dustytown wrote: ↑Thu Jul 29, 2021 3:32 pm
My asset allocation is a conservative split of 50% stocks and 50% fixed income and I rebalance 4 times per year (around 21 mar/21 jun/21 sep/21 dec).
Most people my age would likely be more dynamic/aggressive but for me the 50% in bonds and cash lets me sleep well at all times.
I do not want to increase my return by raising the stock portion of my portfolio.
But I am considering whether I should add some tilt to small-cap and value stocks in the equity part of the portfolio.
Please be very clear on this: small-cap and value stocks are riskier than the stock market as a whole. Not by a huge amount, but noticeably.
If you simply add (say) a small-cap value tilt to your portfolio without changing overall stock allocation, then you are adding risk.
You could
also add risk and expected return by simply increasing stock allocation.
The whole small-cap value proposition should be a
comparison of the two different ways of adding risk. Too many discussions of tilting do not address this, and content themselves with compare tilted versus untilted.
If you do not want to add risk, then when you add a small-cap tilt you ought to
reduce your stock allocation in order to hold risk constant. This is a comparison that tilt advocates rarely make, the usual comparisons will just show (say) 60/40 stock/bond allocations with and without small-cap value tilt in the stocks.
To illustrate my point--not knowing details of your portfolio nor what is available in Europe--I will use the Paul Merriman Ultimate Buy-and-Hold portfolio, designed by a strong advocate of small-cap value tilts. It's a 60/40 allocation, so I will adjust it to match your 50/50 allocation by making every stock allocation 5/6ths of what it was, while making every bond allocation 5/4ths of what it was. That is, I won't change the holdings, or the relative allocations within the stock and bond sleeves. The result is:
VFINX Vanguard 500 Index Investor 5.00%
VIVAX Vanguard Value Index Inv 5.00%
NAESX Vanguard Small Cap Index Inv 5.00%
VISVX Vanguard Small Cap Value Index Inv 5.00%
VGSIX Vanguard Real Estate Index Investor 5.00%
VTMGX Vanguard Developed Markets Index Admiral 10.00%
VEIEX Vanguard Emerging Mkts Stock Idx Inv 5.00%
EFV iShares MSCI EAFE Value ETF 10.00%
VFITX Vanguard Interm-Term Treasury Inv 25.00%
VFISX Vanguard Short-Term Treasury Inv 15.00%
VIPSX Vanguard Inflation-Protected Secs Inv 10.00%
Ignore the relative return, because the use of EFV limits the date range to a period during which value underperformed, the point that I want to make is about
risk. (Generally speaking, any past time period that includes 2000-2003 will show tilted portfolios outperforming, and any time period that doesn't will show them underperforming. This specific fact about past history has launched many sterile debates.)
Source
By the traditional measure of risk--standard deviation, which is a measure of volatility, which is one important kind of risk--and also by maximum drawdown, the tilted portfolio was obviously riskier than the untilted portfolio (and since I used exactly the same bonds in both, the risk was due to the tilt in the stocks).
Suppose you wanted to use the Ultimate Buy-and-Hold, but did not want any more risk than you would have in an untilted 50/50 portfolio. By trial and error I found that I could approximately compensate for the extra risk of Merriman's tilts by cutting the stock allocation from 50/50 to 45/55.
Source
Now, someone might say "yes, the tilt increases risk but it's really a small amount, you can hardly see it with the eye and it's not that important." True. In my jaded opinion, this is how "they" get away with it. Boost risk a little, point to the increased return, don't discuss the increased risk or exhibit
risk-adjusted return.
But the same thing is true for the
simple alternative of increasing risk and expected return just by boosting stock allocation slightly. If I keep the 50/50 allocation in the tilted portfolio, I find that the risk is about equivalent to
boosting the untilted portfolio to 55/45--click on the link for the details:
Click for details
So I am going to make a big vague untested generalization from this. I am going to suggest that the portfolios recommended by small-cap-value advocates are often adding risk equivalent to boosting the stock allocation by around 10%-of-stock-allocation (50% to 55%, 60% to 66%, etc.).
If you don't mind tilting, then you shouldn't mind just boosting your stock allocation to 55%
without tilting. If you really don't want to exceed the risk of 50% stocks, then if you do tilt you should cut your overall stock allocation. And the comparison that always needs to be made is
comparisons with equalized risk.
Tilt advocates
will exhibit backtests in which portfolios would indeed have outperformed even if risk were equalized, but the seemingly strong case definitely becomes weaker if you insist on equalizing risk. In my personal opinion, it vanishes into the grey land of "maybe, and then again maybe not."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.