How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
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.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 2:25 pm
burritoLover wrote: Sat May 27, 2023 2:07 pm I didn’t say all risks are compensated for. Risks that arise from cognitive biases are decidedly not compensated for. It isn’t a binary one or the other either if you are trying to fit it in a box. Thinking that everyone should just invest in a market cap weight portfolio (and not even a global one) is lacking understanding that not everyone is the average investor.
Risks aren't compensated for. Stocks might go up not because they're volatile but because earnings can go up over time and investors might be willing to pay X times the earnings.

If SCV outperformed US TSM, that was because SCV's earnings went up more or valuations went (relatively) higher than the rest of the market.
So no risks aren’t compensated for in markets is your position. Flies in the face of everything that is known about markets but look forward to your groundbreaking paper on the subject.
Last edited by burritoLover on Sat May 27, 2023 4:11 pm, edited 2 times in total.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 4:04 pm So no risks are compensated are for in markets is your position. Flies in the face of everything that is known about markets but look forward to your groundbreaking paper on the subject.
I already explained where the returns *might* come from. Bogle pitched the idea long ago.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

nisiprius wrote: Sat May 27, 2023 3:03 pm
burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 4:06 pm
burritoLover wrote: Sat May 27, 2023 4:04 pm So no risks are compensated are for in markets is your position. Flies in the face of everything that is known about markets but look forward to your groundbreaking paper on the subject.
I already explained where the returns *might* come from. Bogle pitched the idea long ago.
Bogle said there’s no risk premium in the stock market? Love to see some quotes from him on that - don’t think I’ve come across that one from him before.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 4:15 pm Bogle said there’s no risk premium in the stock market? Love to see some quotes from him on that - don’t think I’ve come across that one from him before.
No, I was talking about the simple formula of earnings + PE change + divs = total return.

I said risk isn't compensated because nowhere in the formula has a risk component to it, although you could maybe argue the PE change has some elements; but certainly not part of earnings or divs.
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

burritoLover wrote: Sat May 27, 2023 4:08 pm
nisiprius wrote: Sat May 27, 2023 3:03 pm
burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess.
You are knocking down a strawman.
The whole point is that things are cyclical. It's not that those things are dead now, just like LCG was not dead back when it was underperformed, buy rather that various things lead and lag at different times. No reason to expect one thing to systemically outperform.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 4:16 pm
burritoLover wrote: Sat May 27, 2023 4:15 pm Bogle said there’s no risk premium in the stock market? Love to see some quotes from him on that - don’t think I’ve come across that one from him before.
No, I was talking about the simple formula of earnings + PE change + divs = total return.

I said risk isn't compensated because nowhere in the formula has a risk component to it, although you could maybe argue the PE change has some elements; but certainly not part of earnings or divs.
It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

marcopolo wrote: Sat May 27, 2023 4:19 pm
burritoLover wrote: Sat May 27, 2023 4:08 pm
nisiprius wrote: Sat May 27, 2023 3:03 pm
burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess.
You are knocking down a strawman.
The whole point is that things are cyclical. It's not that those things are dead now, just like LCG was not dead back when it was underperformed, buy rather that various things lead and lag at different times. No reason to expect one thing to systemically outperform.
The OP declares that a diversified basket of small caps is not worth investing in. If it isn’t worth investing in, then what else would you call it other than dead? They didn’t say this was just a bad period for small caps and it would improve in the future.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
:oops: And why exactly do you believe that without supporting evidence?

Besides, aren't we after equity returns, not a discount rate? Why are you chasing an irrelevant metric?

If you want to bet on past SCV outperformance, just say so. There's no reason to add irrelevant narratives that don't hold up outside of SCV.
Last edited by Marseille07 on Sat May 27, 2023 6:58 pm, edited 6 times in total.
rkhusky
Posts: 17654
Joined: Thu Aug 18, 2011 8:09 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
If in fact you can identify stocks that are truly riskier going forward, will the risk be compensated?
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

burritoLover wrote: Sat May 27, 2023 4:26 pm
marcopolo wrote: Sat May 27, 2023 4:19 pm
burritoLover wrote: Sat May 27, 2023 4:08 pm
nisiprius wrote: Sat May 27, 2023 3:03 pm
burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess.
You are knocking down a strawman.
The whole point is that things are cyclical. It's not that those things are dead now, just like LCG was not dead back when it was underperformed, buy rather that various things lead and lag at different times. No reason to expect one thing to systemically outperform.
The OP declares that a diversified basket of small caps is not worth investing in. If it isn’t worth investing in, then what else would you call it other than dead? They didn’t say this was just a bad period for small caps and it would improve in the future.
That also seems like a strawman.
I believe what the OP was saying is that there is no benefit to overweighting, or "tilting" to small cap. Just like there is no benefit to doing the same with LCG. The various groups will take turns leading and lagging. So, own a well diversified portfolio, including things that might be declared "dead" at the moment because they are unlikely to stay that way forever.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

burritoLover wrote: Sat May 27, 2023 4:08 pm...
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess....
I'm talking small-cap growth, not small-cap value. Specifically, I'm talking about the narrative that says small-cap growth is poison. That the reason why small-cap blend has not lived up to expectation is that it is poisoned by small-cap growth, and that the the benefit of small-cap value is not so much value per se as getting rid of small-cap growth.
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.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

burritoLover wrote: Sat May 27, 2023 4:08 pm...
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess....
I'm talking small-cap growth, not small-cap value. Specifically, I'm talking about the narrative that says small-cap growth is poison. That the reason why small-cap blend has not lived up to expectation is that it is poisoned by small-cap growth, and that the the benefit of small-cap value is not so much value per se as getting rid of small-cap growth.

It's the relative performance of small-cap growth to small-cap value I'm looking at. Value in general might underperform, yet one might still hope to see confirmation of theory in small-cap growth performing even worse.
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.
Gaston
Posts: 1205
Joined: Wed Aug 21, 2013 7:12 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Gaston »

nisiprius wrote: Fri May 26, 2023 6:39 am As far as I know the Vanguard 500 Index fund was always no-load ...
Just FYI: According to Charles Ellis in his book The Index Fund Revolution, the Vanguard 500 Index fund (originally called the First Index Investment Trust) had a front-end load, which was common for all funds at the time.
“My opinions are just that - opinions.”
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by JoMoney »

Gaston wrote: Sat May 27, 2023 5:09 pm
nisiprius wrote: Fri May 26, 2023 6:39 am As far as I know the Vanguard 500 Index fund was always no-load ...
Just FYI: According to Charles Ellis in his book The Index Fund Revolution, the Vanguard 500 Index fund (originally called the First Index Investment Trust) had a front-end load, which was common for all funds at the time.
John Bogle confirms that to be the case, at least for it's first year, in this writing:
https://www.johncbogle.com/wordpress/wp ... 9-4-11.pdf
The Professor, the Student, and the Index Fund
... His sixth requirement-that it be a no-load fund-had not been met but, he graciously conceded,
"a professor's prayers are rarely answered in full. " As it happened, his final prayer would be answered
only six months later, when in February 1977 the Vanguard funds eliminated all sales charges and made
an unprecedented conversion to a "no-load" distribution system...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 4:34 pm
burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
:oops: And why exactly do you believe that without supporting evidence?

Besides, aren't we after equity returns, not a discount rate? Why are you chasing an irrelevant metric?

If you want to bet on past SCV outperformance, just say so. There's no reason to add irrelevant narratives that don't hold up outside of SCV.
I'm not even sure what you are saying at this point. That risk plays no role in pricing?
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

rkhusky wrote: Sat May 27, 2023 4:34 pm
burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
If in fact you can identify stocks that are truly riskier going forward, will the risk be compensated?
A higher expected return does not mean it's a guaranteed return - which I think is what you are getting at. For example, there's a higher expected return for stocks over bonds - that is, there is a risk premium for stocks over bonds. That is not a guaranteed return - risk can show up. This is really basic stuff - perhaps professor McQ can do a post on risk and security pricing (not being sarcastic).
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

marcopolo wrote: Sat May 27, 2023 4:37 pm You are knocking down a strawman.
The whole point is that things are cyclical. It's not that those things are dead now, just like LCG was not dead back when it was underperformed, buy rather that various things lead and lag at different times. No reason to expect one thing to systemically outperform.
BurritoLover wrote: The OP declares that a diversified basket of small caps is not worth investing in. If it isn’t worth investing in, then what else would you call it other than dead? They didn’t say this was just a bad period for small caps and it would improve in the future.
That also seems like a strawman.
I believe what the OP was saying is that there is no benefit to overweighting, or "tilting" to small cap. Just like there is no benefit to doing the same with LCG. The various groups will take turns leading and lagging. So, own a well diversified portfolio, including things that might be declared "dead" at the moment because they are unlikely to stay that way forever.
That's not the impression that I got. They even specifically call out that the post has nothing to do with small-cap value. And they make several mentions that imply that the "size effect" is no longer (i.e. my translation = dead). This isn't a post about the waxing and waning of different sub-asset classes of stocks.
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

nisiprius wrote: Sat May 27, 2023 4:44 pm
burritoLover wrote: Sat May 27, 2023 4:08 pm...
Don’t you know - value has been declared dead the last 10 years. I guess small caps are dead too? And international stocks. But sadly, US large cap blend is the only remaining thing to invest in, I guess....
I'm talking small-cap growth, not small-cap value. Specifically, I'm talking about the narrative that says small-cap growth is poison. That the reason why small-cap blend has not lived up to expectation is that it is poisoned by small-cap growth, and that the the benefit of small-cap value is not so much value per se as getting rid of small-cap growth.

It's the relative performance of small-cap growth to small-cap value I'm looking at. Value in general might underperform, yet one might still hope to see confirmation of theory in small-cap growth performing even worse.
So you're declaring something as definitive based on 10 and 20 year returns? And it isn't that all small-cap growth stocks suffer from the lottery effect - it is thought to be primarily small-cap growth stocks with low profitability. Could the "lottery effect" theory be wrong or an incomplete picture of reality - absolutely. If true, can that effect change in the future - absolutely.
rkhusky
Posts: 17654
Joined: Thu Aug 18, 2011 8:09 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

burritoLover wrote: Sun May 28, 2023 7:02 am
rkhusky wrote: Sat May 27, 2023 4:34 pm
burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
If in fact you can identify stocks that are truly riskier going forward, will the risk be compensated?
A higher expected return does not mean it's a guaranteed return - which I think is what you are getting at. For example, there's a higher expected return for stocks over bonds - that is, there is a risk premium for stocks over bonds. That is not a guaranteed return - risk can show up. This is really basic stuff - perhaps professor McQ can do a post on risk and security pricing (not being sarcastic).
What I am speaking of is the notion that one should not invest in single stocks because the risk is not compensated. That is, if one can diversify the risk, the risk is not compensated. Why does that not hold for market segments? Just because a market segment is riskier, why is that risk compensated when one can diversify by adding other market segments?
User avatar
burritoLover
Posts: 4097
Joined: Sun Jul 05, 2020 12:13 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

rkhusky wrote: Sun May 28, 2023 8:00 am
burritoLover wrote: Sun May 28, 2023 7:02 am
rkhusky wrote: Sat May 27, 2023 4:34 pm
burritoLover wrote: Sat May 27, 2023 4:22 pm It is how stocks are priced in an efficient market. Riskier stocks, all else equal, will have a higher discount rate.
If in fact you can identify stocks that are truly riskier going forward, will the risk be compensated?
A higher expected return does not mean it's a guaranteed return - which I think is what you are getting at. For example, there's a higher expected return for stocks over bonds - that is, there is a risk premium for stocks over bonds. That is not a guaranteed return - risk can show up. This is really basic stuff - perhaps professor McQ can do a post on risk and security pricing (not being sarcastic).
What I am speaking of is the notion that one should not invest in single stocks because the risk is not compensated. That is, if one can diversify the risk, the risk is not compensated. Why does that not hold for market segments? Just because a market segment is riskier, why is that risk compensated when one can diversify by adding other market segments?
Not all risk is the same. Some risk is compensated for, other risks are not. You can mitigate the idiosyncratic risk (which you are not compensated for) of an individual stock by adding more stocks to the portfolio. You cannot diversify away systemic risk (that which you are compensated for). For example, you can't diversify in a way that you can have an all-stock portfolio that has stock-like returns with bond-like volatility.

What you could say is that Fama and French factor premiums over the market have been the result of primarily non-systemic risks that you are not compensated for. For example, perhaps, prior to the publication of their paper, the outperformance of value stocks was due mostly to a "loss aversion" bias of investors. Value stocks are more likely to have suffered from recent poor performance than their growth counterparts. And investors tend to react more severely to the "sting" of losses vs. the "joy" of the gains of the same magnitude thus perhaps applying a higher discount rate than normal to these value stocks. However, once this is known (from the publication of the paper) - that premium could be arbitraged away (even if only partially). My position is that it is probably a combination of systematic and non-systematic risks. I would not be one to expect the full historical factor premium.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sun May 28, 2023 6:54 am I'm not even sure what you are saying at this point. That risk plays no role in pricing?
I already explained the formula which is "earnings growth + PE change + divs."

Unless you dispute the formula, it is your critical thinking to figure out where risk fits in, if at all.
Last edited by Marseille07 on Sun May 28, 2023 12:17 pm, edited 1 time in total.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

nisiprius wrote: Sat May 27, 2023 1:15 pm
nedsaid wrote: Sat May 27, 2023 11:25 am...The screening for Quality is one reason I am a big fan of the S&P Indexes...
"Screening for quality" doesn't seem to move the needle very much on the actual quality of the portfolio.

VLCAX, Vanguard Large-cap Index Fund
VFIAX, Vanguard [S&P] 500 Index Fund

Image
How would the S&P 600 Small-Cap Index compare to a CRSP Small-Cap Index? The Morningstar article from a ways back mentioned specifically that a screening for companies that have earnings caused the Small-Cap premium to return with a vengeance. They used the S&P 600 Small-Cap Index as an example of this. Can't remember if they mentioned the Quality factor.
A fool and his money are good for business.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

marcopolo wrote: Sat May 27, 2023 12:39 pm
nedsaid wrote: Sat May 27, 2023 11:29 am
rkhusky wrote: Sat May 27, 2023 9:06 am
nedsaid wrote: Fri May 26, 2023 7:23 pm
SimpleGift wrote: Fri May 26, 2023 8:44 am

Yes, an example of a small cap index that controls for quality is the S&P 600 Small Cap Index, which Vanguard’s Tax-Managed Small Cap Fund has followed since its inception in 1999 (in blue below):
...

This small cap index and fund has been a money-making machine over the past 25 years, dramatically outpacing Vanguard’s S&P 500 Index (in red above). In this respect, investors have realized a substantial small cap quality effect.
Morningstar has an article floating around out there saying the same thing and also used the S&P Small-Cap 600 as their example of the Size premium returning with a vengeance when Quality is added to size. I have been a proud owner of the iShares ETF version of this index for many years, probably back to 2004 or so.
Proud that the fund has matched the returns of the S&P 500 since 2004, with much greater volatility?
https://www.portfoliovisualizer.com/bac ... ion2_2=100
My gosh, did I jinx the Small-Cap effect?
Not really.
It's just that in real life you don't typically get to cherry pick your start and end dates to fit your chosen narrative.
I didn't cherry pick the dates. That was when I bought the fund.
A fool and his money are good for business.
AlwaysLearningMore
Posts: 1914
Joined: Sun Jul 26, 2020 2:29 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by AlwaysLearningMore »

SimpleGift wrote: Sat May 27, 2023 8:00 am
nedsaid wrote: Fri May 26, 2023 7:23 pm Morningstar has an article floating around out there saying the same thing and also used the S&P Small-Cap 600 as their example of the Size premium returning with a vengeance when Quality is added to size. I have been a proud owner of the iShares ETF version of this index for many years, probably back to 2004 or so.
Similar experience here. We just happened into a S&P Small Cap 600 fund (Vanguard's Tax-Managed Small Cap Fund) nearly at its inception in 1999 — which we bought in a lump sum purchase, primarily for its tax efficiency in our all-taxable portfolio. However, its outperformance over large cap stocks in the decades since has certainly been remarkable, and it was always a puzzle to us why it was happening.

Only later did we learn about S&P's quality screens on this index fund, and then much later did we read the Asness et al. research on the small quality factor. So our perspective on this topic is certainly limited — more of a bottom-up understanding based on dumb-luck experience rather than a top-down grasp of things.
You aren't kidding. IIRC Wm. Bernstein mentioned Vanguard Tax-Managed Small Cap in one or more of his books (part of Taxable Ted's portfolio?).

Per S&P https://www.spglobal.com/spdji/en/indic ... /#overview
"The S&P SmallCap 600® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable." S&P must use a pretty good screen.

Image
Retirement is best when you have a lot to live on, and a lot to live for. * None of what I post is investment advice.* | FIRE'd July 2023
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

burritoLover wrote: Sun May 28, 2023 7:13 am
marcopolo wrote: Sat May 27, 2023 4:37 pm You are knocking down a strawman.
The whole point is that things are cyclical. It's not that those things are dead now, just like LCG was not dead back when it was underperformed, buy rather that various things lead and lag at different times. No reason to expect one thing to systemically outperform.
BurritoLover wrote: The OP declares that a diversified basket of small caps is not worth investing in. If it isn’t worth investing in, then what else would you call it other than dead? They didn’t say this was just a bad period for small caps and it would improve in the future.
That also seems like a strawman.
I believe what the OP was saying is that there is no benefit to overweighting, or "tilting" to small cap. Just like there is no benefit to doing the same with LCG. The various groups will take turns leading and lagging. So, own a well diversified portfolio, including things that might be declared "dead" at the moment because they are unlikely to stay that way forever.
That's not the impression that I got. They even specifically call out that the post has nothing to do with small-cap value. And they make several mentions that imply that the "size effect" is no longer (i.e. my translation = dead). This isn't a post about the waxing and waning of different sub-asset classes of stocks.
What do you think "size effect" means?
I always thought that meant there was systemic advantage to owning small. That is what the OP is refuting. That does not mean you should not own them. Simply, that you really should not expect outperformance in the long run. Owning them is not dead, getting better returns from over weighting them is dead, or more accurately, was probably never really alive.

If you think "size effect" just means they should be owned, but not over weighted, then we are in agreement. But, that seems contrary to what you are saying in other posts in this thread. You seem to believe that they provide a systemic advantage, that is what the OP says is dead.
Once in a while you get shown the light, in the strangest of places if you look at it right.
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

nedsaid wrote: Sun May 28, 2023 10:35 am
marcopolo wrote: Sat May 27, 2023 12:39 pm
nedsaid wrote: Sat May 27, 2023 11:29 am
rkhusky wrote: Sat May 27, 2023 9:06 am
nedsaid wrote: Fri May 26, 2023 7:23 pm

Morningstar has an article floating around out there saying the same thing and also used the S&P Small-Cap 600 as their example of the Size premium returning with a vengeance when Quality is added to size. I have been a proud owner of the iShares ETF version of this index for many years, probably back to 2004 or so.
Proud that the fund has matched the returns of the S&P 500 since 2004, with much greater volatility?
https://www.portfoliovisualizer.com/bac ... ion2_2=100
My gosh, did I jinx the Small-Cap effect?
Not really.
It's just that in real life you don't typically get to cherry pick your start and end dates to fit your chosen narrative.
I didn't cherry pick the dates. That was when I bought the fund.
I realize that.
Just pointing out why your experience turned out to be less special than advertised. It's precisely because you didn't get to cherry pick dates.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by SimpleGift »

AlwaysLearningMore wrote: Sun May 28, 2023 10:40 am S&P must use a pretty good screen.
This raises one of the problems with the quality factor in that there is no generally agreed upon screening criteria. Each of the index providers uses multiple screens, which may include profitability (gross margins, return on equity, return on invested capital), stability (e.g., earnings variability), growth (earnings growth or dividend growth), or financial health (e.g., debt/equity ratios). But each index chooses different screens! For example:
If interested, one paper has done an analysis of these various quality screens, going back to the 1960s in both domestic and international markets, to determine which ones have been the most robust: What is Quality?

In our case, it was just luck that decades ago we invested in a small cap fund with S&P's basic quality screens.
Last edited by SimpleGift on Sun May 28, 2023 12:24 pm, edited 2 times in total.
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

McQ wrote: Sat May 27, 2023 1:48 pm
marcopolo wrote: Sat May 27, 2023 12:47 pm I believe this is like trying to determine the integral of a sine wave.
even over long periods of time you can observe negative, positive, or zero values depending on the time period you choose.
Agreed. Down the road I'm thinking of a paper titled something like,

"A Sinusoid Model to Explain Fitful Factor Outperformance"

PS [off-topic aside, for Marcopolo]: Wanted to mention that on Roth conversions I eventually moved quite a bit in your direction on several points, as you will see if you look at my paper just published in the Journal of Financial Planning: https://www.financialplanningassociatio ... sions-OPEN
Interesting read, concisely captured a very long discussion on that thread.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

marcopolo wrote: Sun May 28, 2023 11:17 am
nedsaid wrote: Sun May 28, 2023 10:35 am
marcopolo wrote: Sat May 27, 2023 12:39 pm
nedsaid wrote: Sat May 27, 2023 11:29 am
rkhusky wrote: Sat May 27, 2023 9:06 am
Proud that the fund has matched the returns of the S&P 500 since 2004, with much greater volatility?
https://www.portfoliovisualizer.com/bac ... ion2_2=100
My gosh, did I jinx the Small-Cap effect?
Not really.
It's just that in real life you don't typically get to cherry pick your start and end dates to fit your chosen narrative.
I didn't cherry pick the dates. That was when I bought the fund.
I realize that.
Just pointing out why your experience turned out to be less special than advertised. It's precisely because you didn't get to cherry pick dates.
I buy stuff when I think I need to. What happened in the case of the iShares S&P 600 Small Cap Index ETF was that I made the purchase after a portfolio review by my insurance company. They said that I had very little in Small Cap stocks and recommended that I buy some so that is what I did.

I had investments in Mid-Cap funds at the time because even way back when I believed in the Small Cap premium even before I was aware of any factor research. Just seemed to me that smaller stocks had more growth potential than large stocks.

In 2007 and 2008, I added US Small Cap Value, US Micro-Cap, International Mid/Small-Cap to my portfolio after learning about the academic research at Merriman seminars. I wish I could say that I bought a bunch of T Rowe Price Small Cap Value fund when it became available in the late 1980's but I didn't learn about the Small Cap Value premium until 2007.

So I invested according to what I knew at the time and what I perceived that I needed. If I had purchased Microsoft stock back when it became public, I would be long retired, but I didn't. I did buy it in the early 2000's and have made some great money on it but I didn't know that Microsoft even existed when it came public. Didn't even buy my own personal computer until 1996.
A fool and his money are good for business.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

nisiprius wrote: Sat May 27, 2023 3:03 pm
burritoLover wrote: Sat May 27, 2023 1:30 pm...Small cap growth tends to suffer from the lottery effect. Personally, I wouldn’t invest in small cap blend for that reason. That is the whole “control your junk” point made by someone earlier....
This is the standard narrative from the factor world. And yet...

1) The Vanguard Small Cap Growth fund and the Vanguard Small Cap Value fund have been virtually tied since inception.

Source

Image

2) The DFA Small Cap Growth and Small Cap Value portfolios, ditto:

Source

Image

3) With the iShares S&P Small-Cap 600 Growth and iShares Small-Cap 600 Value, yes, there is a difference... but I don't think it is life-changing, particularly not with the amounts you would typically have in a portfolio. The average annual return was 8.51% for small growth, 9.23% for large value. But an 8.51% annual return is nothing to sneeze at.

Source

Image

The pattern here is interesting. Value pulled far ahead during value's great shining moment in 2001-2002, but then gradually lost all of back... only to pull ahead in 2022.
Nisiprius, your point regarding the very similar performance of the Vanguard Small Cap Value Index fund compared to the Vanguard Small Cap Growth Index fund since inception made me realize that perhaps Lottery stocks were not included in the indexes. This started me on the concept of anti-factors, the
types of stocks that one should avoid. I realized the bogeyman of Lottery stocks just were not in the indexes hence I could never see the Small Growth black hole that the academics discussed.

Later on I thought about the so-called Value traps, stocks that are very cheap for very good reasons. Wasn't too much of a reach to say that even within a Small Cap Value index, that the more successful companies would have larger market caps than the less successful companies, hence a market cap weighted index would tilt away from the Value traps. I added Value traps to my list of anti-factors, so now the list is at two.

After that, reasoning that the best and most successful companies would dominate the US Total Stock
Market Index and the S&P 500, I reasoned that these two indexes would have a tilt towards quality. This is a bit controversial of a point because by definition these two indexes are the market and thus should have no tilt towards or away from any of the other factors than the Market factor.

My firm conviction is that one reason that indexing is so successful is that the Lottery stock anti-factor just doesn't show up and that market cap weighting minimizes the effect of the Value traps, the other anti-factor. Furthermore, I assert that any market cap weighted index would provide some sort of a quality tilt.
The S&P 500 and the Total Stock Market Index have a factor effect by screening out the very worst stocks or minimizing their effect by market cap weighting.

This might get me kicked out of the church of factors as a heretic but so be it. This might be one reason that factor premiums are harder to see with real life investors using real life investment products than academics using their research databases. The academic research doesn't reflect what average investors could have actually invested in way back when. The style index funds didn't come into existence until the late 1990's and actively managed no-load style funds focusing on Mid and Small Cap stocks started coming on investor radar screens probably in the early 1980's.

As I think about it, a counter argument to my points is that I am not accounting for the risk of Large companies failing. Enron, Washington Mutual, Lehman Brothers are examples of large companies that failed and not many folks saw the downfall of these companies beforehand. AIG almost failed but the US Government bailed them out but shareholders saw big losses. So having a Large market cap doesn't guarantee future success. What I will say is that larger companies have more resources to weather economic storms than smaller companies, so this gives larger companies an advantage.
A fool and his money are good for business.
User avatar
Beensabu
Posts: 5618
Joined: Sun Aug 14, 2016 3:22 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Beensabu »

nedsaid wrote: Sun May 28, 2023 12:29 pm I had investments in Mid-Cap funds at the time because even way back when I believed in the Small Cap premium even before I was aware of any factor research. Just seemed to me that smaller stocks had more growth potential than large stocks.
I wonder if the reason that small cap growth is "poison" and has fared less well than small cap value is simply because the stocks with strong performance grow themselves right out of that sub-asset class and into mid cap, leaving the non-performers behind. Whereas the small cap value stocks with strong performance remain small cap (but perhaps not value), because the performance comes from having bought at a discount rather than growth.

Edit: Or perhaps this is why they have fared nearly the same over certain time periods... Small growth performers leave small cap, and small value performers leave value.

That's my (retroactive) thinking behind going with an active small/mid cap growth fund, anyway. A way to hold onto the "winners" if they're winning.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

Beensabu wrote: Sun May 28, 2023 1:24 pm I wonder if the reason that small cap growth is "poison" and has fared less well than small cap value is simply because the stocks with strong performance grow themselves right out of that sub-asset class and into mid cap, leaving the non-performers behind. Whereas the small cap value stocks with strong performance remain small cap (but perhaps not value), because the performance comes from having bought at a discount rather than growth.

Edit: Or perhaps this is why they have fared nearly the same over certain time periods... Small growth performers leave small cap, and small value performers leave value.

That's my (retroactive) thinking behind going with an active small/mid cap growth fund, anyway. A way to hold onto the "winners" if they're winning.
OK...so this factor thing is so fragile that it is at the mercy of whoever classifying size & PE, and those following it mistakenly thought SCG is poison when it wasn't at all if you keep holding it?

What a joke.
User avatar
Beensabu
Posts: 5618
Joined: Sun Aug 14, 2016 3:22 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Beensabu »

Marseille07 wrote: Sun May 28, 2023 1:48 pm
Beensabu wrote: Sun May 28, 2023 1:24 pm I wonder if the reason that small cap growth is "poison" and has fared less well than small cap value is simply because the stocks with strong performance grow themselves right out of that sub-asset class and into mid cap, leaving the non-performers behind. Whereas the small cap value stocks with strong performance remain small cap (but perhaps not value), because the performance comes from having bought at a discount rather than growth.

Edit: Or perhaps this is why they have fared nearly the same over certain time periods... Small growth performers leave small cap, and small value performers leave value.

That's my (retroactive) thinking behind going with an active small/mid cap growth fund, anyway. A way to hold onto the "winners" if they're winning.
OK...so this factor thing is so fragile that it is at the mercy of whoever classifies size & PE, and those following it mistakenly thought SCG is poison when it wasn't at all when you keep holding it?

What a joke.
I don't know about the "factor thing". I'm more of a qualitative thinker, and this was my wondering share. The point is that perhaps SCG is poison if you keep holding it as a whole, because the bits worth holding leave that group. And they are "bits", so identifying them ahead of time is like... playing the lottery. So perhaps mid cap growth is where it's at - the rising stars of small growth enter, and the still burning brights of mid cap growth leave to the large cap index that everyone holds.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

Beensabu wrote: Sun May 28, 2023 1:57 pm I don't know about the "factor thing". I'm more of a qualitative thinker, and this was my wondering share. The point is that perhaps SCG is poison if you keep holding it as a whole, because the bits worth holding leave that group. And they are "bits", so identifying them ahead of time is like... playing the lottery. So perhaps mid cap growth is where it's at - the rising stars of small growth enter, and the still burning brights of mid cap growth leave to the large cap index that everyone holds.
Problem is mid-cap growth isn't doing all that fancy: https://www.portfoliovisualizer.com/bac ... ion2_2=100

And the same line of argument also applies here - maybe great mid-cap growth leaves the group and joins large-cap growth. Turtles all the way down.
marcopolo
Posts: 8411
Joined: Sat Dec 03, 2016 9:22 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

Marseille07 wrote: Sun May 28, 2023 1:48 pm
Beensabu wrote: Sun May 28, 2023 1:24 pm I wonder if the reason that small cap growth is "poison" and has fared less well than small cap value is simply because the stocks with strong performance grow themselves right out of that sub-asset class and into mid cap, leaving the non-performers behind. Whereas the small cap value stocks with strong performance remain small cap (but perhaps not value), because the performance comes from having bought at a discount rather than growth.

Edit: Or perhaps this is why they have fared nearly the same over certain time periods... Small growth performers leave small cap, and small value performers leave value.

That's my (retroactive) thinking behind going with an active small/mid cap growth fund, anyway. A way to hold onto the "winners" if they're winning.
OK...so this factor thing is so fragile that it is at the mercy of whoever classifying size & PE, and those following it mistakenly thought SCG is poison when it wasn't at all if you keep holding it?

What a joke.
I think it was Yogi Berra that said:

In Theory There Is No Difference Between Theory and Practice, While In Practice There Is


It seems like every discussion we see about the small cap effect has advocates providing various explanations as to why it really doesn't seem to pay off in practice, while simultaneously explaining to us why it obviously should, in theory.
Once in a while you get shown the light, in the strangest of places if you look at it right.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

marcopolo wrote: Sun May 28, 2023 2:07 pm I think it was Yogi Berra that said:

In Theory There Is No Difference Between Theory and Practice, While In Practice There Is


It seems like every discussion we see about the small cap effect has advocates providing various explanations as to why it really doesn't seem to pay off in practice, while simultaneously explaining to us why it obviously should, in theory.
We're on the same page.

My stance has always been that factor investing is like betting on a side of a die. Now, there's no denying that SCV in particular has performed better; but there isn't much to it other than the side "five" showed up more than other sides.

I don't see why people come up with a nonsensical narrative like "risk will be compensated" then start calling something "poison" when the data doesn't fit their narrative. They are better served reviewing their narrative instead of trying to bend the data.
Last edited by Marseille07 on Sun May 28, 2023 2:38 pm, edited 1 time in total.
User avatar
Beensabu
Posts: 5618
Joined: Sun Aug 14, 2016 3:22 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Beensabu »

Marseille07 wrote: Sun May 28, 2023 2:00 pm
Beensabu wrote: Sun May 28, 2023 1:57 pm I don't know about the "factor thing". I'm more of a qualitative thinker, and this was my wondering share. The point is that perhaps SCG is poison if you keep holding it as a whole, because the bits worth holding leave that group. And they are "bits", so identifying them ahead of time is like... playing the lottery. So perhaps mid cap growth is where it's at - the rising stars of small growth enter, and the still burning brights of mid cap growth leave to the large cap index that everyone holds.
Problem is mid-cap growth isn't doing all that fancy: https://www.portfoliovisualizer.com/bac ... ion2_2=100
It's start and end date dependent (like everything that gets backtested). The point of backtesting is not "what did better before" or "what has done best so far" - the point is figuring out how to mix things (including that which has done poorly before) so that if future performance is different (which it very well may be), you've reduced your chances of potentially getting stuck with an undesirable outcome and increased your chances of obtaining a good enough outcome.
And the same line of argument also applies here - maybe great mid-cap growth leaves the group and joins large-cap growth. Turtles all the way down.
:D Sure, just hold large cap growth then. Or blend.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

Beensabu wrote: Sun May 28, 2023 2:37 pm It's start and end date dependent (like everything that gets backtested). The point of backtesting is not "what did better before" or "what has done best so far" - the point is figuring out how to mix things (including that which has done poorly before) so that if future performance is different (which it very well may be), you've reduced your chances of potentially getting stuck with an undesirable outcome and increased your chances of obtaining a good enough outcome.
Ask SCV holders why they hold SCV. If they don't tell you "it did better before" or "it has done best so far," they aren't being truthful.

This whole "risk compensation" talk is also that - they have this notion that holding higher-vol instruments will be rewarded later.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

Beensabu wrote: Sun May 28, 2023 1:24 pm
nedsaid wrote: Sun May 28, 2023 12:29 pm I had investments in Mid-Cap funds at the time because even way back when I believed in the Small Cap premium even before I was aware of any factor research. Just seemed to me that smaller stocks had more growth potential than large stocks.
I wonder if the reason that small cap growth is "poison" and has fared less well than small cap value is simply because the stocks with strong performance grow themselves right out of that sub-asset class and into mid cap, leaving the non-performers behind. Whereas the small cap value stocks with strong performance remain small cap (but perhaps not value), because the performance comes from having bought at a discount rather than growth.

Edit: Or perhaps this is why they have fared nearly the same over certain time periods... Small growth performers leave small cap, and small value performers leave value.

That's my (retroactive) thinking behind going with an active small/mid cap growth fund, anyway. A way to hold onto the "winners" if they're winning.
Small Cap Growth isn't poison at all. Look, no fund manager is going to put bad stocks in their fund just because they think such stocks should be represented. An index provider wants their index to do well, they aren't going to deliberately put Lottery stocks in their index, they don't want to be accused of creating a cruddy benchmark. Just as with mutual funds, there is a performance derby with indexes as well.
If the index that you worked so hard to create consistently underperformed similar other indexes, you would have the reputation for creating bad indexes, you would simply tighten your selection criteria in response.
A fool and his money are good for business.
Topic Author
McQ
Posts: 1414
Joined: Fri Jun 18, 2021 12:21 am
Location: California

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by McQ »

OP here. A gentle reminder, if I may. I am not here to declare some factor “dead” or “poison,” “alive” or “resurgent.” I am not here to declare anything at all.

I am also not qualified to say whether the statistically significant beta coefficient for SMB found in the Fama and French work, based on the application of Fama and MacBeth* regressions to monthly data, represents a model mis-specification or somehow rests on problematic data.

*Still waiting for a BH committed to factor tilts to explain to me how FM regressions work and to what extent the much greater precision of FM regressions, relative to the OLS anyone can do in Excel, underwrites the phenomenon ;-)

The thread asks a question: what could the mutual fund investor have got if they had tried to harvest the size effect using the oldest avowedly small cap mutual funds available?

Taking the OP and my second post with its cherry-picks, the answer appears to be a resounding, “It depends.”

Hope to see more charts like Nisiprius and SimpleGift have posted. Also delighted to hear different people’s interpretation of any chart.

I get to ask the question with the support of charts. You get to interpret the charts and answer the question as you see fit.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
rkhusky
Posts: 17654
Joined: Thu Aug 18, 2011 8:09 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

nedsaid wrote: Sun May 28, 2023 2:47 pm
Small Cap Growth isn't poison at all. Look, no fund manager is going to put bad stocks in their fund just because they think such stocks should be represented. An index provider wants their index to do well, they aren't going to deliberately put Lottery stocks in their index, they don't want to be accused of creating a cruddy benchmark. Just as with mutual funds, there is a performance derby with indexes as well.
If the index that you worked so hard to create consistently underperformed similar other indexes, you would have the reputation for creating bad indexes, you would simply tighten your selection criteria in response.
I don’t think indexes purposefully keep out stocks that they think won’t do well. Below are the CRSP investment screens from https://crsp.org/files/crsp-market-inde ... -guide.pdf:
INVESTABILITY SCREENS
At ranking, once the index-eligible universe is defined and capitalization-based breakpoints are determined, investability screens are applied to create the pro forma indexes, which reflect the anticipated post-reconstitution index constituents. The chart on page six summarizes these screens and provides threshold criteria that each security must meet.
The investability screens are:
• Market Capitalization: The total company market capitalization must be at least $15 million to be added to an index at ranking. If, at ranking, the total company market capitalization for a security in the index has fallen below $10 million, the security will be removed from the index.
• Float Shares: A security’s FSO, or those shares readily available for trading, must be at least 12.5 percent of the TSO in order for it to be added to an index at ranking. If the FSO of a security in the index falls below 10 percent of TSO at ranking, the security will be removed from the index. For securities qualifying as a fast-track initial public offering (IPO) the minimum float requirement is 10 percent.
• Trading Volume: CRSP determines a sparse trading score for each security by calculating the average daily split-adjusted consolidated trading volume over the last 125 trading days divided by the FSO as of the end-of-day five trading days before the ranking day. Trading data used for calculating the average for each security is collected no earlier than its first day of regular way trading on a CRSP exchange of interest. In order for a security to be considered for index inclusion at ranking, this ratio must be at least 0.001. If the ratio of a security that is currently a member of the CRSP Market Indexes falls below 0.0008 for two consecutive rankings, it is removed from the index. For the small number of organizations with multiple share classes, CRSP may consider the trading volume for all the securities that are represented in the company’s total market capitalization.
• Trading Gaps: To be considered for index inclusion at ranking, a security must not have a sequence of 10 or more consecutive non-trading (zero volume) days since the last ranking. If an index constituent fails the 10-day rule the security will be removed from the index at ranking. Days that a security is suspended by the exchange do not count toward this requirement.
• Suspended Securities: If a security has been suspended by its listing exchange for at least 40 days on the ranking day, it will be removed. If a security is suspended from trading on the ranking day, it will not be added to the CRSP Market Indexes.
• Seasoning of New Securities: New securities are eligible for index inclusion if they fulfill at least one of the two following conditions:
○ The first day of regular way trading on a CRSP exchange of interest was at least 20 trading days before the ranking day.
○ The first day of regular way trading on a CRSP exchange of interest was at least five trading days before the ranking day and the company’s capitalization is greater than or equal to the lower breakpoint of the CRSP US Small Cap Index.
Securities created by a corporate action payout are not subject to the seasoning rules. Companies that are identified as “readmitted” to an exchange of interest (e.g. transfers from OTC after previously delisting from NYSE) use the original first day of regular way trading before delisting for purposes of this check. Companies that were not previously tracked (e.g. transfers from OTC with no previous exchange of interest history) use the first day of trading after listing on an exchange of interest.
In terms of seasoning, if a company changes from an ineligible to an eligible organization type only as an internal reorganization (e.g. a conversion from an LLC or LP into a C-corp) CRSP will consider the company’s entire primary exchange trading history including the trading days before the organization type change.
If a company changes from an ineligible to an eligible organization type as a part of a conversion involving another entity, such as a de-SPAC transaction, then the resulting entity will be treated as a new company. The conversion/merger date will be the first trade date of the new entity for seasoning purposes. In these cases, the first day of trading of the new company must be twenty days before the ranking regardless of the size of the new entity.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by JoMoney »

McQ wrote: Sun May 28, 2023 5:42 pm...
The thread asks a question: what could the mutual fund investor have got if they had tried to harvest the size effect using the oldest avowedly small cap mutual funds available? ...
FWIW, I haven't seen it mentioned in this thread, but what's regarded as one of the oldest and highest returning mutual funds is the "T Rowe Price Small-Cap Stock Fund" OTCFX , I don't remember if I first read about it from something Mr. Bogle wrote, or from Jeremy Siegel, but it was one of them.
History on it goes back to mid-1956, over the past 67 years it's had something around 12.6% return annualized.
The "survivorship bias" of looking at that fund, without having other small-cap funds over time to compare to is a bit of an issue though.
Also worth pointing out that from 1982 (the first publication on purported Small-cap effect) to present, the funds return are roughly the same (actually a little less) than Vanguard's 500 fund.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
rkhusky
Posts: 17654
Joined: Thu Aug 18, 2011 8:09 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

burritoLover wrote: Sun May 28, 2023 9:11 am Not all risk is the same. Some risk is compensated for, other risks are not. You can mitigate the idiosyncratic risk (which you are not compensated for) of an individual stock by adding more stocks to the portfolio. You cannot diversify away systemic risk (that which you are compensated for). For example, you can't diversify in a way that you can have an all-stock portfolio that has stock-like returns with bond-like volatility.
So, is the risk in small caps compensated? For example, can you diversify the idiosyncratic risk of small caps by adding large caps?
User avatar
Beensabu
Posts: 5618
Joined: Sun Aug 14, 2016 3:22 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Beensabu »

nedsaid wrote: Sun May 28, 2023 2:47 pm Small Cap Growth isn't poison at all. Look, no fund manager is going to put bad stocks in their fund just because they think such stocks should be represented. An index provider wants their index to do well, they aren't going to deliberately put Lottery stocks in their index, they don't want to be accused of creating a cruddy benchmark. Just as with mutual funds, there is a performance derby with indexes as well.
If the index that you worked so hard to create consistently underperformed similar other indexes, you would have the reputation for creating bad indexes, you would simply tighten your selection criteria in response.
The perception still exists, though, right? Perceptions are exploitable.

A lottery stock is simply one with the potential for outsized returns (and the corresponding associated risk). If you cannot select them reliably, you cannot avoid them reliably either. You can avoid penny stocks, which wouldn't make it into an index anyway. You can avoid stocks that meet (or don't meet) certain criteria, and indices do just that. There are so very many of them...
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

JoMoney wrote: Sun May 28, 2023 6:05 pm
McQ wrote: Sun May 28, 2023 5:42 pm...
The thread asks a question: what could the mutual fund investor have got if they had tried to harvest the size effect using the oldest avowedly small cap mutual funds available? ...
FWIW, I haven't seen it mentioned in this thread, but what's regarded as one of the oldest and highest returning mutual funds is the "T Rowe Price Small-Cap Stock Fund" OTCFX , I don't remember if I first read about it from something Mr. Bogle wrote, or from Jeremy Siegel, but it was one of them.
History on it goes back to mid-1956, over the past 67 years it's had something around 12.6% return annualized.
The "survivorship bias" of looking at that fund, without having other small-cap funds over time to compare to is a bit of an issue though.
Also worth pointing out that from 1982 (the first publication on purported Small-cap effect) to present, the funds return are roughly the same (actually a little less) than Vanguard's 500 fund.
So pretty much, the Small Cap effect existed until the academics published about its existence. To capture the premium, you would have had to know about this before the academics and then found a good fund to capture the premium. Most of us don't have the math skills or the access to data to have discovered this on our own. My best guess is that many professional investors suspected the Small Cap premium existed hence the rollout of these type of funds, an additional problem is that most mutual funds back then and even today come with sales loads.

The T Rowe Price fund mentioned above might have had something like an 8 1/2 percent sales load and a 0.25% 12(b)1 fee, which would have taken a chunk of the premium. I see that T. Rowe Price was a pioneer in the no load funds revolution but I could not find whether or not its funds ever charged sales loads.
Last edited by nedsaid on Sun May 28, 2023 6:36 pm, edited 1 time in total.
A fool and his money are good for business.
User avatar
Charles Joseph
Posts: 2366
Joined: Tue Apr 05, 2022 10:49 pm

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Charles Joseph »

Just buy total market or S&P 500. It is good enough.
"The big money is not in the buying and selling, but in the waiting." - Charles Munger
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by JoMoney »

nedsaid wrote: Sun May 28, 2023 6:29 pm
JoMoney wrote: Sun May 28, 2023 6:05 pm
McQ wrote: Sun May 28, 2023 5:42 pm...
The thread asks a question: what could the mutual fund investor have got if they had tried to harvest the size effect using the oldest avowedly small cap mutual funds available? ...
FWIW, I haven't seen it mentioned in this thread, but what's regarded as one of the oldest and highest returning mutual funds is the "T Rowe Price Small-Cap Stock Fund" OTCFX , I don't remember if I first read about it from something Mr. Bogle wrote, or from Jeremy Siegel, but it was one of them.
History on it goes back to mid-1956, over the past 67 years it's had something around 12.6% return annualized.
The "survivorship bias" of looking at that fund, without having other small-cap funds over time to compare to is a bit of an issue though.
Also worth pointing out that from 1982 (the first publication on purported Small-cap effect) to present, the funds return are roughly the same (actually a little less) than Vanguard's 500 fund.
So pretty much, the Small Cap effect existed until the academics published about its existence. To capture the premium, you would have had to know about this before the academics and then found a good fund to capture the premium. Most of us don't have the math skills or the access to data to have discovered this on our own. My best guess is that many professional investors suspected the Small Cap premium existed hence the rollout of these type of funds, an additional problem is that most mutual funds back then and even today come with sales loads. The T Rowe Price fund mentioned above might have had something like an 8 1/2 percent sales load and a 0.25% 12(b)1 fee, which would have taken a chunk of the premium.
I don't think professional investors give much credence to 'Efficient Market' theories like "Risk Premiums", but in The Intelligent Investor, when discussing ideas an 'enterprising' (not passive - who he suggested avoid small stocks completely) investor might look at, Benjamin Graham did discuss the "Bargain-Issue Pattern in Secondary Companies" and going over the odd valuation changes from smaller companies at times being relative bargains compared to the larger 'primary' stocks, and sometimes the pendulum swinging to overvalue them.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

Beensabu wrote: Sun May 28, 2023 6:24 pm
nedsaid wrote: Sun May 28, 2023 2:47 pm Small Cap Growth isn't poison at all. Look, no fund manager is going to put bad stocks in their fund just because they think such stocks should be represented. An index provider wants their index to do well, they aren't going to deliberately put Lottery stocks in their index, they don't want to be accused of creating a cruddy benchmark. Just as with mutual funds, there is a performance derby with indexes as well.
If the index that you worked so hard to create consistently underperformed similar other indexes, you would have the reputation for creating bad indexes, you would simply tighten your selection criteria in response.
The perception still exists, though, right? Perceptions are exploitable.

A lottery stock is simply one with the potential for outsized returns (and the corresponding associated risk). If you cannot select them reliably, you cannot avoid them reliably either. You can avoid penny stocks, which wouldn't make it into an index anyway. You can avoid stocks that meet (or don't meet) certain criteria, and indices do just that. There are so very many of them...
Here are a couple Larry Swedroe quotes regarding Lottery stocks.
Lottery-like distributions have been found in IPOs, “penny stocks,” extreme high-beta stocks, small-growth stocks with low profitability and high investment, and financially distressed stocks that are either in or near bankruptcy.
Stocks with more lottery preference are smaller in size, are growth stocks, have higher momentum, are less liquid and have higher market beta than stocks with lower lottery preference.
This effect is mostly in the Small Growth area of the market and yet when you look at the performance of actual Small Growth indexes and Small Growth funds, you just don't see the "black hole of investing" effect that the academics describe. These stocks have been avoided by active managers and by the indexers otherwise we would see the "black hole effect" with real life funds.

There are limits to arbitrage to Lottery stocks, one of the limits is that many of these stocks are difficult to short because of costs and the fear of shorting such volatile stocks. When you buy a speculative stock, your downside risk is limited to your investment in the stock. When you short a speculative stock, your downside risk can be many times that if the shorted stock soars in price hence the fear of shorting. Lower trading volumes contribute to higher volatility as it takes fewer trades to really move the price. Higher costs from lower trading volumes come from higher bid/ask spreads. Hence these stocks are not efficiently priced as short sellers are reluctant to play in this arena. According to Swedroe, "They (investors with a preference for Lottery stocks) pay a premium to gamble."

https://www.advisorperspectives.com/art ... -surprised
Last edited by nedsaid on Sun May 28, 2023 7:28 pm, edited 1 time in total.
A fool and his money are good for business.
Post Reply