Why does the Dividend Aristocrats Index beat the S&P 500?

[Dodge]

The thread is predicated on the following chart, asking why the white line beats the orange line:



Upon inspection, the white line soars above the orange line in 2014, and both lines represent total return:



Next, for comparison, I showed the total return in 2014 of two actual funds which follow these indexes, and we see one does not soar over the other:



It's a rather small bump, not soaring.  In fact, if we look at the fund which tracks the Dividend Aristocrats, from its inception to today, it's actually lagging the fund which tracks the S&P500:



All charts in this post are total return charts.  Indeed, there is a growing gap that can't be explained by the the expense ratio, or by reinvesting dividends, because they are already included here.

At this point I'm genuinely curious.  Why can't the dramatic outperformance of the Dividend Aristocrats Index be replicated in the real world?

[Dodge]

No comment on the Dividend Aristocrats, but I am surprised that a user would be able to delete their entire thread and have all the replies disappear along with it.  That's a strange configuration for a public forum.

Me too.  I thought it would get a "Moved to Graveyard" tag, with the link still active.  That's how it typically has worked for me anyway.

Yeah. I thought we learned some stuff on the thread that others may have benefitted from learning as well.

FYI: The thread is back, but locked:

http://forum.mrmoneymustache.com/investor-alley/survivorship-bias-the-single-greatest-fallacy-in-investing/

[index]

Dodge,

I don't know what you are trying to disprove. Sure I don't know why you are unable to reconcile the two charts for 2014. The TR aristocrat index returned 15.93% in 2014 the TR S&P 500 returned 14.13%. Over three years the Div Aristocrat index beats the S&P total return by ~2.5% annualized according to Google Finance and the S&P's website. Over ten years it beats the S&P 500 TR by 2.6% according to the S&P's website. Over 26 years the index out-performs by 2.62% according to Bloomberg.

These are the hard numbers.

You seem to be stuck on laying two charts that have a greatly exaggerated 3*Y to X scale on top of each other. Stop trying to draw pictures and ask yourself why this ~2.5-2.6% out-performance is occurring.   

[skyrefuge]

My problem with cap weighting is it essentially forces you to buy high when you are adding money. For example, during the tech boom in 1999-2000 as tech companies became more and more valuable your contributions to a float/cap weighted index fund bought larger and larger proportions of the high flying tech companies as they grew.

1) Sure, to believe in the value of cap-weighted indexing, you must first believe in the power of harnessing the wisdom of markets. Sometimes that market wisdom is proven wrong by the passage of time, as it was in the tech bubble. That doesn't mean it wasn't the best available guess at the time the guess was made. And a wise man who is sometimes wrong is only worthless if you know a wiser man who is never wrong. An equal-weight index says "I'm not going to use any wisdom at all; the fact that I'm indexing shows that I don't care about any single analyst/manger's wisdom, and the fact that I'm not cap-weighting shows that I don't even care about the collective wisdom of market participants". Who knows, maybe the completely-blind distribution of your money into an equal-weight index is better than using market wisdom to determine that distribution, but that goes even further than a "nobody knows nuthin'" belief into a "seeing is worse than being blind" belief.

2) The "buy high" effect of a cap-weighted index is countered by the "sell high" effect.

[skyrefuge]

Upon inspection, the white line soars above the orange line in 2014, and both lines represent total return:

It's because that chart has a linear Y-axis, not logarithmic. Both lines increased by a similar percentage in 2014, but since the white line started near 1500 while the red line started near 750, the white line will rise twice as much for the same percentage increase. In other words, it's not a valid comparison to just drag one line down to the Y-value of the other.

Morningstar uses log charts, so the differences (particularly over long timeframes) will look smaller there than they do on a linear chart. Google allows you to switch between log and linear.

[Indexer]

The point is Vanguard has money. It is not a charity. Vanguard is still a business. The founder, Bogle, has a responsibility to the company to promote their product.

You got the chicken and the egg backwards here.  Bogle was preaching low cost index funds long before he founded Vanguard.  He founded Vanguard because no one was listening so he decided to just do it himself.  Bogle also stepped down from CEO at Vanguard in the 90s.  He doesn't have a responsibility to Vanguard, and actually spoke out when Vanguard starting doing ETFs.  You are correct it isn't a charity...  However at-cost does mean basically the same thing as non-profit, and the company is set up for the benefit of its owners.... the investors.


On market cap Vs equal weighting:  When you are looking at the 500 index it 'can' be argued either way.  Market cap, or 0.2% in each of the 500 companies.  The bottom 250 will probably be less established than the top 250 so you might see more volatility but you might also see higher returns.  However if you own the 500 equal weighted index you are STILL market cap weighting your portfolio because it is primarily large cap.  Are you going to equal weight the WHOLE market?  Imagine a equal weight total stock index.  XYZ micro cap company in Chicago making batteries has the same weighting as Apple?  Really?  If that sounds like a good idea I have a bridge basket of penny stock I can sell you!

[Dodge]

Upon inspection, the white line soars above the orange line in 2014, and both lines represent total return:

It's because that chart has a linear Y-axis, not logarithmic. Both lines increased by a similar percentage in 2014, but since the white line started near 1500 while the red line started near 750, the white line will rise twice as much for the same percentage increase. In other words, it's not a valid comparison to just drag one line down to the Y-value of the other.

Morningstar uses log charts, so the differences (particularly over long timeframes) will look smaller there than they do on a linear chart. Google allows you to switch between log and linear.

Got it, thanks Skyrefuge!

Reading through the thread again with this in mind, the first thing that pops out is survivorship bias.  Probably because the article I posted earlier:

http://youarenotsosmart.com/2013/05/23/survivorship-bias/

and the book I'm currently reading, A Random Walk Down Wall Street.  There have been a great number of dividend focused funds over the decades, and I personally haven't seen any actual funds that outperform (feel free to link some, again I'm genuinely curious).  When we are pouring over the data to determine why the backtesting of a particular dividend strategy outperformed over a specific time period...we are implicitly making an assumption...that this strategy is special.  After all, 100% of the other strategies failed, why did this one win?  There must be some special property it exploited.

I believe this assumption is a logical fallacy.

The book has a relevant (in my opinion) example.  Take a large number of people, and ask them to flip a coin.  If they flip heads they win, tails and they're eliminated from the game.  After the first flip, about half the people will be eliminated.  Then ask them to flip again, and again, and again.  After 10 flips, only a select few people will be left.  Are these people "lucky"?  Are they "skilled".  Would anything be gained by spending time studying their coin flipping strategy?

Interestingly enough, the article linked above has the same example as the book:



"The mentalist Derren Brown once predicted he could flip a coin 10 times in a row and have it come up heads every time. He then dazzled UK television audiences by doing exactly that, flipping the coin into a bowl with only one cutaway shot for flair. How did he do it? He filmed himself flipping coins for nine hours until he got the result he wanted. He then edited out all the failures and presented the single success."

In other words, considering the large initial sample size, I think studying this one particular backtested strategy, and trying to peel out the "why" behind its results, is an effort in futility.  Studies have shown time and time again, that funds which outperform over a particular time period, show no increased likelihood of outperforming over the next time period.  There was actually a slight negative correlation, implying a reversion to the mean was in play.  We're not even dealing with an actual fund in this thread, we're dealing with a backtested strategy.  While it might be interesting to check in 20 years and see if NOBL's underperformance continues, it will likely end up being just another footnote in the latest edition of A Random Walk.

That said, I don't have anything further about this specific strategy to add to the thread, so enjoy the analysis!

[Aphalite]

Seems like Dodge has a really heavy lean towards statistics and probability whereas index has a lean towards the importance of dividends

As others have already said, growing dividends usually signifies strong company. On the other hand, these are companies that are at the downside of the growth curve, as the fact they are paying dividends means they don't have a good place in the business to allocate capital. Since yields are low right now this might be one of the reasons a dividend index is tracking higher. The other reason could be that investors are avoiding growth companies FOR NOW due to 2000-01 and 08-09. Eventually it will probably come back around. I don't think there's a way to know which index will outperform the other because you have reduced the conditions to 1) float weighted index of 500 companies, which reinforces itself since new money will be allocated by existing float and 2) companies that grow dividends, which as discussed mostly consists of mature companies with lower capacity for capital appreciation on their paper. Focusing on 1) is ignoring fundamentals (I think the market as a whole will either slag along until inflation picks up or earnings catch up to valuations) and focusing on 2) is ignoring the chance of holding a Microsoft or Google or Home Depot or Starbucks in its growing infancy

Both parties are just reaffirming their cognitive biases, when in fact both parties will end up rich because 1) we live below our means 2) we avoid turnover and 3) we keep investing costs low

[theoverlook]

No comment on the Dividend Aristocrats, but I am surprised that a user would be able to delete their entire thread and have all the replies disappear along with it.  That's a strange configuration for a public forum.

Didn't you read the fine print when you signed up as a participant in this forum?  I hope so, because there's an important clause about the moderators' ability to erase you from existence, not only on this forum, but IRL.

Sure, I would certainly expect a moderator to be able to delete a thread, but my understanding was that Dodge had deleted the thread.  That is what was surprising.

And of course a moderator can erase you IRL - if you're not on the grid you don't exist!  Right?

[forummm]

No comment on the Dividend Aristocrats, but I am surprised that a user would be able to delete their entire thread and have all the replies disappear along with it.  That's a strange configuration for a public forum.

Didn't you read the fine print when you signed up as a participant in this forum?  I hope so, because there's an important clause about the moderators' ability to erase you from existence, not only on this forum, but IRL.

Sure, I would certainly expect a moderator to be able to delete a thread, but my understanding was that Dodge had deleted the thread.  That is what was surprising.

And of course a moderator can erase you IRL - if you're not on the grid you don't exist!  Right?

The MMMatrix is all around you.