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

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

Post by McQ »

As a preface, and in hopes that no one will yell at me, this post does NOT address the potential outperformance of smallcap value. It concerns the size effect only, i.e., the performance of small stocks collectively, whether value, growth, or blend, relative to large stocks collectively.

Small value, as an interaction effect, does not depend on there being a statistically significant main effect for either size or value. In fact, in my home field of experimental social psychology, main effects were considered of minor importance. You published (or not), and got tenure (or not), based on your ability to find an interesting interaction effect. Non-significant main effects were frosting, not poison, adorning the cake, which was a uniquely interpretable interaction effect.

Fear not, smallcap value fans—there is nothing in this thread to threaten you.

The size effect--a brief history

Banz (1981), looking at the bottom quintile of NYSE stocks by capitalization from 1926 – 1980 inclusive, found outperformance by these (very) small stocks. https://citeseerx.ist.psu.edu/document? ... 1c3b5b79ab

Beginning in 1982, Dimensional Fund Advisors launched a mutual fund providing investors an opportunity to invest in the smallest stocks. That fund and its successors (currently Microcap) provide the “small stock” returns from 1982 forward reported in the Stocks, Bonds, Bills and Inflation yearbook.

Banz’ data is typical of historical work: it is completely cost-free, and assumes that investors can always buy or sell at the midpoint of the bid-ask spread, and that if there was no trade on the valuation day, the midpoint of a stale bid-ask spread could be used without much loss of information.

In contrast, the DFA fund beginning in 1982 provides returns that were available in the world, to actual investors, after all costs and fees, reported in keeping with strict government regulations.

A decade later, Fama and French launched the factor tilt revolution, confirming Banz’s data for size, and adding value, momentum, and more. SMB—small minus big, the performance of stocks below median capitalization against those above the median cap—is reported monthly on Ken French’s website, and annual SMB returns from 1927 – 2022 can be downloaded.

*Nisiprius is wont to say that Banz’ work was later found wanting. However, the time sequence matters: regardless of the fate of Banz’ work, if Fama-French still found a size effect a decade later, and if they have not recanted in the decades since, then academic orthodoxy continues to hold that a size effect obtains.

In theory. If able to buy and sell at the midpoint of the bid-ask spread. Last month’s spread if need be.

Note that SMB, as currently constituted, can’t be dismissed as “performance available only from the tiniest stocks, those too small for institutions to own, and too small for anyone to build much of a position without driving up the price.” SMB is all the stocks below the median against all the stocks above the median, bottom half against the top half.

*Because of skewness in the capitalization distribution, above-median stocks account for far more than half of total market capitalization. Thus, Apple alone recently surpassed the entire capitalization of the Russell 2000—which holds 66.67% of stocks in the Russell 3000, i.e., 500 above-median stocks.

The second dismissal of the size effect, with which many BH will be familiar, rests on an arbitrage argument: “The size effect might have been real in Banz’ data. But if it was real before, it would quickly be arbitraged away after publication once knowledge of its existence diffused.” One presumes the same argument would apply to any Fama-French factor after its discovery.

The empirical question remains: could a mutual fund investor have ridden the size effect to superior wealth accumulation?

Mutual fund versus mutual fund

Investors have been able to own the market of large cap stocks ever since 1976 when John Bogle launched the predecessor to today’s Vanguard 500 Index fund. The S&P fund is not strictly cap based, but it does own most of the 500 largest stocks, and most of its holdings rank high up the capitalization ladder. And it has been available for as long as the DFA fund.

Both funds provide after-cost performance on an all-in basis: commissions, transaction costs, fund management costs, client service costs, etc. If small caps outperform in the laboratory under idealized conditions, but this advantage disappears under real world conditions because of liquidity issues, wide bid-ask spreads, difficulty in building positions, yada yada, then that laboratory outperformance will not be found in the DFA fund results.

Conversely, if the DFA fund investor has outperformed the S&P investor over the 41 years available, then that provides an apples-to-apples demonstration that the size effect can be harvested to accumulate greater wealth--by actual investors using real money, as opposed to academics testing beta coefficients for statistical significance.

Here is the chart

Image

Looks like small cap did outperform … 11.35% annualized versus 11.34% annualized. Superiority of +1 bp, what’s not to like?

An investment of $10,000 turned into $822,063 with the DFA microcap fund, but only $818,297 in the S&P 500 index fund. A clear victory amounting to $3,766, or 38% of the starting portfolio value.

Oh wait. I’m told that DFA funds in that era charged a 1% load. So the final portfolio value will be $8,221 lower, corresponding to an annualized return, on the full $10,000, sans load, of 11.33%. Score now for the 500 index fund. Costs matter, as Mr. Bogle liked to say.

Oh well. Forget about the load (maybe your brother-in-law rebated the DFA charge as a credit against his annual advising fee).

Suppose you only allocated 20% to the DFA fund. Factor tilts are fine, you said to yourself, but don’t get carried away. Looks like, on a $10,000 starting investment, you would have made an extra $753 with that 20% tilt to small caps (no rebalancing on this run). Your wealth accumulation is 100.0009202% of what it would have been from the S&P 500 fund alone.

Go, size effect!

Pause for comments, and then I’ll probe these results further.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by psteinx »

A few more strikes against DFA Micro (and in some cases, other DFA funds):

1) Of course, the difficulty and fees involved with even accessing it (advisor-level, in addition to the ER itself).

2) Likely higher risk.

3) Likely worse for taxes (and fewer individual investors had substantial tax deferred in the early years). Micro graduates companies (to large cap) at the top of its valuation range, S&P 500 typically loses companies at the bottom.

4) Not sure if your numbers account for lower costs on Vanguard's admiral share class, which kicked in at some point, and most investors (by dollar-weight anyways) likely could/would have switched to.

5) Timing effects for most of the factor tilters have likely been terrible. Most folks became aware of factor tilting from about 2004-2010 or so, after factors had had a big run (vs. market beta) from 2000-2004. I suspect that DFA's US equity funds have been relatively worse on a dollar-weighted versus a time-weighted basis vs. a simple S&P 500 (or TSM) benchmark.

6) At least one prominent tilting advocate (who used to post a lot here and is still revered by, IMO, too many on these forums) used the allegedly higher performance of tilting strategies to justify lower equity exposures. But in fact, if you lowered your equity exposure, but got ~the same returns on your equities (i.e. micro and/or other tilts didn't deliver), then you likely fell short of those who maintained "full" equity exposure, untilted. 1982 forward is a pretty GREAT period to be heavily in equities, especially US equities.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by psteinx »

Cubs fans used to say "Every team can have a bad century."

Maybe small/micro tilters are just having a bad half-century...

EDIT - I did my math wrong - mere 41 years in, not 51 as I was thinking. Those 65 year olds who started overweighting small at 24 have a couple decades yet for things to really pay off!
Last edited by psteinx on Fri May 26, 2023 9:29 am, edited 1 time in total.
Gaston
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Gaston »

McQ wrote: Thu May 25, 2023 10:26 pm Go, size effect!
Good post. Thank you.

Sometimes it feels that one can find a credible source for whatever one wants to believe. Dr. Eugene Fama, for example, has said that there is no justification for the size effect (Rational Reminder podcast, episode 200, timestamp 00:33:00). However, his former student, Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Starting in 1992 - the year Fama and French's "factor" paper was published, with equivalent low-cost funds (Vanguard which has had no load fees since 1977), the small fund averaged an extra EDIT: 0.17% per year. Starting with $10k with 20% tilt to small, you would have made an extra $4711 to date. Granted, not the historical small premium we would expect (with a long-only portfolio, should be something over 1% I would imagine, long-short was over 2% I believe) but not a total nothing burger if you could have stuck with it.

Image
Last edited by burritoLover on Sat May 27, 2023 11:29 am, edited 1 time in total.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

One can see in the plots that sometimes SC outperforms LC and sometimes LC outperforms SC, so any overall outperformance depends on the endpoints of the time period. Perhaps it will continue that way into the future. Or not. Added risk in the stock market is no guarantee of added return.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

McQ wrote: Thu May 25, 2023 10:26 pm...Oh wait. I’m told that DFA funds in that era charged a 1% load. So the final portfolio value will be $8,221 lower, corresponding to an annualized return, on the full $10,000, sans load, of 11.33%.
We talk a lot about the indexing revolution in this forum, but it occurs to me that the "no-load revolution" was important, too.

As far as I know the Vanguard 500 Index fund was always no-load, but I don't think John C. Bogle led the charge against sales loads. I'm not really clear on just how that happened. Probably Charles Schwab had a lot to do with it, just as Schwab helped with the mainstreaming of mutual funds by building the business mechanisms that made it possible and normal to buy mutual funds through brokerages. Certainly Schwab advertised the availability of hundreds of no-load funds as part of the appeal of its "mutual fund supermarket."

Before brokerages offered mutual funds, it was actually pretty difficult to buy an index fund. To begin with, no brokerage or advisor was ever going to volunteer any information about them, not even about their existence. To become aware of their existence, you couldn't walk into a brokerage storefront, you pretty much had to see a Vanguard ad, or read about it in a book (like Andrew Tobias' "The Only Investment Book You Will Ever Need.") And then, I think you pretty much had to write to Vanguard. Pre-Schwab, the only way to hold a mutual fund--and for some time later, the common way--was to open an account directly at a fund company. The fact that you could perform free exchanges within a fund family in these accounts was a big deal, and thus you would judge a mutual fund, not merely on its own merits, but on the merits of the entire fund family.

In 1972, in New York magazine, Charles and Susan Ellis wrote:
Conventional mutual funds may be the only firms in town which, if they raised the price of their merchandise, would sell more of it. The reason is that built into the price of each share is a hefty sales commission that has proved, over the years, to be a powerful incentive to a legion of hard-selling salesmen….

No-load funds in general are no better than load funds in general, but the point is—as proved year after year by Forbes magazine and others—that they are no worse either. Why anyone would want to invest $1,000, say, in a load fund, knowing that only $920 of it will go to work for him, when he could invest the same amount in a no-load and see the whole $1,000 invested, is beyond us.
And in 1978, Andrew Tobias wrote:
The first step in choosing among mutual funds is about the only one that is at all clear-cut. There are funds that charge individual sales fees of 3% or more, known as the “load”; and there are others that charge no load. Choose a no-load fund. To do otherwise is to throw money out the window.
This was controversial and debated into the 1980s. It was common to suggest that you had to pay a load to get the "best" funds.
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SimpleGift
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by SimpleGift »

Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Svensk Anga »

rkhusky wrote: Fri May 26, 2023 6:26 am One can see in the plots that sometimes SC outperforms LC and sometimes LC outperforms SC, so any overall outperformance depends on the endpoints of the time period. Perhaps it will continue that way into the future. Or not. Added risk in the stock market is no guarantee of added return.
The back-and-forth in returns leadership also suggests that there was a rebalancing bonus to be had, provided one was wise to the effect and disciplined enough to implement it through the years.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Taylor Larimore »

Bogleheads:

Using "Past Performance" to forecast future performance is so misleading that the U.S. Government requires Mutual Fund Companies to tell us that "Past Performance" does not forecast future performance.

I suggest we listen to Nobel Laureate's--not small-cap fund salesmen:

Douglas Diamond: "Asked what he’ll do with his share of the prize money, Diamond said he’ll probably put it in a total market index fund."

Eugene Fama: "Whether you decide to tilt toward value depends on whether you are willing to bear the associated risk...The market portfolio is always efficient...For most people, the market portfolio is the most sensible decision."

Daniel Kahneman: "Investors shouldn't delude themselves about beating the market. They're just not going to do it. It's just not going to happen."

Harry Markowitz: "A foolish attempt to beat the market and get rich quickly will make one's broker rich and oneself much less so."

Merton Miller: "Most people might just as well buy a share of the whole market, which pools all the information, than delude themselves into thinking they know something the market doesn't"

Paul Samuelson: "The most efficient way to diversify a stock portfolio is with a low-fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios."

William Sharpe: "You may think your opinion is superior, but it pays to be humble, investing in the market rather than trying to beat it."

Robert Shiller: "A portfolio approximating the market may be the most important portfolio."

Experts agree.

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

Post by rkhusky »

SimpleGift wrote: Fri May 26, 2023 8:44 am
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
However, over the last dozen years, VFINX has done better. Who knows what the next dozen years will bring?
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by SimpleGift »

rkhusky wrote: Fri May 26, 2023 9:13 amWho knows what the next dozen years will bring?
A very good reason to diversify among both large cap and small cap stocks.

"Diversification is a safety factor that is essential because we should be humble enough to admit we can be wrong.” Sir John Templeton, 1912-2008
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

Gaston wrote: Fri May 26, 2023 6:06 am ...However, his former student, Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk...
https://funds.aqr.com >> view by asset class >> equities
>> asset class: equities, and uncheck everything but "small cap"
>> share class, uncheck everything but "I"

We are left with exactly two AQR small-cap mutual funds:
AQR Small Cap Momentum Style Fund, ASMOX
AQR Small Cap Multi-Style Fund, QSMLX

We have at least ten years of data for each of these funds.

Since inception, ASMOX was outperformed by the Vanguard Small-cap Index Fund, NAESX, and both were outperformed by Vanguard Total Stock, VTSAX.

Since inception, QSMLX was outperformed by the Vanguard Small-cap Index Fund, NAESX, and both were outperformed by Vanguard Total Stock, VTSAX.

Dr. Cliff Asness used the phrase "Size Matters, If You Control Your Junk." I don't know if AQR was "controlling its junk" but certainly investors didn't lose out on anything important by just using Total Stock.

ASMOX

Image

QSMLX

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

Post by SimpleGift »

nisiprius wrote: Fri May 26, 2023 1:07 pm Dr. Cliff Asness used the phrase "Size Matters, If You Control Your Junk." I don't know if AQR was "controlling its junk" but certainly investors didn't lose out on anything important by just using Total Stock.
To be fair, one should look at the historical performance of small cap indexes or funds that actually have quality screens or requirements for inclusion — rather than two random AQR small cap funds with momentum and multi-style in their names.

From the linked paper by Asness et al., these were the quality criteria used in their study of historical U.S. and international small cap performance:
Asness et al. wrote:We use as different determinants of quality the profitability and investment measures of Fama and French (2016); the profitability, growth, safety, and payout measures of Asness et al. (2014) as well as their composite index of quality, which is an average of these measures; a revised composite index of Asness et al. (2017) that excludes pay-out and drops accruals from the growth composite; a Safe-Minus-Risky (SMR) factor based off of the betting-against-beta (BAB) factor from Frazzini and Pedersen (2014), where for simplicity we will refer to this factor throughout the paper as simply BAB; and credit ratings of corporate debt.
Much simpler and more accessible for the retail investor, these are the quality screens used by the S&P Small Cap 600 Index:
None of this is meant to counter Professor McQ’s original post on the historical small cap effect, which he found to be microscopic for micro-cap stocks in general. The quality small cap effect is just an interesting sidelight — but one that can easily be invested in with S&P’s Small Cap 600 index, as one example.
Last edited by SimpleGift on Fri May 26, 2023 6:07 pm, edited 1 time in total.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by McQ »

SimpleGift wrote: Fri May 26, 2023 3:45 pm
nisiprius wrote: Fri May 26, 2023 1:07 pm Dr. Cliff Asness used the phrase "Size Matters, If You Control Your Junk." I don't know if AQR was "controlling its junk" but certainly investors didn't lose out on anything important by just using Total Stock.
To be fair, one should look at the historical performance of small cap indexes or funds that actually have quality screens or requirements for inclusion — rather than two random AQR small cap funds with momentum and multi-style in their names.

From the linked paper by Asness et. al., these were the quality criteria used in their study of historical U.S. and international small cap performance:
Asness et. al. wrote:We use as different determinants of quality the profitability and investment measures of Fama and French (2016); the profitability, growth, safety, and payout measures of Asness et al. (2014) as well as their composite index of quality, which is an average of these measures; a revised composite index of Asness et al. (2017) that excludes pay-out and drops accruals from the growth composite; a Safe-Minus-Risky (SMR) factor based off of the betting-against-beta (BAB) factor from Frazzini and Pedersen (2014), where for simplicity we will refer to this factor throughout the paper as simply BAB; and credit ratings of corporate debt.
Much simpler and more accessible for the retail investor, these are the quality screens used by the S&P Small Cap 600 Index:
None of this is meant to counter Professor McQ’s original post on the historical small cap effect, which he found to be microscopic for micro-cap stocks in general. The quality small cap effect is just an interesting sidelight — but one that can easily be invested in with S&P’s Small Cap 600 index, as one example.
Nicely done, SimpleGift. I'll build on what you and Nisiprius did in a few days, when I expand the scope to small cap value. In the meantime, thanks for adding this content to the thread.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by unwitting_gulag »

rkhusky wrote: Fri May 26, 2023 9:13 am However, over the last dozen years, VFINX has done better. Who knows what the next dozen years will bring?
It's done better since around 2003-2004, or in other words, around 20 years. That isn't a mere blip, even over a full human lifetime. Also the log-plot, as do most log-plots, is an obfuscation, even if an innocent one. Large cumulative differences can appear to be small.

We should also mention volatility. Not only have small-caps underperformed, but the Russell-2000 and Vanguard small-cap index fund have been more volatile than the S&P 500. Less return, and more volatility! Is there any way to add more insult to injury?
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by McQ »

There’s no law against cherry-picking here on the forum, right? viewtopic.php?t=401454

So let’s have a little weekend fun.

Same data series as before, lowest cost version of VFIAX (SP 500 fund) per Simba’s spreadsheet, DFA Microcap and predecessors per the SBBI.

But this time I anchor the series to December 31st, 1993, giving exactly 29 years of performance through the end of 2022, almost three decades. Thirty years is a good proxy for “the long run,” wouldn’t you agree?

Image

Wow. Now that’s a size effect: 10.44% for small stocks, only 9.60% for large stocks. Small stocks turned $10,000 into $177,719, large stocks only $142,655, an increment over 3X the starting value.

But hey, as long as we are cherry-picking, let’s take a different cut: back to the December 1981 start point, terminating 18 years later at the end of 1999.

Image

Whoa! That’s an ANTI-size effect. The S&P 500 fund turned $10,000 into $203,285, the DFA fund only gave $111,288. Small stocks underperformed by almost 400 bp, 14.32% annualized to 18.21%.

There you have it.

Do small caps outperform, under real-world, with-cost conditions?

You let me pick the cherries, I’ll produce whichever answer you want.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

So your conclusion is what exactly? There's no risk premium for small stocks?
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

SimpleGift wrote: Fri May 26, 2023 3:45 pm...To be fair, one should look at the historical performance of small cap indexes or funds that actually have quality screens or requirements for inclusion — rather than two random AQR small cap funds with momentum and multi-style in their names...
They're not "random," I tried to look at all the small cap funds AQR offers. Did I miss one?

ASMOX does not show high on the quality factor according to Morningstar. But QSMLX does. In fact its factor profile is similar to that of XSHQ, the Invesco SmallCap Quality ETF, which tracks the S&P SmallCap 600® Quality Index. It was the only fund or ETF I could find that explicitly tracks small-cap quality. (For VTMSX, see below.

Size Matters, If You Control Your Junk was published in 2015, so if Cliff Asness believed that QMJ was hugely important and not being properly exploited by existing AQR funds, there has been plenty of time to launch one.


QSMLX, XSHQ

Image

I won't post the image, but these funds have tracked fairly close to each other in performance. during the time they've existed. But QSMLX takes us back much farther than XSHQ.

QSMLX is not merely from AQR; it lists Cliff Asness first among the fund managers.

So QSMLX is: And since inception--see chart and statistics--it has underperformed
  1. a small-cap fund with no quality screen,
  2. a total stock market fund with no small-cap tilt, and
  3. an S&P 500 fund with a slight large-cap tilt.
The most interesting detail to me is #1. Cliff Asness repeatedly says that the quality factor "resurrects" the size factor (and of course you can only resurrect something by acknowledging that it was dead). Over the lifetime of QSMLX, small-caps returned a CAGR of 8.84%, the S&P 500 12.27%, a underperformance of (geometric difference) 3.15% per year. But tilting to quality didn't "resurrect" the size effect or close the gap; it widened it slightly.
Last edited by nisiprius on Fri May 26, 2023 7:38 pm, edited 1 time in total.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

SimpleGift wrote: Fri May 26, 2023 8:44 am
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

SimpleGift wrote: Fri May 26, 2023 8:44 am...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...
If it is controlling for quality, the effect is not obvious to me.

Morningstar thinks it is lower in quality than the category average for small-cap blend funds, and certainly lower in quality than an S&P 500 fund.

https://www.morningstar.com/funds/xnas/vtmsx/portfolio]VTMSX[/url], VFIAX (S&P 500)

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

Post by secondopinion »

From all the data, there is a size effect in the sense it causes some deviation from the market. Whether it results in any extra returns is debatable.

Once we can figure out under what conditions should an investor tilt towards small-cap, I could determine if I am one of them or not. Is smallness risk a positively skewed risk or is it negatively skewed (after one accounts for the other factors and the often higher beta)? I have had such trouble with how it interacts with growth and value to determine it; I wonder if it is positively skewed.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by SimpleGift »

nisiprius wrote: Fri May 26, 2023 7:07 pm The most interesting detail to me is #1. Cliff Asness repeatedly says that the quality factor "resurrects" the size factor (and of course you can only resurrect something by acknowledging that it was dead). Over the lifetime of QSMLX, small-caps returned a CAGR of 8.84%, the S&P 500 12.27%, a underperformance of (geometric difference) 3.15% per year. But tilting to quality didn't "resurrect" the size effect or close the gap; it widened it slightly.
Arguing against the small cap quality factor based on a single mutual fund that a) is only 10 years old, and b) is a multi-factor fund featuring "drivers of returns such as value, momentum, and quality/profitability" doesn’t seem quite kosher. Better to go back the original Asness et al. paper on the small quality factor and their research results:
Asness et al. wrote:Panel B of Fig. 7 plots the rolling ten-year betas of each size decile. Again, the time series variation in the betas is relatively small, but more interesting, the ordered relation between size and quality or junk is extremely stable though time, as smaller size deciles consistently have more negative quality betas and the effect is very stable throughout the sample.

Few periods exist in which betas with respect to quality are not ordered almost perfectly by size, a remarkable feat considering the estimation error inherent in beta estimates. Repeating the same exercise for other measures of quality or junk using the various measures of Asness et al. (2014), Fama and French (2016), or Frazzini and Pedersen (2014) yields similar results.
As is so often the case with research on these various risk premia or factors, determining their effectiveness in actual real-world mutual funds or ETFs — with their differing expense ratios, portfolio constructions, quality screens, and start-and-end dates — is always going to be problematic. But the original research here is intriquing, to my mind.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by BetaTracker »

Holy cow, that first chart you used as a primary example of your argument looked really inaccurate.
So, I put DFA US Microcap (DFSCX) into Portfolio Visualizer against Vanguard Total Stock Market Index Fund (VSTMX) … and it showed from Jan. 1993-April 2023:
—- The DFA US Microcap produced a CAGR of 10.63% vs. VTSMX with 9.63% in that period.
— If you’d put $10,000 into both in 1993, the Microcap fund would’ve returned $214,279.00 while the large-cap oriented VTSMX would’ve returned $162,467.00
Such a large difference makes sense because the microcap fund had an average standard deviation of 20.44 vs. 15.34 in that nearly 30-year period.
Maybe you were using a price chart, not a total returns chart that included all dividends and other distributions?
Also, Fama’s research has found that the small cap premium is not only less pronounced than the value premium, but also less persistent.
Another observation: Comparing a blended fund with a lot of growth in the small cap asset class seems like it’s missing one of the major points of Fama and others’ work in this area — when combined, the small and value premiums are much more pronounced than when implemented separately. It might be argued, then, that considering a small-cap value index/fund against a total stock market index/fund might be a more practical application. More precisely, comparing a small-cap value index/fund against a large-cap value index/fund might be the most appropriate review. [Worth mentioning: If you’re comparing different funds, Vanguard’s index funds don’t have as great of a value or size loadings (tilts) as DFA’s or some other index funds.}
Also, the beauty of indexing is that you don’t have to rely on active management’s game of hiding poor results over the years by using style drift and not accounting properly for survivorship bias. In that respect, if you’re going to study the significance of factor tilts, why not use one of indexing’s strengths — you can go directly to the indexes to collect and analyze data over the longest period available.
A key point suggested in Nobel laureate-level research by Fama and Markowitz, among others, is that you need a robust enough data set to develop real insights. Fama has written that he likes to see at least 30 years worth of data to have enough confidence to formulate any sort of working hypothesis.
In other words, why would you simply want to go back to 1993 to try to come up with a good strategy of how to allocate your portfolio between small and large caps? If you’re an indexer, it would seem to make sense to take advantage of the much more abundant and consistent level of market data available through indexes … then, match the appropriate fund(s) depending on how much risk you want a portfolio to be exposed to at any given time.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

burritoLover wrote: Fri May 26, 2023 6:17 am Starting in 1992 - the year Fama and French's "factor" paper was published, with equivalent low-cost funds (Vanguard which has had no load fees since 1977), the small fund averaged an extra 0.23% per year. Starting with $10k with 20% tilt to small, you would have made an extra $4711 to date. Granted, not the historical small premium we would expect (with a long-only portfolio, should be something over 1% I would imagine, long-short was over 2% I believe) but not a total nothing burger if you could have stuck with it.

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Why would we "expect" that?
Just because it has happened over sometime period in the past does not mean it will happen on your relevant time period. It appears the outperformance of either is cyclical (not all that surprising), and which one wins, and buy how much, is mostly dependent on your chosen time period.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

SimpleGift wrote: Fri May 26, 2023 8:44 am
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
I suppose if you slice things finely enough, and look back historically, you can find all sort of things that provide outperformance, maybe we should be looking at the "companies named after fruit" factor.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

marcopolo wrote: Sat May 27, 2023 4:49 am
burritoLover wrote: Fri May 26, 2023 6:17 am Starting in 1992 - the year Fama and French's "factor" paper was published, with equivalent low-cost funds (Vanguard which has had no load fees since 1977), the small fund averaged an extra 0.23% per year. Starting with $10k with 20% tilt to small, you would have made an extra $4711 to date. Granted, not the historical small premium we would expect (with a long-only portfolio, should be something over 1% I would imagine, long-short was over 2% I believe) but not a total nothing burger if you could have stuck with it.

Image
Why would we "expect" that?
Just because it has happened over sometime period in the past does not mean it will happen on your relevant time period. It appears the outperformance of either is cyclical (not all that surprising), and which one wins, and buy how much, is mostly dependent on your chosen time period.
That isn't what I'm saying. This is taken in context of the OP's comments - primarily what I've copied below. I was showing a comparison of 30 years of two low-cost funds (both Vanguard) where the small cap fund was instituted around the time of Fama and French's 3-factor paper. The mention of expected returns pertains to the historical factor premiums. I don't make any claims about what the future holds for factor premiums but I do believe, however, there is some risk premium with small caps.

An apples-to-apples comparison (low-cost Vanguard funds) shows that it isn't a complete waste of time - if someone wants to take on more risk on their equity side (which include increased volatility and drawdown risk), it wasn't a complete nothing burger over the last 30 years. And this period includes the incredible run of US large caps after the GFC. What does the future hold for small caps? No one knows, but I don't think a 20% tilt to small caps is anything unreasonable if you can stick with it.
McQ wrote: Both funds provide after-cost performance on an all-in basis: commissions, transaction costs, fund management costs, client service costs, etc. If small caps outperform in the laboratory under idealized conditions, but this advantage disappears under real world conditions because of liquidity issues, wide bid-ask spreads, difficulty in building positions, yada yada, then that laboratory outperformance will not be found in the DFA fund results.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by SimpleGift »

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

Post by Raycpact »

I have a question about small cap. It seems to me the large tech companies often purchase smaller companies that look like they have a good potential. Does that mean that we see the small cap value come through the larger companies? Does it mean the small cap companies never have a chance to fully develop on their own before being swallowed by a larger company? Are we receiving the small cap premium through the large companies?
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by rkhusky »

nedsaid wrote: Fri May 26, 2023 7:23 pm
SimpleGift wrote: Fri May 26, 2023 8:44 am
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by JoMoney »

rkhusky wrote: Fri May 26, 2023 9:13 am
SimpleGift wrote: Fri May 26, 2023 8:44 am
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
However, over the last dozen years, VFINX has done better. Who knows what the next dozen years will bring?
The VFINX fund vastly out-performed small caps over the dozen+ years prior to the 1999 start date of that fund as well.
... and looking at the entire period available for the DFSCX fund that was created with the intent of capturing the "Smallcap Effect" one doesn't see any outperformance,
And an "elephant in the room" is people neglecting to compare the Russell 2000 index performance, which is by far the "small cap index" du jour that a lot of indexed money would have been indexed to.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Raycpact wrote: Sat May 27, 2023 8:55 am I have a question about small cap. It seems to me the large tech companies often purchase smaller companies that look like they have a good potential. Does that mean that we see the small cap value come through the larger companies? Does it mean the small cap companies never have a chance to fully develop on their own before being swallowed by a larger company? Are we receiving the small cap premium through the large companies?
It might be interesting to look at the percentage of small companies acquired that are in the value or in the growth space. I would guess this happens more often in the growth space but would be curious if there are any stats out there on this.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 7:05 am An apples-to-apples comparison (low-cost Vanguard funds) shows that it isn't a complete waste of time - if someone wants to take on more risk on their equity side (which include increased volatility and drawdown risk), it wasn't a complete nothing burger over the last 30 years. And this period includes the incredible run of US large caps after the GFC. What does the future hold for small caps? No one knows, but I don't think a 20% tilt to small caps is anything unreasonable if you can stick with it.
It is unreasonable in the sense that it is unnecessary. It's kind of like going to the gas station and get 8 gallons of 87 and 2 gallons of 89. You could do this but it is an unusual way of pumping.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 11:01 am
burritoLover wrote: Sat May 27, 2023 7:05 am An apples-to-apples comparison (low-cost Vanguard funds) shows that it isn't a complete waste of time - if someone wants to take on more risk on their equity side (which include increased volatility and drawdown risk), it wasn't a complete nothing burger over the last 30 years. And this period includes the incredible run of US large caps after the GFC. What does the future hold for small caps? No one knows, but I don't think a 20% tilt to small caps is anything unreasonable if you can stick with it.
It is unreasonable in the sense that it is unnecessary. It's kind of like going to the gas station and get 8 gallons of 87 and 2 gallons of 89. You could do this but it is an unusual way of pumping with merits unclear.
Well, we talk a lot here about taking on more equity than bond risk when we have the need, willingness and ability to take on more risk. The same concept can apply if you wish to take on more risk than the market portfolio in the equities space. Or, you may have a job at a mega corp and large cap performance is more highly correlated to your job security so you may want to diversify that risk by holding a small cap tilt.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 11:10 am Well, we talk a lot here about taking on more equity than bond risk when we have the need, willingness and ability to take on more risk. The same concept can apply if you wish to take on more risk than the market portfolio in the equities space. Or, you may have a job at a mega corp and large cap performance is more highly correlated to your job security so you may want to diversify that risk by holding a small cap tilt.
I looked at the graph posted above and it seemed like a wash to me. Small cap value seems *slightly* riskier - but the key word is slightly. You don't really feel it over the course of 30 years, especially when you only allocate 20% of equities to it.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 11:15 am
burritoLover wrote: Sat May 27, 2023 11:10 am Well, we talk a lot here about taking on more equity than bond risk when we have the need, willingness and ability to take on more risk. The same concept can apply if you wish to take on more risk than the market portfolio in the equities space. Or, you may have a job at a mega corp and large cap performance is more highly correlated to your job security so you may want to diversify that risk by holding a small cap tilt.
I looked at the graph posted above and it seemed like a wash to me. Small cap value seems *slightly* riskier - but the key word is slightly. You don't really feel it over the course of 30 years, especially when you only allocate 20% of equities to it.
Keep in mind we are talking about small caps not small cap value and a period that was not very kind to small caps. We don't know what the future holds, but it is not unreasonable to expect a higher return from small caps over long periods and for someone who is willing to take on that risk and can handle the volatility to allocate a tilt to it. Just like someone might tilt towards high-yield bonds for example rather than just stick with total bond.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

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.
The screening for Quality is one reason I am a big fan of the S&P Indexes.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nedsaid »

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
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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?
A fool and his money are good for business.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

burritoLover wrote: Sat May 27, 2023 11:24 am Keep in mind we are talking about small caps not small cap value and a period that was not very kind to small caps. We don't know what the future holds, but it is not unreasonable to expect a higher return from small caps over long periods and for someone who is willing to take on that risk and can handle the volatility to allocate a tilt to it. Just like someone might tilt towards high-yield bonds for example rather than just stick with total bond.
It's not unreasonable to chase past SCV performance, but your reasoning is unsound. It has little to do with risk or volatility.

For example, SCG is even more volatile than SCV but the returns have been poor: https://www.portfoliovisualizer.com/bac ... ion2_2=100
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

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
Gaston wrote: Fri May 26, 2023 6:06 am ....Dr. Cliff Asness, argues the size effect is alive and well if one controls for quality (ie., junky stocks). Here is his paper on the topic: https://www.aqr.com/Insights/Research/W ... -Your-Junk

So I guess it's a case of pick your poison and proceed with caution.
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.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by marcopolo »

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.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by unwitting_gulag »

BetaTracker wrote: Fri May 26, 2023 10:28 pmA key point suggested in Nobel laureate-level research by Fama and Markowitz, among others, is that you need a robust enough data set to develop real insights. Fama has written that he likes to see at least 30 years worth of data to have enough confidence to formulate any sort of working hypothesis.
The professors' logic is unimpeachable. But even if we definitively find out-performance by some asset class, cumulatively, over lengthy periods, what if this out-performance is in an incommodious time during an investor's individual life? If I did super-well as a young person, who didn't have much money, only to do lousily in more recent years, when I had more money, the CAGR of the asset may be good, but my personal CAGR won't be.

Which brings us to...
burritoLover wrote: Sat May 27, 2023 11:24 am...We don't know what the future holds, but it is not unreasonable to expect a higher return from small caps over long periods and for someone who is willing to take on that risk and can handle the volatility to allocate a tilt to it.
Good point, but isn't that the whole crux of the debate? If it's "reasonable to expect" SOME higher return over "long periods", and we've just gone through (and are still amidst?) a lengthy period of under-performance by small caps, it's so darn appealing to be optimistic about small-caps outperforming in the ensuing decades. That's an actionable conclusion, is it not? But is it correct?
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by nisiprius »

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. A little, yes.

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VFIAX, Vanguard [S&P] 500 Index Fund

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Last edited by nisiprius on Sun May 28, 2023 8:06 pm, edited 2 times in total.
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by secondopinion »

Raycpact wrote: Sat May 27, 2023 8:55 am I have a question about small cap. It seems to me the large tech companies often purchase smaller companies that look like they have a good potential. Does that mean that we see the small cap value come through the larger companies? Does it mean the small cap companies never have a chance to fully develop on their own before being swallowed by a larger company? Are we receiving the small cap premium through the large companies?
If the company gets acquired, then the fund effectively sells it; therefore, anything that happens to the company afterwards is irrelevant to the funds returns. What happens prior to it matters. Sometimes, acquisition is the goal for some of the smaller companies; and good results in an acquisition can be quite profitable for the shareholders (especially if public and the large company has to pay a premium to acquire all the shares).

So to answer the question, the acquired company sometimes adds to the large company; but it is often a risky prospect for a large company.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
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burritoLover
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 12:31 pm
burritoLover wrote: Sat May 27, 2023 11:24 am Keep in mind we are talking about small caps not small cap value and a period that was not very kind to small caps. We don't know what the future holds, but it is not unreasonable to expect a higher return from small caps over long periods and for someone who is willing to take on that risk and can handle the volatility to allocate a tilt to it. Just like someone might tilt towards high-yield bonds for example rather than just stick with total bond.
It's not unreasonable to chase past SCV performance, but your reasoning is unsound. It has little to do with risk or volatility.

For example, SCG is even more volatile than SCV but the returns have been poor: https://www.portfoliovisualizer.com/bac ... ion2_2=100
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.
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McQ
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by McQ »

JoMoney wrote: Sat May 27, 2023 9:25 am ...
And an "elephant in the room" is people neglecting to compare the Russell 2000 index performance, which is by far the "small cap index" du jour that a lot of indexed money would have been indexed to.
Good point. But as you may recall, Vanguard used to index some funds to the Russell 2000, but moved on: too much gaming by traders around the June reconstitution date (I believe there was even an academic study documenting the gaming).

So we need a mutual fund, for sure, to measure investor returns on the Russell 2000 index, and I didn't think there would be a fund as old as the DFA (Russell 2000 dates to 1984).

Anyone know the oldest mutual fund tracking the Russell 2000 continuously?

PS: it's easy to find small cap funds after 1993, but as my cherry pick #2 showed, small cap performance looks very different after that date.
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.
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McQ
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by McQ »

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
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.
Marseille07
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

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.
It's dangerous to craft extra narratives when the data doesn't fit your thesis. You argued that taking higher risk will be compensated solely on the basis of taking higher risk. It's better to review the thesis instead, for it might not have been correct.
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burritoLover
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by burritoLover »

Marseille07 wrote: Sat May 27, 2023 1:54 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.
It's dangerous to craft extra narratives when the data doesn't fit your thesis. You argued that taking higher risk will be compensated solely on the basis of taking higher risk. It's better to review the thesis instead, for it might not have been correct.
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.
Marseille07
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Re: How Much of the Smallcap Effect Could Mutual Fund Investors Have Got?

Post by Marseille07 »

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.
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