Author Topic: Getting greater risk exposure with index funds  (Read 1376 times)

Gateau

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Getting greater risk exposure with index funds
« on: September 13, 2020, 01:45:02 PM »
Hi Guys,

Just a quick question about tuning the risk exposure of my index fund portfolio.

I am currently 100% in global all cap index funds. For a few reasons (namely, that I have housing security, income security and the desire to work in my chosen profession for the next 10 years) I find that I would like to get a greater risk exposure in my portfolio.

I am considering shifting the distribution of my portfolio to 70% global all-cap and 30% global small-cap.

I am pretty limited in my investing knowledge and have tended to prefer 'set it and forget it' approaches.

What do you guys think? Is this daft? Is there a better way to increase my risk exposure than small caps?

Thanks in advance!

Geraint

Retire-Canada

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Re: Getting greater risk exposure with index funds
« Reply #1 on: September 14, 2020, 10:18:04 AM »
If you want more risk you can always use leverage to get it and stay in index funds. How much leverage and what type will determine the level of risk you are adding.

Heckler

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Re: Getting greater risk exposure with index funds
« Reply #2 on: September 14, 2020, 01:46:46 PM »
why is small cap riskier?

https://www.callan.com/wp-content/uploads/2020/01/Classic-Periodic-Table.pdf

Because in a 19 year history, it's only ranked #1 in asset classes twice.

Annual positions for small caps in the above Asset Class Periodic table, sorted for 1 (best performance) to 9 (worst):

1, 1,
2, 2,
4, 4, 4, 4, 4, 4, 4,
5, 5, 5,
6, 6,
7,
8, 8

bacchi

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Re: Getting greater risk exposure with index funds
« Reply #3 on: September 14, 2020, 02:03:30 PM »
why is small cap riskier?

https://www.callan.com/wp-content/uploads/2020/01/Classic-Periodic-Table.pdf

Because in a 19 year history, it's only ranked #1 in asset classes twice.

Annual positions for small caps in the above Asset Class Periodic table, sorted for 1 (best performance) to 9 (worst):

1, 1,
2, 2,
4, 4, 4, 4, 4, 4, 4,
5, 5, 5,
6, 6,
7,
8, 8

3 times for US small cap: 2010, 13, and 16.

US large cap isn't much better

2015, 2019
2013, 2014
2016, 2017
2005, 2011
2006, 2007, 2010, 2012, 2018
2003, 2008, 2009
2000, 2004
2001
2002

That's not global SC, though, which is what the OP wants to do.

Buffaloski Boris

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Re: Getting greater risk exposure with index funds
« Reply #4 on: September 27, 2020, 10:01:44 AM »
Iím looking at this from a different perspective: is adding more risk necessarily going to provide better return?  None of us really know what the stock markets are going to do. But we can look at history. Has the different allocation been back tested on say portfoliocharts?

So does adding international small cap really improve the expected return? Does it help to diversify? If the answers arenít yes, then why bother?

(I have a pretty good idea of the answer, and am a big fan of international, but I think itís good to get into the habit of looking.)
« Last Edit: September 27, 2020, 10:07:45 AM by Buffaloski Boris »

dondon

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Re: Getting greater risk exposure with index funds
« Reply #5 on: September 29, 2020, 06:00:42 PM »

I am considering shifting the distribution of my portfolio to 70% global all-cap and 30% global small-cap.


There are two assumptions there:
  • Small-casp are more risky and
  • More risk = better returns.

If we assume that risk = volatility (which is the academic definition of risk and a whole other "can of worms") than you can say that small-caps are more volatile and therefore more risky.
But in order to get advantage of this "More risk = better returns" part of the equation, you have to be able to capture that volatility and that means you will have to be more active with the "more risky" part of your portfolio.

ChpBstrd

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Re: Getting greater risk exposure with index funds
« Reply #6 on: September 30, 2020, 08:00:55 AM »

I am considering shifting the distribution of my portfolio to 70% global all-cap and 30% global small-cap.


There are two assumptions there:
  • Small-casp are more risky and
  • More risk = better returns.

If we assume that risk = volatility (which is the academic definition of risk and a whole other "can of worms") than you can say that small-caps are more volatile and therefore more risky.
But in order to get advantage of this "More risk = better returns" part of the equation, you have to be able to capture that volatility and that means you will have to be more active with the "more risky" part of your portfolio.

^These are good points. The world is full of risky investments with no rationale for being higher-returning.

I'll add that academics also split the concept of investment risk into 2 parts: systemic and asystemic. Systemic is the risk that the whole market loses value. Asystemic is the risk that something bad happens to a particular investment or company, such as if Ford(F) announces a multi-billion dollar recall, or Facebook(FB) is taxed and regulated out of the EU.

In your diversified global index fund, you have mitigated the risk of any particular misfortune at any particular company blowing up your portfolio. However, your index fund will never beat the index. To beat the index, you would have to make a concentrated bet on particular sectors, countries, companies, etc. and also win that bet. Thus, the adoption of asystemic risk would seem to be required to beat the index. It is a gamble whether the particular asystemic risks you choose will end up benefiting or burning you.

There is one other way to outperform the index, and that is by gambling with options. For example, you could sell covered calls on your index fund and *probably* beat the index by 1% per year, but *possibly* underperform by several percent if the index rallies hard. Technically this is not the adoption of asystemic risk, it is the transfer of systemic risk from one market outcome to another. In other words, selling some of your potential upside in exchange for cash-in-hand.

On the flip side, you could also allocate some funds to buying call options. You could, for example, get 10:1 leverage on most of the upside of the index, while risking only a small percentage of your portfolio - the amount paid for the options. A portfolio with 100 shares of the index fund and 1 call option contract controlling 100 shares of the index fund is similar to a portfolio with 200 shares, but requires a much smaller investment.

cool7hand

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Re: Getting greater risk exposure with index funds
« Reply #7 on: September 30, 2020, 08:23:05 AM »
I tend to think first about how not to lose what I already have, but I think Bridgewater can explain why better than I can: https://www.bridgewater.com/research-and-insights/the-all-weather-story.

shinn497

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Re: Getting greater risk exposure with index funds
« Reply #8 on: October 02, 2020, 07:37:16 AM »
I am small cap weighted. Now and for forever. I say do it! Also don't forget about Value.

dondon

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Re: Getting greater risk exposure with index funds
« Reply #9 on: October 04, 2020, 11:20:45 PM »

In your diversified global index fund, you have mitigated the risk of any particular misfortune at any particular company blowing up your portfolio. However, your index fund will never beat the index. To beat the index, you would have to make a concentrated bet on particular sectors, countries, companies, etc. and also win that bet. Thus, the adoption of asystemic risk would seem to be required to beat the index. It is a gamble whether the particular asystemic risks you choose will end up benefiting or burning you.

There is one other way to outperform the index, and that is by gambling with options. For example, you could sell covered calls on your index fund and *probably* beat the index by 1% per year, but *possibly* underperform by several percent if the index rallies hard. Technically this is not the adoption of asystemic risk, it is the transfer of systemic risk from one market outcome to another. In other words, selling some of your potential upside in exchange for cash-in-hand.

On the flip side, you could also allocate some funds to buying call options. You could, for example, get 10:1 leverage on most of the upside of the index, while risking only a small percentage of your portfolio - the amount paid for the options. A portfolio with 100 shares of the index fund and 1 call option contract controlling 100 shares of the index fund is similar to a portfolio with 200 shares, but requires a much smaller investment.

This is pretty much how I run my portfolio. I have larger diversified portfolio (90-93% of capital) where I try to minimise risk/volatility and diversify not only among stocks but also across asset classes (for the "systemic" risks") and I have small speculative portfolio (7-10%) where I take "bets" in form of options and (usually momentum) single stocks selection. I only buy options though, I'm not a fan of the short volatility trades. Running the small-speculative portfolio is definitely not a"set it and forget it" type of investment though :)