Author Topic: You Can Beat the Market: Non-Cap Weighted Investments  (Read 3780 times)

Scortius

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You Can Beat the Market: Non-Cap Weighted Investments
« on: June 19, 2018, 09:32:59 AM »
I'd be curious to hear from our more seasoned members on their thoughts on this Seeking Alpha article/video.

https://seekingalpha.com/article/4182197-can-beat-s-and-p-500-common-sense

He points out some simple truisms that often the highest cap weighted stocks have the highest P/E ratios and that small caps outperform large caps over time.

The data is also limited to this millennium, starting in 2000, which is a horrible sample.

Still, is there any value for those of us willing to take on a higher risk to up-weighting our portfolios with 1) small-cap stocks and 2) S&P 500 companies with the lowest P/Es and price/valuations? I'm not looking to make any changes myself, I'm more interested in a discussion.

FIRE@50

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #1 on: June 19, 2018, 10:43:27 AM »
Are you asking if you can beat an index fund by buying individual stocks? The answer is absolutely yes you can! I wish anyone the best of luck in attempting to do that over the course of a lifetime.

Scortius

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #2 on: June 19, 2018, 10:49:01 AM »
No, I'm not. I'm asking about the value of looking at non-cap weighted index funds and the extra volatility and risk associated with a small-cap focused portfolio. I found the video linked to be worth of discussion if nothing else.

OurTown

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #3 on: June 19, 2018, 11:13:47 AM »
The "Coffeehouse" portfolio has a 10% small cap value position.  He also has a 10% REIT position.  I am generally a standard Bogleheads three-fund portfolio person, but I do have SCV, REIT, and emerging markets in relatively small portions, about $10k each.

maizefolk

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #4 on: June 19, 2018, 12:20:29 PM »
My guess is that you could get essentially the same increase in returns from having separate large cap and small cap index fund allocations (with small cap substantially overweight relative to their proportion of total market cap) and manually rebalancing periodically.

That would require a lot fewer transactions by the folks running the index funds than trying to keep thousands of stocks equally weighted and prices increase and decrease, so I'm guessing you'd also be able to find funds with much lower expense ratios by using different cap weighted index funds for different market cap classes than from a single equal weight index fund.

But I could well be wrong. *shrug*

neil

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #5 on: June 19, 2018, 12:48:08 PM »
A thread on counters:
https://www.bogleheads.org/forum/viewtopic.php?t=136498

I feel efficient market theory is theory for a reason, but I also think the availability of information has improved exceptionally even when compared with ten years ago, never mind the much longer history of the market.  You can practically buy indexes in all sorts of things now, for very low cost.  OTOH, low
interest rates are a very good explanation for the most recent run of high correlation as well.

I do believe there are systematic reasons why small cap has larger drawdowns, as volume affects these more.  DFTSX went ~11% lower.  It was only less exposed in the tech bubble because there were distribution problems with capital at the time. Drawdown can't be ignored in retirement.

The solution is generally to do some light overweighting and capture some returns via rebalancing, but I think this mostly complicates portfolios.  If there is a 1-2% capture to be had and your weight at 20%, you'll reduce the benefit to .2-.4%.  If you're paying that in fees for some reason, you're definitely wasting your time.  If you save the fees and do it yourself, you increase decision making.  Over time, I believe that behavior has an impact and the only thing I trust is that I can't measure it.

I actually don't hold a strong opinion that beating the index is impossible, but doing it via other very similar index funds seems unlikely when the idea is not unusual and can be attacked by quants.

FIRE@50

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #6 on: June 19, 2018, 12:55:08 PM »
No, I'm not. I'm asking about the value of looking at non-cap weighted index funds and the extra volatility and risk associated with a small-cap focused portfolio. I found the video linked to be worth of discussion if nothing else.

Well, I watched the video and it was all about buying individual small caps. Your question referred to stocks and companies.

I agree. It is worth discussion.

Scortius

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #7 on: June 19, 2018, 03:05:10 PM »
A thread on counters:
https://www.bogleheads.org/forum/viewtopic.php?t=136498

I feel efficient market theory is theory for a reason, but I also think the availability of information has improved exceptionally even when compared with ten years ago, never mind the much longer history of the market.  You can practically buy indexes in all sorts of things now, for very low cost.  OTOH, low
interest rates are a very good explanation for the most recent run of high correlation as well.

I do believe there are systematic reasons why small cap has larger drawdowns, as volume affects these more.  DFTSX went ~11% lower.  It was only less exposed in the tech bubble because there were distribution problems with capital at the time. Drawdown can't be ignored in retirement.

The solution is generally to do some light overweighting and capture some returns via rebalancing, but I think this mostly complicates portfolios.  If there is a 1-2% capture to be had and your weight at 20%, you'll reduce the benefit to .2-.4%.  If you're paying that in fees for some reason, you're definitely wasting your time.  If you save the fees and do it yourself, you increase decision making.  Over time, I believe that behavior has an impact and the only thing I trust is that I can't measure it.

I actually don't hold a strong opinion that beating the index is impossible, but doing it via other very similar index funds seems unlikely when the idea is not unusual and can be attacked by quants.

Thanks for the link, there's some great discussion there. I agree that regardless, the effects of overweighting (or tilting as they call it) is going to be minimal when you take into account the magnitude of the weight and the increased expenses, especially when compared against VTSAX which does contain the full spectrum already. I was more curious to see if there were some good analyses as to how an index weighted against P/Es might perform. I think on the surface it's tempting to assume it would do well considering the so-called 'value' of the overall portfolio, but I also imagine that a relatively efficient market will have already placed those P/Es right where they should be.

Proud Foot

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #8 on: June 20, 2018, 01:18:36 PM »
Still, is there any value for those of us willing to take on a higher risk to up-weighting our portfolios with 1) small-cap stocks and 2) S&P 500 companies with the lowest P/Es and price/valuations? I'm not looking to make any changes myself, I'm more interested in a discussion.

Keeping with the S&P500 you could invest in RSP which is an equal weighted S&P500 ETF rather than market cap weighted like VOO.  With VOO your top 5 holdings make up 13.76% of the portfolio, while they make up 1.18% of RSP. Since inception in 2003 RSP has outperformed VOO (had to use Vanguard 500 Index Investor fund VFINX to go back far enough on portfolio visualizer) with a CAGR of 10.5% to 9.22% respectively.

AnonymousCoward

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #9 on: June 20, 2018, 08:25:27 PM »
Since inception in 2003 RSP has outperformed VOO (had to use Vanguard 500 Index Investor fund VFINX to go back far enough on portfolio visualizer) with a CAGR of 10.5% to 9.22% respectively.

VOO's turnover ratio is 3%, versus RSP's 21%. Head over to the Tax tab on your MorningStar links, they list the tax-adjusted returns of both funds. Unfortunately VOO's records only go back five years. At that period though, VOO has a higher tax-adjusted return.

This is irrelevant inside of tax-advantaged accounts, but it definitely matters in ordinary brokerage accounts. I like the idea of an equal-weighted index fund, but the marginal benefit doesn't seem to outweigh the costs.

I like maizeman's suggestion to use a small cap index fund to tilt a portfolio. Even VB (Vanguard's Small-Cap ETF) has a turnover ratio of 14.5% though.

If someone figures out how to run a tax-efficient, low-fee, and equal-weighted index fund I'd be happy to buy it. But I don't think it exists.

Proud Foot

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #10 on: June 21, 2018, 08:13:26 AM »
Good points @Anonymous Coward. I had not considered the tax implications for the returns. I agree that it would not make sense to do this outside of a tax advantaged account.

I think the way to run a tax-efficient, low-fee equal-weighted index fund would be to run it as a mutual fund rather than an ETF. You would be able to re-balance as cash flows in and out of the fund. Then you would also need to set up parameters for re-balancing so you're not doing it daily, either with parameters for how far out of balance to trigger the re-balancing or at a consistent, set frequency. You will still have more turnover than VOO but I think this would help to cut down the turnover and tax consequences.

CorpRaider

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #11 on: June 21, 2018, 08:51:06 AM »
I think Bogle and others would point out that the equal weighting is arguably just a mid or small cap tilt.  You can look at VO or VB (as opposed to VOO) versus RSP.  They track pretty much identically the last time I've checked and of course one is more tax efficient. 

Also, fundamental indexes have much lower turnover than the equal weight strategy, at least since inception (DTD, PRF, FNDB, ETC...).  Finally, weird timing for this subject to arise, haven't they all been getting their asses kicked by market cap weighting in this bull market/decade (except maybe the midcap tilt)?
« Last Edit: June 21, 2018, 08:53:19 AM by CorpRaider »

AdrianC

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #12 on: June 21, 2018, 09:19:39 AM »
Vanguard introduced factor funds earlier this year. They havent gained much traction as yet.  Look interesting though.

https://advisors.vanguard.com/web/cf/factor/products?EXCMPGN=EX:PS:XX:FAS:XX:20180215:ALL:XX:XX:NEWPROD:FACTORS:FUNDS&mkwid=5bEYxOBo

Telecaster

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #13 on: June 21, 2018, 10:51:16 AM »
Equal weight trumps cap weight pretty handily.   And the more I ponder the question, the more I think that cap-weighting doesn't make sense for a investment index.  But a few caveats.   Cap weight would have beat equal weight in the 1990s.  And it is hard to backest.   

You can create a synthetic RSP by combing 25% S&P500 index with 75% mid-cap.   That combo beats the S&P 500 or the classic 60/40 blend by a decent margin since 1972. 



https://www.lynalden.com/equal-weighted-index-funds/


Scortius

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #14 on: June 21, 2018, 11:50:28 AM »
That's a very striking graph, as it's intended to be. Any chance you have 1) the same graph on a log plot, and 2) data that goes back farther than the 70s? I realize these indices haven't been around that long so that past data is lacking, but I imagine someone must have put together some data on a retroactive Russel 2000 or something similar.

Telecaster

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #15 on: June 21, 2018, 04:31:20 PM »
That's a very striking graph, as it's intended to be. Any chance you have 1) the same graph on a log plot, and 2) data that goes back farther than the 70s? I realize these indices haven't been around that long so that past data is lacking, but I imagine someone must have put together some data on a retroactive Russel 2000 or something similar.

Sadly, I don't.  I've heard there are backtests that go back farther than that, but I haven't seen one. 

Roland of Gilead

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #16 on: June 21, 2018, 04:40:01 PM »
Are you asking if you can beat an index fund by buying individual stocks? The answer is absolutely yes you can! I wish anyone the best of luck in attempting to do that over the course of a lifetime.

Easy to do.  All one would have had to do is buy Berkshire stock and they would have beat the index funds handily over the course of a lifetime.

MustacheAndaHalf

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #17 on: June 23, 2018, 01:38:53 AM »
Since inception in 2003 RSP has outperformed VOO (had to use Vanguard 500 Index Investor fund VFINX to go back far enough on portfolio visualizer) with a CAGR of 10.5% to 9.22% respectively.
VOO's turnover ratio is 3%, versus RSP's 21%. Head over to the Tax tab on your MorningStar links, they list the tax-adjusted returns of both funds. Unfortunately VOO's records only go back five years. At that period though, VOO has a higher tax-adjusted return.
...
If someone figures out how to run a tax-efficient, low-fee, and equal-weighted index fund I'd be happy to buy it. But I don't think it exists.
I had the same thought, but drew a different conclusion from morningstar's "tax" data.  You can also use VFIAX (Vanguard S&P 500 Admiral shares) for longer-term comparison, since it holds identical assets to VOO.


tax impact on S&P 500 (VFIAX)
http://performance.morningstar.com/fund/tax-analysis.action?t=VFIAX
5 yr -0.75% ... 10 yr -0.54% ... 15 yr -0.48%

tax impact on equal weight S&P 500 (RSP)
http://performance.morningstar.com/fund/tax-analysis.action?t=RSP
5 yr -0.70% ... 10 yr -0.60% ... 15 yr -0.55%

The tax impact between the two only differs by 0.05% to 0.07%.  Although I expected otherwise, I consider RSP tax efficient based on that data.

One small caution: RSP has 0.08% of it's expense ratio paid for by it's parent company (Investco, I assume), which results in the 0.20% expense ratio.  At $15 billion in assets, I'm surprised the "expense waiver" is still in place.  Expect to pay 0.28% in the future.
http://financials.morningstar.com/etfund/operations.html?t=RSP
« Last Edit: June 23, 2018, 01:40:26 AM by MustacheAndaHalf »

Telecaster

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #18 on: June 23, 2018, 09:51:33 AM »

One small caution: RSP has 0.08% of it's expense ratio paid for by it's parent company (Investco, I assume), which results in the 0.20% expense ratio.  At $15 billion in assets, I'm surprised the "expense waiver" is still in place.  Expect to pay 0.28% in the future.
http://financials.morningstar.com/etfund/operations.html?t=RSP

RSP recently lowered its expense ratio from 0.4% to 0.2%, so you could well be right. 

That said, you can create a synthetic equal weight with 25% VFIAX (Vanguard s&P 500) and 75% VIMAX (Vanguard mid-cap) that tracks RSP pretty closely with an expense ratio of 0.05%.

MustacheAndaHalf

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #19 on: June 24, 2018, 05:11:15 AM »
Didn't know about the prior expense ratio, that's interesting.  I found some other good and bad examples of equal weighting.

GSEW (Goldman Sachs Equal Weight U.S. Large Cap Equity ETF) has an excellent expense ratio (0.09%), but no historical performance.  It's top 50 stocks hold 11.1% of assets, which is only 1.1x expected weight.

EUSA (iShares MSCI USA Equal Weighted ETF) has an expense ratio of 0.15%, and it's top 50 assets account for 9.1% (of 628 stocks).  That's 1.15x of expected.

RSP (Invesco S&P 500 Equal Weight ETF) costs 0.20% per year - I wonder how much of that pays for "S&P 500" in it's name?  It's top 50 hold 10.85% of it's assets, or 1.1x of expected.

EQAL (Invesco Russell 1000 Equal Weight ETF) has an 0.20% expense ratio and holds 956 stocks.  It's top 50 hold a surprisingly high 12.9% of assets, or 2.5x of expected.  Despite having 956 stocks, it's more concentrated in the top 50 than any of the ETFs with only 500-600 stocks.  Seems like "equal weight" is only the starting point for this ETF.

For those interested in equal weight, maybe that list provides some additional choices to consider.

bacchi

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Re: You Can Beat the Market: Non-Cap Weighted Investments
« Reply #20 on: June 25, 2018, 11:31:46 PM »
This bogle thread has some great graphs in the first few pages comparing a small-cap tilt to a standard S&P allocation. I believe are some graphs in the later pages that go back farther than 1970.

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=38374&sid=e117c2fb0ccafd7d7ae6bc1fb73c9500

tl;dr Small cap is higher risk, higher gains. It may not be suitable for the withdrawal years but it's probably worth it for the accumulation years.