Author Topic: Value weighted indexing - The Big Secret for the Small Investor  (Read 7433 times)

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1621
  • Age: 48
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
I just finished reading Joel Greenblatt's The Big Secret for the Small Investor.  The main point is there are better mousetraps than market cap weighted indexing.  I've long been familiar with equal weight (RSP), and fundamental weight (PRF), but the new "Value Weight" is a mystery to me. 

Anyone have experience with this?  I've done a search for some tickers and it looks like Value/weight is mostly theoretical at this point.  The only thing I can find that seems to fit the bill is VLUE and it has a very short market history.  I'm primarily not an index guy but for the portion I do index, I'd like to use the "best" indexing strategy.

Thoughts from index-cool-aid-drinking hoi polloi??

If I can get my head around these concepts, I smell a blog post coming on.

forummm

  • Walrus Stache
  • *******
  • Posts: 7389
  • Senior Mustachian
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #1 on: July 26, 2015, 03:41:13 PM »
I just finished reading Joel Greenblatt's The Big Secret for the Small Investor.  The main point is there are better mousetraps than market cap weighted indexing.  I've long been familiar with equal weight (RSP), and fundamental weight (PRF), but the new "Value Weight" is a mystery to me. 

Anyone have experience with this?  I've done a search for some tickers and it looks like Value/weight is mostly theoretical at this point.  The only thing I can find that seems to fit the bill is VLUE and it has a very short market history.  I'm primarily not an index guy but for the portion I do index, I'd like to use the "best" indexing strategy.

Thoughts from index-cool-aid-drinking hoi polloi??

If I can get my head around these concepts, I smell a blog post coming on.

Not having read the book, what does "value weight" mean in his definition? It seems like "value" is very subjective.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1621
  • Age: 48
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #2 on: July 26, 2015, 03:50:45 PM »

Not having read the book, what does "value weight" mean in his definition? It seems like "value" is very subjective.

Oh yeah.  Context.  My bad.  There is a whole website dedicated to promoting the idea: http://valueweightedindex.com/

Basically, one or more objective measures are used to weight tickers fitting certain criteria (say russell 2000 for a population).  The cheapest in terms of P/E or P/FCF for example would get the relative highest weights, proportionally.  Back-testing (hindsight would be a great way to invest, no?) seems to indicate strong out-performance versus just buying Russ2k.  (Assuming a long enough period of time.)

I suppose it is moot if no one is actually providing such a vehicle to invest in.

forummm

  • Walrus Stache
  • *******
  • Posts: 7389
  • Senior Mustachian
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #3 on: July 26, 2015, 05:26:43 PM »
It makes sense that value weighted indexing would have superior returns over the last 20 years because value funds have had superior returns during that time frame. But will they going forward? <shrug>

You could do P/E. But some firms have low P/E because they are utilities or otherwise not growing.

Quote
A true value weighted index should weight stocks in the portfolio based on how cheap they appear based on the selected value factors (as opposed to market cap), and rebalance the portfolio toward the cheapest stocks on a regular basis to account for changes in underlying fundamentals and stock price movements.

Oh "selected" (and undisclosed--at least as far as this website goes) "value factors".

And no mention as to whether the transaction costs were accounted for in the analysis that says the backtested strategy outperformed other indexes.

It's an interesting idea. But potentially expensive to implement. And not certain to provide excess returns, especially after costs.

dungoofed

  • Pencil Stache
  • ****
  • Posts: 661
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #4 on: July 27, 2015, 01:35:46 AM »
lol @his websites for each of his books.

ooo a RAFI-killer!

The thing is, with any ETF that uses a proprietary formula they're going to have to pay a licensing fee. And when fees increase not only do you have to make a decision "is it worth risking my capital on?" but you also have to ask "what kickbacks if any does the formula's creator give?"

Jack

  • Magnum Stache
  • ******
  • Posts: 4726
  • Location: Atlanta, GA
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #5 on: July 27, 2015, 02:00:23 AM »
Here's the thing: in large part, the point of index investing is that low expense ratios cause maximum return. How do you get a low expense ratio? By using an algorithm instead of an expensive adviser, but more importantly, by trading as little as possible. How do you trade as little as possible? By cap-weighting the stocks -- any other weighting requires lots of re-balancing every time stocks' values change relative to each other, but cap weighting (by definition) doesn't. Instead, cap weighting only requires trading when stocks enter or exit the index, or when people buy or sell the fund as a whole.

Until I initiated a rollover on Friday, my 401(K) had been invested in an equal-weight S&P 500 fund, VADDX. It had double the expense ratio of (cap-weighted) VFINX -- let alone VFIAX -- and similar-to-worse performance to show for it.

CorpRaider

  • Bristles
  • ***
  • Posts: 439
    • The Corpraider Blog
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #6 on: July 27, 2015, 06:09:57 AM »
MSCI uses the term value weighting in reference to the index underlying VLUE, but if you look into it you will see it is really a RAFI clone (albeit with a lower ER than the RAFI linked fund choices).  The Guggenheim pure value etfs track indexes that weigh exposures based on value characteristics (they also have growth ones), but JG classifies those as traditional value on his site.  His mutual funds seem to implement the strategy, but he's added a long-short aspect.

He uses the magic formula to weight/determine value. 

Not sure about the equal weight problems you've experienced above.  Seems like Vanguard's site indicates RSP (your fund wasn't in the available choices) has outperformed VFINX over 1, 3, 5 and 10 years.  The interesting rebuttal to this from Bogle is that equal weighting is really weighting to a mid-cap exposure.  VO and RSP do track very similarly for sure, but they are comprised of different stocks, exclusively so, if you use the same (S&P here) indexes... 

You're right the secret sauce of indexing is low after tax costs. 
« Last Edit: August 03, 2015, 07:49:13 AM by CorpRaider »

forummm

  • Walrus Stache
  • *******
  • Posts: 7389
  • Senior Mustachian
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #7 on: July 27, 2015, 06:51:20 AM »
Here's the thing: in large part, the point of index investing is that low expense ratios cause maximum return. How do you get a low expense ratio? By using an algorithm instead of an expensive adviser, but more importantly, by trading as little as possible. How do you trade as little as possible? By cap-weighting the stocks -- any other weighting requires lots of re-balancing every time stocks' values change relative to each other, but cap weighting (by definition) doesn't. Instead, cap weighting only requires trading when stocks enter or exit the index, or when people buy or sell the fund as a whole.

Until I initiated a rollover on Friday, my 401(K) had been invested in an equal-weight S&P 500 fund, VADDX. It had double the expense ratio of (cap-weighted) VFINX -- let alone VFIAX -- and similar-to-worse performance to show for it.

Note that the expense ratio is probably the lowest increased expense for this fund. The trading costs (which do not show up in the expense ratio) are probably much higher than VFIAX. I think VFIAX trading costs are about 0.001%. I wouldn't be surprised if the equal weight trading costs were on par with their ER.

Jack

  • Magnum Stache
  • ******
  • Posts: 4726
  • Location: Atlanta, GA
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #8 on: August 03, 2015, 07:45:33 AM »
The trading costs (which do not show up in the expense ratio)

Could you explain how the trading costs don't show up in the expense ratio?

forummm

  • Walrus Stache
  • *******
  • Posts: 7389
  • Senior Mustachian
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #9 on: August 03, 2015, 08:18:31 AM »
The trading costs (which do not show up in the expense ratio)

Could you explain how the trading costs don't show up in the expense ratio?

The ER doesn't include transaction costs such as fees paid to the brokerage house that does the trading, the bid/ask spread, or changes in market pricing due to the firm buying or selling a large number of securities. The tax cost of CGs also don't show up in the ER, but they are distributed to the fund holder so they are transparent in that way.

innerscorecard

  • Pencil Stache
  • ****
  • Posts: 589
    • Inner Scorecard - Where financial independence, value investing and life meet
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #10 on: August 03, 2015, 06:53:23 PM »
Gotham Funds does basically value-weighting indexing, except it adds a lot of complication that makes me not want to invest, like "proprietary data" and shorting. That also makes these funds quite expensive in terms of expense ratio.

I wish he had simply done value-weighted indexing instead, as it is a good idea, but it is not as good of a business.

Why not just buy QVAL and call it a day? I really do think the Magic Formula was Greenblatt at his best.
« Last Edit: August 03, 2015, 06:55:01 PM by innerscorecard »

a1smith

  • Bristles
  • ***
  • Posts: 360
  • Location: 44 15.478N, 082 50.088W
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #11 on: August 03, 2015, 08:15:49 PM »
Here's the thing: in large part, the point of index investing is that low expense ratios cause maximum return. How do you get a low expense ratio? By using an algorithm instead of an expensive adviser, but more importantly, by trading as little as possible. How do you trade as little as possible? By cap-weighting the stocks -- any other weighting requires lots of re-balancing every time stocks' values change relative to each other, but cap weighting (by definition) doesn't. Instead, cap weighting only requires trading when stocks enter or exit the index, or when people buy or sell the fund as a whole.

Until I initiated a rollover on Friday, my 401(K) had been invested in an equal-weight S&P 500 fund, VADDX. It had double the expense ratio of (cap-weighted) VFINX -- let alone VFIAX -- and similar-to-worse performance to show for it.

You can't use price plots to compare total returns for mutual funds due to LT & ST CG payouts, dividend payouts, etc.  If you look at this Morningstar performance page for VADDX you will see it has a better 3yr, 5yr, 10yr,  and 15yr TR than the SP500 TR (which includes dividend payouts).  The 1yr and YTD return is lower but those are short time periods.

CorpRaider

  • Bristles
  • ***
  • Posts: 439
    • The Corpraider Blog
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #12 on: August 04, 2015, 09:41:51 AM »
In my opinion, stock market genius was his best.  It is just a widely followed/implemented strategy now.  It's the book that launched a thousand hedge funds.

hodedofome

  • Handlebar Stache
  • *****
  • Posts: 1384
  • Age: 40
  • Location: Texas
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #13 on: August 04, 2015, 10:21:42 AM »
Why not just buy QVAL and call it a day? I really do think the Magic Formula was Greenblatt at his best.

That's definitely the closest we're probably going to get to a magic formula fund with a reasonable expense ratio. If we want it any cheaper, we'll have to do it ourselves. Honestly, I think we can just rebalance the magic formula stocks once a year (instead of doing the monthly or quarterly thing he proposes) and be done with it. Not that much work, sell losing stocks at the end of December and buy new ones, and sell winning stocks first day of January and buy new ones. Making 30 round trip trades over a few days when you're home for the holidays doesn't sound too bad. It will require some monitoring for stocks that are acquired or delisted however.

innerscorecard

  • Pencil Stache
  • ****
  • Posts: 589
    • Inner Scorecard - Where financial independence, value investing and life meet
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #14 on: August 04, 2015, 03:13:42 PM »
In my opinion, stock market genius was his best.  It is just a widely followed/implemented strategy now.  It's the book that launched a thousand hedge funds.

For CoBF, VIC, or SumZero, sure. For regular individual investors, I think the Magic Formula idea was just so elegant, and more importantly, scalable and persistent (for now).

Why not just buy QVAL and call it a day? I really do think the Magic Formula was Greenblatt at his best.

That's definitely the closest we're probably going to get to a magic formula fund with a reasonable expense ratio. If we want it any cheaper, we'll have to do it ourselves. Honestly, I think we can just rebalance the magic formula stocks once a year (instead of doing the monthly or quarterly thing he proposes) and be done with it. Not that much work, sell losing stocks at the end of December and buy new ones, and sell winning stocks first day of January and buy new ones. Making 30 round trip trades over a few days when you're home for the holidays doesn't sound too bad. It will require some monitoring for stocks that are acquired or delisted however.

Yes, and it's encouraging that QVAL has now crossed the USD 50 million NAV mark. Well, with these things it's odd. You want it to be big enough to survive and allow Wesley Gray and his company to make a good living, but you don't want it to be so big they can't implement their strategy and must compromise. I think it's in a good spot right now and seems to have a good runway.

acroy

  • Handlebar Stache
  • *****
  • Posts: 1699
  • Age: 43
  • Location: Dallas TX
    • SWAMI
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #15 on: August 04, 2015, 03:26:38 PM »
Unfortunately every 'weighed' fund I've looked into has more reasons to avoid than to invest.
For instance QVAL has high expense ratio and is 'actively managed' which means built-in costs, carrying cash, etc.
I really liked the concept of equal weight (RSP and others) but long-term performance, high expense ratio, etc does not make a convincing argument over straight-up index fund.

innerscorecard

  • Pencil Stache
  • ****
  • Posts: 589
    • Inner Scorecard - Where financial independence, value investing and life meet
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #16 on: August 04, 2015, 05:13:49 PM »
QVAL's expense ratio is not high. It is not a weighted index fund. If it were, 0.79% would be high. 0.79% is very low for an active fund, which is what it is.

hodedofome

  • Handlebar Stache
  • *****
  • Posts: 1384
  • Age: 40
  • Location: Texas
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #17 on: August 04, 2015, 06:41:21 PM »
If I had to pick an active fund, I'd rather pick a systematic fund where I know what they are doing, than a discretionary fund that could suffer just because the manager prefers golf over trading these days.


Sent from my iPhone using Tapatalk

innerscorecard

  • Pencil Stache
  • ****
  • Posts: 589
    • Inner Scorecard - Where financial independence, value investing and life meet
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #18 on: August 05, 2015, 01:56:26 AM »
Yes, QVAL is active and systematic - not the same as a stock-picking fund, and also not the same as a tilted index fund.

CorpRaider

  • Bristles
  • ***
  • Posts: 439
    • The Corpraider Blog
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #19 on: August 05, 2015, 06:32:44 AM »
RPV might be a good option for you guys to monitor as well.  I caught a Kiplinger article the other week that indicates that the QVAL sponsor would like to lower the ER as assets grow (no quotes though).  .0079 of $50 Million isn't a ton for a company with several employees and overhead, although I know they run other larger accounts as well.
« Last Edit: August 05, 2015, 06:37:32 AM by CorpRaider »

innerscorecard

  • Pencil Stache
  • ****
  • Posts: 589
    • Inner Scorecard - Where financial independence, value investing and life meet
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #20 on: August 05, 2015, 11:20:00 AM »
Yes, Wesley Gray is pretty Mustachian (see http://blog.alphaarchitect.com/2015/05/29/value-investing-in-a-honda-civic-and-proud-of-it/), but $40,000 a year for a firm with multiple people is not that much!

dungoofed

  • Pencil Stache
  • ****
  • Posts: 661
Re: Value weighted indexing - The Big Secret for the Small Investor
« Reply #21 on: August 05, 2015, 04:23:13 PM »
Well if the fund is systematic then they don't need to keep any of those pesky portfolio managers on the books. Anyone know which broker they use, lo-touch or hi-touch, etc?