clearly.
So do you view them as foolish?
No, I don't view them as foolish, or I would have described them as foolish. I said they're artificial. That's what I've been getting at since the beginning -- you have ten arbitrary, synthetic categories and membership in the categories is extremely important for the 'appropriate' amount of the company to hold according to the strategy. But there's no reason there aren't nine sectors, or eleven, or fifteen, and not all the sectors are equally important to our economy, as evidenced by their market capitalizations, profits, revenues, number of employees, and countless other metrics. Frisch's just is not as big a company and Proctor and Gamble, even if they both sponsor the symphony!

If your classification scheme is not intrinsic to the market you're studying -- and it should be clear that it's not, since companies can border between two sectors, acquire companies in other sectors, and change their business models -- then why should it outperform any other arbitrary classification scheme, unless you happen to overweight the sectors that outperform going forward and underweight the others?

If I start a mutual fund that only invests in companies whose names start with M, and then the companies whose names start with M outperform the others over the next year, that doesn't mean that the alphabet has deep powers of investment prediction. If I buy a mutual fund with only 40% the financials and three times the utilities, and then utilities outperform, that doesn't demonstrate the virtue of holding each sector in equal amounts. If I buy a mutual fund that overemphasizes mid-caps, then mid-caps outperform, that doesn't mean that the strategy is sound.

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Good, you have brought the discussion back on topic, which is are the advantages or disadvantages based on actual data or intelectual perspective.
That's what I've been trying to discuss since the thread started. So what's with this antagonistic tone I've gotten in return?

tooqk4u22

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Re: AA by Sectors
« Reply #17 on: May 20, 2013, 09:46:54 AM »
Grant - you keep saying that the sectors are arbitrary/artificaial/synthetic but keep missing that they are not - there are actual sectors that are defined based on the companies core operations. But you are correct that companies can change and hand have operations over multiple sectors.

I still don't agree with your view that market cap matters more than anything else and that you have to be perfecly weighted with the overall economy.....did you see my note about bonds vs stocks as far as market cap goes.  Also the S&P 500 only accounts for about 11% of the US economy, yet it is fairly common acceptance to have far more than 11% of your AA in it.

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Good, you have brought the discussion back on topic, which is are the advantages or disadvantages based on actual data or intelectual perspective.
That's what I've been trying to discuss since the thread started. So what's with this antagonistic tone I've gotten in return?

I don't mean to be antagonistic but you seem to be refuting the idea out of hand or based on the notion of the market cap/relevance to the economy matters, but it doesn't and that is not what an AA is meant to achieve. 

At the height, the financial sector accounted for 25-30% of the S&P 500....leading up to that it it would have been good to only have 10% and when the rotation happened to more defensvive stocks you would have been better off, likewise when those heated up you would have rebalanced and picked up some more financials.  That is the premise, no different than a 60/40 equity/bonds AA strategy.  AA is about risk tolerance first and then smoothing it out second.


arebelspy

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Re: AA by Sectors
« Reply #18 on: May 20, 2013, 12:21:24 PM »
Grant - you keep saying that the sectors are arbitrary/artificaial/synthetic but keep missing that they are not - there are actual sectors that are defined based on the companies core operations.

Can you make an argument that this is the case?  How were they chosen?  Why do you think they aren't arbitrary?

I'm just not seeing it, I'm more inclined towards what grant's said, but would love to hear your reasoning on why the sectors were chosen and how it isn't arbitrary..
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tooqk4u22

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Re: AA by Sectors
« Reply #19 on: May 20, 2013, 05:37:22 PM »
Grant - you keep saying that the sectors are arbitrary/artificaial/synthetic but keep missing that they are not - there are actual sectors that are defined based on the companies core operations.

Can you make an argument that this is the case?  How were they chosen?  Why do you think they aren't arbitrary?

I'm just not seeing it, I'm more inclined towards what grant's said, but would love to hear your reasoning on why the sectors were chosen and how it isn't arbitrary..

I must be slow, but I am not sure what you (and Grant) are suggesting.  It seems that you are suggesting that choosing sectors is completely arbitrary and random.  A sector is nothing more than a compilation of similar business operations. I will concede that there may be a bit of abitrary in defining the sectors, but so to is there in everything in life that requires some decision, what makes it a sector/norm/typical/standard is that the approach/view/evaluation/methodology is consistently applied over time.  So if you don't believe that sectors exist or that they are completely arbitrary then your whole life (even total market index investing) must be viewed as abitrary as well.


Here are some sites that break down the sectors:

http://biz.yahoo.com/p/
http://www.sectorspdr.com/
https://personal.vanguard.com/us/funds/etf/all?assetclass=ss&assetclass=ss


I found some views on sector investing, although they seem to be more in the context of timing I think, whereas I am suggesting a fixed allocation that rebalances periodically.

http://www.forbes.com/sites/greatspeculations/2013/01/22/sector-investing-much-smarter-than-trying-to-guess-whats-growth-and-value/

https://www.fidelity.com/viewpoints/how-to-use-business-cycle

http://www.schwab.com/public/schwab/resource_center/expert_insight/todays_market/recent_commentary/schwab_sector_views.html

grantmeaname

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Re: AA by Sectors
« Reply #20 on: May 21, 2013, 06:58:46 AM »
I still don't agree with your view that market cap matters more than anything else and that you have to be perfecly weighted with the overall economy
That's not what I'm saying at all. I said this:
Why does being over- or under-weighted matter?
Because it introduces sector risk that you don't have with a broad market index.
You've got a new risk that you're taking on and I don't see a compelling reason that you can expect a better return because of it, so I don't see how the strategy can possibly increase your risk-adjusted return. That's why I'm asking how the strategy can generate excess returns.

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AA is about risk tolerance first and then smoothing it out second.
Right. I'm not suggesting that everyone should hold the sectors in equal proportion to their market caps because it's what the economy is. I think that's the default because it offers the best return possible with that level of risk.

tooqk4u22

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Re: AA by Sectors
« Reply #21 on: May 22, 2013, 03:17:50 PM »
Because it introduces sector risk that you don't have with a broad market index.
You've got a new risk that you're taking on and I don't see a compelling reason that you can expect a better return because of it, so I don't see how the strategy can possibly increase your risk-adjusted return. That's why I'm asking how the strategy can generate excess returns.
[/quote]

Yeah, but that is no different than determining what the AA amounts between anything (equities vs. bonds, domestic vs. international, emerging markets vs. eurozone, real estate vs. paper assets, gold vs. cash, or any variation or percentage mix thereof) or anything else for that matter, so the answer is not avoiding the risk but understanding them and making an informed decision.   

Because we have cycles and changes in risk appetite I believe there may be value in sector investing just like bonds play a role.

I think that's the default because it offers the best return possible with that level of risk.

The default might be fine but I am not sure that it does (or doesn't) provide the best possible return, but it may be the easiest and therefore the best possible return on effort/energy expended in deciding.   

I think the crux of the problem is that I believe that stocks/markets/sectors/whatever can/have/will be over/under valued at any given time, which you and others would claim to be market timing and you believe more in EMH, which to me is true in the sense that all information is out there and strocks are priced appropriately but a fallacy in that it ignores emotion/valuations/changing sentiment, trends, expecations and whole bunch of other things - EMH is a point in time view not a dynamic view.   To me an AA that includes sector investing might lie in the middle of the two views by giving you the cyclical adjustment (timing) combined with timed rebalancing (EMH).

« Last Edit: May 22, 2013, 03:19:25 PM by tooqk4u22 »

tooqk4u22

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Re: AA by Sectors
« Reply #22 on: May 24, 2013, 01:41:16 PM »
See attached breakdown of SPDR Sector funds, look at bottom of p. 1.  http://www.sectorspdr.com/shared/pdf/SPDR-Periodic-Table-web.pdf

The returns below demonstrate that sector investing is beneficial (at least historically and for the S&P 500).  I showed the Vanguard Total Market returns, which demonstrates that it performs better (again historically) than the S&P500, and if the correlation between plain index strategy vs. sector strategy is the same then that could be even more powerful from a return perspective.

              S&P 500              S&P equal wt sector     Vanguard Total Market
1 year      16.0%                  14.78%                      14.43%
3 year       10.86%               11.23%                       13.04%
5 year       1.66%                   2.67%                       6.55%
10 year      7.09%                  8.69%                       9.42%
Cum          98.58%                 130.3%


grantmeaname

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Re: AA by Sectors
« Reply #23 on: May 25, 2013, 07:46:18 AM »
Yeah, but that is no different than determining what the AA amounts between anything (equities vs. bonds, domestic vs. international, emerging markets vs. eurozone, real estate vs. paper assets, gold vs. cash, or any variation or percentage mix thereof) or anything else for that matter, so the answer is not avoiding the risk but understanding them and making an informed decision.   

Because we have cycles and changes in risk appetite I believe there may be value in sector investing just like bonds play a role.
I entirely agree with this.

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I think the crux of the problem is that I believe that stocks/markets/sectors/whatever can/have/will be over/under valued at any given time, which you and others would claim to be market timing and you believe more in EMH, which to me is true in the sense that all information is out there and strocks are priced appropriately but a fallacy in that it ignores emotion/valuations/changing sentiment, trends, expecations and whole bunch of other things - EMH is a point in time view not a dynamic view.   To me an AA that includes sector investing might lie in the middle of the two views by giving you the cyclical adjustment (timing) combined with timed rebalancing (EMH).
No, I believe that lots of securities are over- and under-valued right now. But neither Mohammed El-Erian nor I know which ones are which, and there are no reliable or effective indicators - that's the EMH.

grantmeaname

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Re: AA by Sectors
« Reply #24 on: May 25, 2013, 07:47:58 AM »
Here's a relevant link I found yesterday, btw: Rick Ferri's Total Economy Portfolio. Like holding more bonds, it does more closely mirror the total economy. But does it provide a better risk-adjusted return, or just a better overall return due to all the small-caps?

tooqk4u22

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Re: AA by Sectors
« Reply #25 on: May 25, 2013, 02:31:41 PM »
Here's a relevant link I found yesterday, btw: Rick Ferri's Total Economy Portfolio. Like holding more bonds, it does more closely mirror the total economy. But does it provide a better risk-adjusted return, or just a better overall return due to all the small-caps?

Thanks for the link, another variation.  I agree with the authors view but not necessarily his approach.

Your question at the end is good and I think, correct me if I am wrong, what you have trying to get at all along.  I don't know the answer but if the overall returns are higher then the benchmark then you would be compensated for the additional risk, but its possible that it is not fully compensated.  This of course assumes that the sector investing is more risky, which I am not conceding that point and I don't think either of us have the data to say one way or the other.