Which ETF would you suggest to tilt to small cap and/or value?

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dustytown
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Which ETF would you suggest to tilt to small cap and/or value?

Post by dustytown »

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.
I understand that there is a scientific agreement that size and value are factors not to be ignored.

The equity part of my portfolio is split equally between:
  • 50% : iShares Core MSCI World (IE00B4L5Y983) (IWDA)
  • 50% : iShares Core MSCI Europe (IE00B4K48X80) (IMAE)
Maybe overweighting Europe already tilts me to value stocks? But I am definitely not yet exposed to the small-cap stocks (size factor).

Rather than continue to contribute the above 2 ETF's .. should I consider adding future contribution to some Vanguard or iShares ETF that would focus on small cap stocks? Does anyone else follow this strategy? If so, which ETF (iShares or Vanguard preferred) would you recommend to tilt to small cap stocks?
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dustytown
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by dustytown »

To add, why I feel I should add a few percentage of small-cap stocks to my current equity ETF's :

If I analyze the 50% IWDA and 50% IMAE through the classic Morningstar x-ray tool it shows me the following 3x3 box:

Value Blend Growth
Large Cap 24 35 28
Mid Cap 4 6 3
Small Cap 0 0 0

So I have to conclude I indeed am not exposed to the size factor (small cap stocks) at all.

If I look at the bogleheads wiki FAQ page on small-caps https://www.bogleheads.org/wiki/FAQ_small_cap_funds I see that in the US-centric Total Stock Market Index Fund they show:

Value Blend Growth
Large Cap 26 22 24
Mid Cap 6 6 7
Small Cap 3 3 3

So my idea is to start contributing to a 'small cap ETF' for the next 2 years or so, so I reach a similar exposure to small caps at some point.
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calmaniac
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by calmaniac »

1: How old are you & where are you in your investing journey? What are your investing goals?

2: Even small cap value evangelists will tell you that SCV can underperform for long periods (10-15-20 years). Tilting to SCV is a long-term, 10-20 year commitment; you are likely not to see much difference in the short term of 1-5 years. If you don't expect to have the stomach to watch SCV underperform for the next decade, you may as well just keep it simple and do total market index.
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.
3: Rebalancing 4 times a year is unnecessary. Once a year should be fine. More than annually is probably more entertainment than real value, and may entice you to tinker.

4: 50/50 would make my skin crawl. I can barely stand 30% bonds. YMMV. :D
"Pretired", working 20 h/wk. AA 75/25: 30% TSM, 19% value (VFVA/AVUV), 18% Int'l LC, 8% emerging, 25% GFund/VBTLX. Military pension ≈60% of expenses. Pension+SS@age 70 ≈100% of expenses.
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dustytown
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by dustytown »

calmaniac wrote: Thu Jul 29, 2021 4:10 pm 1: How old are you & where are you in your investing journey? What are your investing goals?
I'm 42 and have been investing for about 15 years. Learned valuable lessons in 2007-2009 but luckily did not have much invested back then. I only started learning about index investing & staying the course after that. The 2007-2009 investment mistakes I made did teach me a lot. During the 2020 correction I did not even flinch. But in fairness I believe that is because of 3 reasons:
  • the great run-up we have had since 2010
  • the fact that I keep an unusual high allocation to fixed income which even allowed me to rebalance in comfort
  • the fact that I got a little wiser and learned to not panic anymore was a third element :)
I realize that I have missed a lot of growth these past few years by not allocating a higher percentage to stocks and that I should not have been tilting to Europe either, and that I should not have ignored emerging markets but at the end of the day : I did so much better than in 2007-2009 so that's ok.

I am not quite sure what I am investing for. Given the two generous pension plans (defined benefit + defined contribution) I will get from my employer, I will easily be able to maintain my standard of living when I retire. But I will only be able to take early retirement when I'm 60. Earlier and all bets are off. My savings rate simply is too low to compensate for the financial loss linked to retiring before 60.
I also haven't got any children and neither has my sister. So for now the investing is just a bit of a hobby I guess. Well not the investing as such, but rather reading up on it is at least.
calmaniac wrote: Thu Jul 29, 2021 4:10 pm 2: Even small cap value evangelists will tell you that SCV can underperform for long periods (10-15-20 years). Tilting to SCV is a long-term, 10-20 year commitment; you are likely not to see much difference in the short term of 1-5 years. If you don't expect to have the stomach to watch SCV underperform for the next decade, you may as well just keep it simple and do total market index.
I understand and accept that. Just as I am sure that somehow I will be proven right when European stocks revert back to the mean and will start outperforming US stocks, so too do I believe we will see the reemergence of value in the next few years. What small cap stocks will do? I have no feeling in either direction, but I feel it would still be wiser to maximize the diversification and that I should seek some exposure to that as well
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calmaniac
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by calmaniac »

You may want to check our Paul Merriman's web site. On it, Chris Pedersen does an analysis of Best in Class ETFs for a number of asset classes, including small cap value. They recently switched their recommendation to Avantis U.S. Small Cap Value (AVUV) and have a short explanation why. They also have a list of alternative ETF recommendations that are quite close. I'm not convinced the AVUV juice is worth the squeeze and have not made the move.

One thing to watch out for is if you Google "Vanguard Small Cap Value", the first hit you get is VBR, which last time I looked was less small and value-y than the other Vanguard SCV ETF, VIOV (they use different indices). I have about 50:50 VIOV:VFVA, the latter of which is a mix of small and large value.

I need to get to work, so I can't add more to that. Boglehead Grabiner has posted some great stuff on small cap value, I suggest you Google "Grabiner" and "small cap value" or some such, and read some of his posts.
"Pretired", working 20 h/wk. AA 75/25: 30% TSM, 19% value (VFVA/AVUV), 18% Int'l LC, 8% emerging, 25% GFund/VBTLX. Military pension ≈60% of expenses. Pension+SS@age 70 ≈100% of expenses.
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by TedSwippet »

calmaniac wrote: Fri Jul 30, 2021 6:17 am You may want to check our Paul Merriman's web site. On it, Chris Pedersen does an analysis of Best in Class ETFs for a number of asset classes, including small cap value. ...
Just FYI, this is the 'Non-US Investing' forum, and the topic author is (I think) a resident of Belgium and not a US citizen or green card holder. This means that the specific funds or ETFs mentioned by you, Paul Merriman or Chris Pederson will not be available to them. (Also, Belgium has no US estate tax treaty, so even if any were available, they would be best avoided for tax reasons.)
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nisiprius
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by nisiprius »

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

Image

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

Image

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."
Last edited by nisiprius on Fri Jul 30, 2021 8:43 am, edited 2 times in total.
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JoMoney
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by JoMoney »

When people bring up small caps, I like to point out that the "risk premium" model they are usually basing that idea on, hasn't worked the way it's often imagined or described.
By example, the Wilshire US MIcro Cap Index, since inception, has failed to perform as well as the broader total market on both a "Risk Adjusted Return" and on a total return basis.
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Topic Author
dustytown
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by dustytown »

nisiprius wrote: Fri Jul 30, 2021 8:04 am
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 in any detail.

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.).
Thank you for this well documented analysis ! I indeed was thinking adding some small-cap was like a free lunch. I should have known there is no such thing. I will abandon the idea of adding small caps. Not worth the hassle, and, as you said it would be the same as increasing the equity part in my portfolio.
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galeno
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Re: Which ETF would you suggest to tilt to small cap and/or value?

Post by galeno »

I disagree about reducing the equity percentage when adding the higher risk SC ETF.

For me there is only ONE SC ETF worth considering. That's Ishares WSML.

We used to hold 45% VWRD + 5% WSML. Now we hold 50% VWRD.
KISS & STC.
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