Gyroscopic Investing

Here's the weights for the Golden Butterfly+ using Vanguard mutual funds.  Not as tight as with the free Schwab ETF's, but you'll get el lazy autoinvestment!



VTSMX 72.68%
VIMSX 6.83%
NAESX 1.14%
VTMSX 19.36%

At last, I can post my latest research. But first, I want to answer MT''s question before the forum went kablooey.

Can we simplify the suggestions in this thread for a typical PP investor?

What suggested change to the asset weights is being suggested, and how much additional return can the change be expected to deliver?

It sounds like the suggestion is to lighten up on gold and cash, while beefing up the LT bond holdings.

And my answer is it is not currently worth the effort. The improvement is only marginal and may not even be statistically significant. Here are the results using point-in-time weights:


EW = equal weight

RP = naive risk parity, ERC = correlated risk parity, MV = minimum variance, MD = maximum diversification, MC/MC2 = minimum correlation

These would have to be risk rescaled downwards to allow for cash. But we can already see the CAGR outperformance isn't significant enough to offset that.

So, I wanted to backtest the equal size concept to see if it really passed the mustard or not for real world implementation. Along the way I identified exactly why the size effect is complete and utter bullshit. First, the results of various backtests (Value Weight means market cap weighting, not valuation):




Now for the size effect:



Its turns out that before 1972 (NASDAQ inclusion) and 1962 (AMEX inclusion) what passed for the bottom 10% of the stock market was a hundred or so former LargeCaps (Blue Chips?) that fell on hard times due to the Great Depression. They have no relation to what passes for several thousands of bottom-dwelling garbage nowadays (not counting OTCBB or Pink Sheets). Now keep in mind that SmallCap is the bottom 7% of the market. MicroCaps are the bottom 3% of the market. We are literally talking about the garbageman's garbage here. MegaCap to MidCap literally accounts for 90% of market capitalization.

To enhance the effect of this bottom-dwelling SmallCap and MicroCap garbage, one can equal weight all companies in an index or portfolio. The more defined an index or portfolio is to a relatively lower market cap, the more the SmallCap and MicroCap garbage will be overweighted. The nicest example is EQWS which is literally 62.77% exposed to MicroCap compared to 2.61% for VTI. So to dig really, really, really deep, you equal weight a MicroCap or SmallCap index like the Russell 2000 instead of value weight. Value weight will amazingly avoid the dogshit even in the SmallCap and MicroCap quadrant; equal weight will have you literally rolling around in heaping mounds of it.

Now post-1972 you could make a better argument for the size effect because the uninvestable Wilshire 5000 Equal Weight index returned 16.70% a year. I cannot find what the market cap exposure was to replicate it, so I decided to do an equal market cap size with equal stock weighting (left is Wilshire 5000 EW, right is AllCap EW):



The same garbageman's garbage effect occurs, just not to the same outrageous extent as pre-1972. It would be interesting to see how low the Nifty 50 dropped in terms of market cap at the bottom.

Anyway, the verdict is that equalizing size probably isn't worth it because a) pre-1972 wasn't realistic; b) post-1972 is now dead due to post-2000 structural changes; c) minuscle real world improvement when value weighting SmallCap or MicroCap; d) higher expenses and more funds required to equal weight both size and stocks successfully. So stick to the 90% (or VTI) and use crowdfunding for the remaining 10% (or 3%). We are never going to see another Microsoft IPO at a $65 million market cap (which is about $150 million in today's money). Those days are long over.

Basic question: What is the PP's max DD if you throw out gold's parabolic move up followed by the crash in 1980/1981. In other words, can you run the stats from 1982 forward?

Kbg wrote:Basic question: What is the PP's max DD if you throw out gold's parabolic move up followed by the crash in 1980/1981. In other words, can you run the stats from 1982 forward?

I get -15.30%.

I'm inclined to see this figure as more representative of PPs worse case. Gold is much more main stream now. I just don't see it going down or up like that again...but who knows!

And thank you for taking the time.

Vanguard sucks. And so may the Golden Butterfly because the return data used before 1999 isn't even VSIAX. You'll wind up with essentially the same risk and performance as the PP but at a higher cost.

VTV = Vanguard Large Cap Value, VUVLX = Vanguard Large Cap Value, VSIAX = Vanguard SmallCap Value

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MachineGhost wrote:Vanguard sucks. And so may the Golden Butterfly because the return data used before 1999 isn't even VSIAX. You'll wind up with essentially the same risk and performance as the PP but at a higher cost.
VTV = Vanguard Large Cap Value, VUVLX = Vanguard Large Cap Value, VSIAX = Vanguard SmallCap Value

Having eased into the Golden Butterfly at the start of the year I am now up 7.24% as opposed to 6.67% for the vanilla PP so I'm happy with my decision (recency bias acknowledged - could obviously have gone the other way). Small Cap Value stocks are in Roth IRA accounts for a long term bet (and I can call it my VP if it offends anyone's purist sensibilities).

And the Roth IRA is Vanguard. The charts didn't tell me why you think they suck.

Also, in another post you asserted that the Golden Butterfly is not a tilt towards prosperity but something else (I forget what). Can you better explain why you think a 40% stock allocation is not a tilt towards prosperity? That seemed like a no-brainer to me, if one decided to go that route.

InsuranceGuy wrote: Vanguard VFINX(LCB) with 4.9% CAGR and 18.4% StDev
Fama French Small Blend(SCB) with 9.4% CAGR and 22.6% StDev
Vanguard NAESX(SCB) with 8.4% and 21.0% StDev
Fama French Small Value(SCV) with 10.7% CAGR and 21.8% StDev
Vanguard VISVX(SCV) with 9.1% CAGR and 18.9% StDev

Is there tracking error? Well yes it seems so, but even with the tracking differences there is still a considerable premium. Below shows the daily returns charted (my charts are bland):

How can your SCV be beating LCB in your chart, but it is merely keeping pace with LCB in mine? Very strange. I stand by my statement that Vanguard SCV sucks. The tracking error seems to be growing! And what specific definition of French-Fama SCV are you using?

EDIT: It seems to spread like yours in my own backtesting, so maybe the issue is with the Yahoo charts.

BTW, why are your French-Fama returns more or less single digits yet mine are always double digits? It's the same data and same calculaton, yet I see an upwards bias. For instance, I get 12.76% CAGR for "small blend" from 12/31/1998 to 12/31/2015.

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curlew wrote:

MachineGhost wrote:Vanguard sucks. And so may the Golden Butterfly because the return data used before 1999 isn't even VSIAX. You'll wind up with essentially the same risk and performance as the PP but at a higher cost.
VTV = Vanguard Large Cap Value, VUVLX = Vanguard Large Cap Value, VSIAX = Vanguard SmallCap Value

Having eased into the Golden Butterfly at the start of the year I am now up 7.24% as opposed to 6.67% for the vanilla PP so I'm happy with my decision (recency bias acknowledged - could obviously have gone the other way). Large Cap Value stocks are in Roth IRA accounts for a long term bet (and I can call it my VP if it offends anyone's purist sensibilities).

And the Roth IRA is Vanguard. The charts didn't tell me why you think they suck.

Also, in another post you asserted that the Golden Butterfly is not a tilt towards prosperity but something else (I forget what). Can you better explain why you think a 40% stock allocation is not a tilt towards prosperity? That seemed like a no-brainer to me, if one decided to go that route.

It has to do with the data makeup that is used on PortfolioCharts which is from a backtest spreadsheet maintained by Simba at Bogleheads. The spreadsheet contains what I consider to be atrocious data quality to put it midly. In the case of SCV, before 1999 I think it was, it used Russell 2000 Value and before that in the early to mid 1970's it used the CRSP database. Here's the problem. Every single index provider has a different method of determining the breakpoints for what qualifies as Mega, Large, Mid, Small and Micro, nevermind Value and Growth. So different indexes and different index funds are simply not interchangeable. Beyond that, funds can have horrible tracking error and that is definitely magnified in Vanguard's SmallCap Value at present. My point is if you expect to have similar performance up to 1999 based on crappy data to justify using Vanguard's SCV, you may be in for a rude awakening. The only real solution to this problem is to completely throw out the data that PortfolioCharts is based on and then rerun the assumptions that make up the GB. Judging by InsuranceGuy's chart, I think it will be safe to say the GB will work as promised as long as you can find a fund that tracks the indexes used. In this case, we're more or less limited to the CRSP database. And as far as I know, only DFA specifically tracks those indexes in their funds, but unfortunately they're only sold via advisors. They obviously got a good thing going and they know it.

The GB is definitely a 40% tilt towards prosperity, so I don't know what you think I may have said nor do I remember. I think the GB is just a different version of the PP. You could just as easily split 12.5% LCB to 12.5% SCV in the PP, so I really don't know why there's a 40% allocation unless it was data mining to get better risk/reward parameters.

InsuranceGuy wrote: Well, returns-wise it's easily verifiable that Vanguard SCV > Vanguard SCB > Vanguard LCB using the Yahoo Finance gross returns. I'd guess there is some type of error in whatever tracking mechanism you are using if that isn't the case.

I dunno, but I'm no longer relying on Yahoo for charting. It was just a quick hack 'cuz I was too lazy to run the returns myself last night (it was around midnight).

You are certainly entitled to your opinion that Vanguard SCV sucks, but the tracking error is largely because it tracked a higher average market cap than something like IJS. Either way, it is really not that bad and offers a superior return to the S&P 500 with similar volatility. Also, the tracking error actually isn't growing, it's just a visual effect of compounding returns.

I agree with this in concept. But I would prefer something that actually tracks a standard definition of Small Cap Value with minimal tracking error. Said another way, I would prefer something that actually tracks the CRSP database since that is all we have to use to go back in far history. I believe that Vanguard actually used to, but they changed over to something else a few years back. Not sure if that was because they were having tracking error issues like you see with SCV or due to licensing fees. Hmm!

I don't think I'm nitpicking about this issue when transanction fees and taxes easily eats away at these small edges above the S&P 500. It's a bit too close for comfort. Remember, Schwab Broad only costs .03% a year!!! I thnk at this point if I had to make an immediate decision about accessing SCV exposure, it certainly is not going to be VSIVX, it would be IWN.

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BTW, I'm not sure if I said it before or not, but I consider SCV to be a hack to get at equal weight of size using value weight indexes/funds. The value factor is technically size independent so there's no reason as a true value investor that you would want to limit it like that. Apple's pretty fantastically cheap right now and they may even return to growth this year.

InsuranceGuy wrote: Well the reason my proxy doesn't match is that I fit 3 Small Book-to-Market portfolios to the Russell 2000 and Russell 2000 Value index returns for 1980 to 1998. While VISVX isn't my favorite because it is more of a Mid-Cap Value than SCV, I don't think it is terrible. That said, I prefer and use IJS which seems to better track my proxy portfolios. IWN would be equally desirable for the same reason.

The only thing I will disagree with you on that saying transaction fess and taxes eats away the 3.5% to 4% returns advantage for SCB/SCV over the S&P seems a little disengenuous.

Well, I don't see a long-term advantage like that comparing just the sizes, but I haven't got around to mixing size and value/growth just yet. Do you have such a pure French-Fama mixture back to 1968 to show us?

BTW, dividends eat up .5% to 3% of your return each and every year when you have to pay taxes on them, so would you consider that disengenous?

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InsuranceGuy wrote:

MachineGhost wrote:BTW, I'm not sure if I said it before or not, but I consider SCV to be a hack to get at equal weight of size using value weight indexes/funds. The value factor is technically size independent so there's no reason as a true value investor that you would want to limit it like that.

That seems like a reasonable hypothesis, and maybe you are right and it will eventually play out that way. Looking at the historical data, it doesn't seem that value has as much impact on returns for larger market caps as it has for smaller market caps yet though.

I suspect that is because large cap stocks have so much attention and are bought by so many investors regardless of valuation that the discounts just never gets to grow big enough except during bear markets. Apple is an absolutely crazy oxymoron; its both undervalued, a divided grower, a growth stock and one of the largest mega caps in the world. I just shake my head in wonderment. Something's gotta give...

I updated the micro-cap returns and added a style tilt where available. I'm gonna put this dog to rest now, unfortunately.

3% allocation. I think if you exclude the dot.com bubble, there's no advantage.

Weight reflects allocation size for a growth cap weighted portfolio for about 43.5% average expected growth. Many of these sectors have dedicated ETF's already. I'd suggest using Motif Investing or RobinHood.

DeMiguel, Garlappi, and Uppal (2009) conducted a highly influential study where they demonstrated that none of the optimized portfolios consistently outperformed the naive diversification. This result triggered a heated debate within the academic community on whether portfolio optimization adds value. Nowadays several studies claim to defend the value of portfolio optimization. The commonality in all these studies is that various portfolio optimization methods are implemented using the datasets generously provided by Kenneth French and the performance is measured by means of the Sharpe ratio. This paper aims to provide a cautionary note regarding the use of Kenneth French datasets in portfolio optimization without controlling whether the superior performance appears due to better mean-variance efficiency or due to exposures to established factor premiums. First, we demonstrate that the low-volatility effect is present in virtually all datasets in the Kenneth French online data library. Second, using a few simple portfolio optimization models that are said to outperform the naive diversification, we show that these portfolios are tilted towards assets with lowest volatilities and, after controlling for the low-volatility effect, there is absolutely no evidence of superior performance. The main conclusion that we reach in our paper is that a convincing demonstration of the value of portfolio optimization cannot be made without showing that the superior performance cannot be attributed to profiting from some known anomalies.

Paper: http://papers.ssrn.com/sol3/papers.cfm? ... id=2786291

Here's a new MicroCap spreadsheet with S&P 500 returns for easy comparison:



It looks to me like we have this year or next left before a correction.