Small Cap Value vs US Total Stock Market

Discussion of the Stock portion of the Permanent Portfolio

Moderator: Global Moderator

Post Reply
ppnewbie
Executive Member
Executive Member
Posts: 862
Joined: Fri May 03, 2019 6:04 pm

Small Cap Value vs US Total Stock Market

Post by ppnewbie »

Interested in hearing opinions about SCV vs TSM investing for my children. Seems like over the long term SCV beats TSM by a long way. Wondering if there are any gotcha's with SCV. I'm planning on starting with one automated investment to keep things simple.
Attachments
Screen Shot 2023-05-08 at 9.17.17 PM.png
Screen Shot 2023-05-08 at 9.17.17 PM.png (294.2 KiB) Viewed 5700 times
D1984
Executive Member
Executive Member
Posts: 730
Joined: Tue Aug 16, 2011 7:23 pm

Re: Small Cap Value vs US Total Stock Market

Post by D1984 »

ppnewbie wrote: Mon May 08, 2023 11:17 pm Interested in hearing opinions about SCV vs TSM investing for my children. Seems like over the long term SCV beats TSM by a long way. Wondering if there are any gotcha's with SCV. I'm planning on starting with one automated investment to keep things simple.
Two come immediately to mind (although they aren't so much "gotchas" as just points to be aware of).

One, if this investment is to be in taxable be aware that SCV--being composed of value stocks--will probably throw off a bit more in (taxable) dividends than TSM will or the S&P 500 will.

Two, whoever this investment is for (presumably you and then eventually your children/your heirs) has to be aware of--and fully accepting of -the fact that while SCV has outperformed over the long-term and (hopefully) will keep doing so--and there are indeed fundamental reasons that this should theoretically be the case--almost all of its outperformance has come in "bursts" and/or "fits and starts". 1933-1936, 1942-1945, 1954-1958, 1965-1968, 1975-1979, 1981-83, 1991-93, 2000-06, 2012-13, and then most recently late Sept or early Oct 2020 to late Feb or early March 2023. SCV will appear to be stinking up the joint (i.e. underperforming badly compared to TSM) and then all of a sudden will go on a years-long tear. If you sell at exactly the worst possible time (i.e. after years of seemingly never ending underperformance) owning SCV instead of TSM will have been for naught; for instance, if you had bought SCV (in the form of DFSVX) at its inception in early 1993 and held until today you would've enjoyed a roughly 1.2% CAGR outperformance vs TSM since then.....but....if you had sold at the "trough of underperformance despair" in autumn of 2020 you would actually have received a slightly negative premium vs simply investing in TSM!
User avatar
Dieter
Executive Member
Executive Member
Posts: 656
Joined: Sat Sep 01, 2012 10:51 am

Re: Small Cap Value vs US Total Stock Market

Post by Dieter »

Ditto on the “tracking error” bit — if trying to get them to learn, I’d probably start with TSM or some such so that it better tracks the news
User avatar
seajay
Executive Member
Executive Member
Posts: 435
Joined: Mon Aug 09, 2021 11:11 am

Re: Small Cap Value vs US Total Stock Market

Post by seajay »

viewtopic.php?p=249810#p249810

A PP variant of 33/17/25/25 SCV/gold/cash/LTT has worked well/better than a classic PP since 1934
User avatar
seajay
Executive Member
Executive Member
Posts: 435
Joined: Mon Aug 09, 2021 11:11 am

Re: Small Cap Value vs US Total Stock Market

Post by seajay »

D1984 wrote: Tue May 09, 2023 2:11 am
ppnewbie wrote: Mon May 08, 2023 11:17 pm Interested in hearing opinions about SCV vs TSM investing for my children. Seems like over the long term SCV beats TSM by a long way. Wondering if there are any gotcha's with SCV. I'm planning on starting with one automated investment to keep things simple.
Two come immediately to mind (although they aren't so much "gotchas" as just points to be aware of).

One, if this investment is to be in taxable be aware that SCV--being composed of value stocks--will probably throw off a bit more in (taxable) dividends than TSM will or the S&P 500 will.

Two, whoever this investment is for (presumably you and then eventually your children/your heirs) has to be aware of--and fully accepting of -the fact that while SCV has outperformed over the long-term and (hopefully) will keep doing so--and there are indeed fundamental reasons that this should theoretically be the case--almost all of its outperformance has come in "bursts" and/or "fits and starts". 1933-1936, 1942-1945, 1954-1958, 1965-1968, 1975-1979, 1981-83, 1991-93, 2000-06, 2012-13, and then most recently late Sept or early Oct 2020 to late Feb or early March 2023. SCV will appear to be stinking up the joint (i.e. underperforming badly compared to TSM) and then all of a sudden will go on a years-long tear. If you sell at exactly the worst possible time (i.e. after years of seemingly never ending underperformance) owning SCV instead of TSM will have been for naught; for instance, if you had bought SCV (in the form of DFSVX) at its inception in early 1993 and held until today you would've enjoyed a roughly 1.2% CAGR outperformance vs TSM since then.....but....if you had sold at the "trough of underperformance despair" in autumn of 2020 you would actually have received a slightly negative premium vs simply investing in TSM!
... so could the SCV "premium" instead be considered as being a benefit of avoiding a "large cap drag" effect, or the overall advantage of being more equal weighted rather than 'tilted'?

Below large cap you will have a index that feeds both in and out of its top and bottom. Large cap in contrast holds its largest both during the rise, and falls of giants. Japan 1990's for instance, where some stocks became global household names (Sony ...etc.), rose to dominate the index, but then even after having halved or more still remained big and dominant of the index.
ppnewbie
Executive Member
Executive Member
Posts: 862
Joined: Fri May 03, 2019 6:04 pm

Re: Small Cap Value vs US Total Stock Market

Post by ppnewbie »

Here are some portfoliovisualizer charts. It seems like these two classes are decently correlated. It shows a correlation of .89.
Screen Shot 2023-05-11 at 4.43.34 PM.png
Screen Shot 2023-05-11 at 4.43.34 PM.png (344.12 KiB) Viewed 5544 times
And...Log scale turned off
Screen Shot 2023-05-11 at 4.49.00 PM.png
Screen Shot 2023-05-11 at 4.49.00 PM.png (237.04 KiB) Viewed 5544 times
User avatar
seajay
Executive Member
Executive Member
Posts: 435
Joined: Mon Aug 09, 2021 11:11 am

Re: Small Cap Value vs US Total Stock Market

Post by seajay »

ppnewbie wrote: Thu May 11, 2023 6:49 pm Here are some portfoliovisualizer charts. It seems like these two classes are decently correlated. It shows a correlation of .89.

Screen Shot 2023-05-11 at 4.43.34 PM.png

And...Log scale turned off

Screen Shot 2023-05-11 at 4.49.00 PM.png
10.33 and 13.4 stdev's from your image. 10.33 / 13.4 = 0.77, 77% SCV instead of 100% TSM.

Some suggest you might increase TSM weighting to scale up the risk to compare in risk/reward to SCV.

Others suggest you might hold less SCV instead of TSM to compare in risk/reward.

In a similar vein some suggest that you might hold more stock instead of bonds, shift the bond risk over to the stock side. Or vice-versa.

Broadly all-washes. If you don't like LTT's then shift some of the bond risk over to the stock side and hold more cash. For instance split your stash into three equal piles, then take half of the third pile and put that half on top of the first pile to end up at a 50/33/17 split and invest that respectively into cash/SCV/gold ... and whether that betters or lags a PP is unpredictable, but will tend to be in the same ball-park.
User avatar
joypog
Executive Member
Executive Member
Posts: 561
Joined: Wed Apr 27, 2022 7:42 pm

Re: Small Cap Value vs US Total Stock Market

Post by joypog »

The tracking error of SCV is a behavioral risk, even if it's better long term. Cause everybody else is going hot when the Dow or SP500 is going gangbusters.

I'd recommend a simple 50/50 split of SP500 and SCV. Perfectly mediocre and you're never missing out It does quite nicely on Paul Merriman's quilt chart, never the best but never the worst.

Since it's for your children, I'd avoid LTT's, Cash, Gold....better to let the money accumulate and grow...and give them a copy of HB's Fail Safe Investing so they'll be ready to roll into those funds when it's time.
1/n weirdo. US-TSM, US-SCV, Intl-SCV, LTT, STT, GLD (+ a little in MF)
aj76er
Junior Member
Junior Member
Posts: 7
Joined: Sun Mar 06, 2016 1:28 pm

Re: Small Cap Value vs US Total Stock Market

Post by aj76er »

Small cap value backtests well because small, growing companies used to enter the public markets early for additional funding (e.g. through an IPO). However, now successful companies often stay private for longer and grow much larger before entering the public markets. For example, SpaceX and ChatGPT are huge private companies that have not yet entered the public markets, so private equity investors have made a fortune while public, small cap indexes have not benefited.
User avatar
Smith1776
Executive Member
Executive Member
Posts: 3528
Joined: Fri Apr 21, 2017 6:01 pm

Re: Small Cap Value vs US Total Stock Market

Post by Smith1776 »

Small cap value fo' life.
DITM
www.allterraininvesting.com
boglerdude
Executive Member
Executive Member
Posts: 1317
Joined: Wed Aug 10, 2016 1:40 am
Contact:

Re: Small Cap Value vs US Total Stock Market

Post by boglerdude »

Buffett can tour a factory and get insider info. He defines value as great companies that are underpriced.

Guru quants eg Asness & Arnott define value as bad/underperforming based on a few metrics like price to book.

We are competing with millions of investors poring over public data online, daily. Why are they consistently mispricing companies?
User avatar
ArthurPooh
Full Member
Full Member
Posts: 54
Joined: Sat Jan 13, 2024 11:48 am

Re: Small Cap Value vs US Total Stock Market

Post by ArthurPooh »

boglerdude wrote: Thu Mar 21, 2024 11:16 pm Buffett can tour a factory and get insider info. He defines value as great companies that are underpriced.

Guru quants eg Asness & Arnott define value as bad/underperforming based on a few metrics like price to book.

We are competing with millions of investors poring over public data online, daily. Why are they consistently mispricing companies?
That's a very good point. Is the value premium based on anything fundamental, or just the fact it has not been a very popular style of investing? Why should it persist when it's now widely recognized?

The definition of "value" also seems a bit problematic. I've seen ETFs that use forward earnings (i.e. divination from goat entrails) as component of their "value" weightings. At this point one might just invest in an actively managed fund.

And even if we restrict ourselves to the basic definition of "book value in excess of market value" it still relies on a peculiar assumption that these companies are mispriced while the underlying assets are not.
User avatar
vnatale
Executive Member
Executive Member
Posts: 9472
Joined: Fri Apr 12, 2019 8:56 pm
Location: Massachusetts
Contact:

Re: Small Cap Value vs US Total Stock Market

Post by vnatale »

Smith1776 wrote: Thu Mar 21, 2024 4:57 pm
Small cap value fo' life.


As I stated I made my allocations in January 2003 and have not added or subtracted to them since.

For those who are facile with such things what has been the relative total performance (with dividends reinvested) for:

Total Stock Market

Value

Small Cap Value
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
User avatar
vnatale
Executive Member
Executive Member
Posts: 9472
Joined: Fri Apr 12, 2019 8:56 pm
Location: Massachusetts
Contact:

Re: Small Cap Value vs US Total Stock Market

Post by vnatale »

boglerdude wrote: Thu Mar 21, 2024 11:16 pm
Buffett can tour a factory and get insider info. He defines value as great companies that are underpriced.

Guru quants eg Asness & Arnott define value as bad/underperforming based on a few metrics like price to book.

We are competing with millions of investors poring over public data online, daily. Why are they consistently mispricing companies?


They are not.

The classic is that two equally brilliant, educated Yale / Princeton people have one of them deciding to sell a stock while the other is deciding to buy a stock. There could be various circumstances wherein each of their opposite actions could be justified. But, for the most part, it comes down to judging / guessing.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
User avatar
Smith1776
Executive Member
Executive Member
Posts: 3528
Joined: Fri Apr 21, 2017 6:01 pm

Re: Small Cap Value vs US Total Stock Market

Post by Smith1776 »

One possible explanation that Fama put forth is that value companies may not be mispriced. It's possible that people just don't like them and don't have a taste for them. It could be that people have an affinity for glamour companies like Nvidia or Tesla and are willing to pay a premium to hold them. Weirder thing have occurred in finance. As an example, on an old episode of Rational Reminder Ben Felix explains the findings in an academic paper that illiquid investments actually seem to demonstrate a negative illiquidity premium.

Then there's also the good ol' risk based explanation. Larry Swedroe demonstrated in his factor book that value companies tend to consistently be riskier than average on several key metrics.

Another possible explanation of the value premium is that it simply avoids the bubbles that occasionally pop up in the market (like the dot com bubble).
DITM
www.allterraininvesting.com
User avatar
Smith1776
Executive Member
Executive Member
Posts: 3528
Joined: Fri Apr 21, 2017 6:01 pm

Re: Small Cap Value vs US Total Stock Market

Post by Smith1776 »

vnatale wrote: Fri Mar 22, 2024 10:27 am
Smith1776 wrote: Thu Mar 21, 2024 4:57 pm Small cap value fo' life.
As I stated I made my allocations in January 2003 and have not added or subtracted to them since.

For those who are facile with such things what has been the relative total performance (with dividends reinvested) for:

Total Stock Market

Value

Small Cap Value
Good question. I wanted to see too. Here's what it looks like to me on Portfolio Visualizer.

https://www.portfoliovisualizer.com/bac ... hfObDs1apO
DITM
www.allterraininvesting.com
User avatar
Xan
Administrator
Administrator
Posts: 4402
Joined: Tue Mar 13, 2012 1:51 pm

Re: Small Cap Value vs US Total Stock Market

Post by Xan »

Smith1776 wrote: Fri Mar 22, 2024 10:45 amfindings in an academic paper that illiquid investments actually seem to demonstrate a negative illiquidity premium
There are so many negatives there I'm confused. Is this saying that one would expect that illiquid investments would be priced lower than liquid investments, because having liquidity has value; but it turns out that illiquid investments are priced higher instead?
User avatar
Smith1776
Executive Member
Executive Member
Posts: 3528
Joined: Fri Apr 21, 2017 6:01 pm

Re: Small Cap Value vs US Total Stock Market

Post by Smith1776 »

Xan wrote: Fri Mar 22, 2024 11:26 am
Smith1776 wrote: Fri Mar 22, 2024 10:45 amfindings in an academic paper that illiquid investments actually seem to demonstrate a negative illiquidity premium
There are so many negatives there I'm confused. Is this saying that one would expect that illiquid investments would be priced lower than liquid investments, because having liquidity has value; but it turns out that illiquid investments are priced higher instead?
Sorry about that. My verbiage definitely needs work.

To elaborate, most would expect that, all other things being equal, an illiquid investment should have higher returns than an identical investment that is liquid. In other words, there should be a return premium that the investor receives for bearing illiquidity risk. Ben Felix in his Rational Reminder episode on the topic demonstrated that the return premium for illiquidity risk is negative. Investors are literally getting lower returns for bearing illiquidity risk!

The theory is that investors are willing to endure the lower returns in exchange for the "return smoothing" effect of having illiquid investments that aren't marked to market.
DITM
www.allterraininvesting.com
User avatar
vnatale
Executive Member
Executive Member
Posts: 9472
Joined: Fri Apr 12, 2019 8:56 pm
Location: Massachusetts
Contact:

Re: Small Cap Value vs US Total Stock Market

Post by vnatale »

Smith1776 wrote: Fri Mar 22, 2024 10:47 am
vnatale wrote: Fri Mar 22, 2024 10:27 am
Smith1776 wrote: Thu Mar 21, 2024 4:57 pm
Small cap value fo' life.


As I stated I made my allocations in January 2003 and have not added or subtracted to them since.

For those who are facile with such things what has been the relative total performance (with dividends reinvested) for:

Total Stock Market

Value

Small Cap Value


Good question. I wanted to see too. Here's what it looks like to me on Portfolio Visualizer.

https://www.portfoliovisualizer.com/bac ... hfObDs1apO


Thanks for this.

After asking I realized I can give the exact results for me, which I will later do today.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
425
Junior Member
Junior Member
Posts: 11
Joined: Thu Feb 01, 2024 4:52 pm

Re: Small Cap Value vs US Total Stock Market

Post by 425 »

My belief is that you want to be fully exposed to beta/market risk/equity premium/systematic credit risk and that any attempt to tilt could be detrimental to the PP on a risk adjusted basis.

If you were equities only, my understanding is that theory suggests you can improve your capital efficiency (risk per unit of capital) and hence returns by factor tilting which is explained by exposure to some additional risk premia. Perhaps you can even get better risk adjusted returns than the market as a whole if you continue to tilt to those risks during a long period of past underperformance for those factors.

However, within the PP, Gold and US treasuries give you exposure to pure monetary and counterparty risk (or lack thereof) and pure duration risk. PP investors believe that fundamentally there are certain economic conditions are favourable to certain types of pure risk (credit/duration/monetary) making them not only uncorrelated, but at often important times negatively correlated while each producing positive nominal returns in the long run.

When you tilt your exposure to equities away from the market premium within the PP, then your total risk adjusted returns could be negatively impacted because you might actually be less diversified. I'm not going to be able to provide any data to back anything up, but my understanding is that if you put all the factors together you begin to get the market returns so you really have to tilt and that to me means you're moving away from the market premium which in theory would be the pure credit risk exposure that you're looking to be exposed to in the PP.

Whether the S&P500 represents that pure credit risk exposure that is efficient and sufficiently diversified I don't know but it seems to be between the Nasdaq 100 and the DJIA when it comes to risk. I will admit that sometimes I wonder if the Russell 2000 represents the market better but I think people generally associate overall market performance to be correlated to how the S&P500 is doing.
Post Reply