# (Not so) Smart Beta



## DeepState (8 December 2014)

Any views?



Source: FT


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## Faramir (9 December 2014)

Hi DeepState
Can I offer any contribution? (I am really struggling to understand it - I am struggling to evaluate its merits or lack of merits from your view?)

Paragraph 1): Last sentence stating volatile markets and uncertain economic climate. This cycle has always happened. Smart Beta should have been "invented" or "used" or at least sold to the naive investor for many years. This is the first time I have heard of Smart Beta - I must be very naive.

Paragraph 3): Please help me. It shows my lack of understanding of how Fund Managers work. Especially when they need to re-balance their portfolios according to the Top ASX 50, ASX 100, ASX 300???? 

Paragraph 4): Alternative weighing schemes like volatility or dividends. I cannot understand how this can produce a better result. Some companies borrow to pay dividends (to artifically hold up a share price that doesn't deserve to be at the level?) I need some explanation please.

Paragraph 5): "to take advantage of perceived systematic biases or inefficencies market" OK Everyone thinks they can do this. Everyone except me since I am a beginner. The manager is "passive", so therefore it is cheaper than an "active" manager.

Paragraph 6): I guess since 2005, Research Affliliates have been producing outstanding results.

Paragraph 7): I can't comment.

Paragraph 8): "Controlling risk than simply maximising their returns." Interest in Smart Beta started around 2007-2008, why not 2000? why not 1987? why only now?

Paragraph 9): (Leave for others to comment)

Paragraph 10): (Leave for others to comment) I don't think many Super Funds are using Smart Beta, please let me know if any do

That's my simple understanding (or lack of). DeepState, I awaited your contribution and views.


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## The Falcon (9 December 2014)

Yep, its an elegant concept, and no doubt, it offers on paper outperformance of dumb market weighted indices. But as an investor, we aren't looking for on paper performance, what matters to us is after tax performance. I offer as an example, Russell Australian Value ETF, ASX : RVL. At first blush, this ETF looks like it might offer outperformance for the lazy "value" type investor. It follows Russell's Australia High Value index, which is a rules based index comprised of companies that have low PE and strong medium term earnings growth.

Management fee is 35bps, which isn't bad and performance, net of fees (ie. after fees) has provided healthy outperformance over the last 3 years since inception. RVL accumulation 16.32% pa vs ASX300 13.30%. 

ok, sounds pretty valuey to me, and I'm lazy but like to consider myself smarter than the herd...this ticks all the boxes! 3% pa outperformance for doing nothing? sign me up.

So the lazy value indexer is feeling pretty good and then tax time rolls around, he's done fairly well for himself and is in the top tax bracket. He gets his end of year tax statement from Russell, and sees that they have churned this bloody thing, RVL is distributing 6-9% and the lazy value bloke now has to deal with non discounted capital gains of 30-70%. In 12/13 almost 76% of the distribution was non discounted capital gains, and only 13% franked divis....compare this to his dumb mate who has just invested in VAS (ASX 300) index fund at 15bps, which distributions are 60-75% franked and there is bugger all, non discounted capital gain. I know who is happier come tax time. 

RY, this is what I was referring to as not so smart beta, after initially being attracted to the headline numbers, a bit of digging around shows that all that glitters, in the hands of the investor post tax, is not gold. Rules based ETFs create lots of friction, which usually just damages after tax outcomes for investors...I read somewhere that Vanguard had to cut the rebalancing on their high yield fund from quarterly to twice annually, as the rebalancing was creating far too much non discounted capital gains. 

Obviously its a much bigger subject than just this, but this is just one aspect that people need to consider and is often, conveniently from a managers perspective overlooked.

For mine, I have decided to stay with the dumb and cheap market weight ETFs (VAS and VTS) for my index component, and look for outperformance myself.....at least then I can control the tax events! I have some thoughts on the Small Cap tilt thing as well but have to get on a flight shortly so have to run...if I have time i'll post on that from Boracay, otherwise next week


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## DeepState (9 December 2014)

Faramir said:


> Hi DeepState
> Can I offer any contribution? (I am really struggling to understand it - I am struggling to evaluate its merits or lack of merits from your view?)
> 
> Paragraph 1): Last sentence stating volatile markets and uncertain economic climate. This cycle has always happened. Smart Beta should have been "invented" or "used" or at least sold to the naive investor for many years. This is the first time I have heard of Smart Beta - I must be very naive.
> ...




Smart Beta is generally described as a rules determined way of building a portfolio to extract what are thought to be sources of persistent returns for reasons of risk bearing, illiquidity, behavioural bias, market dynamics... It is not seeking to profit from detailed knowledge of individual circumstances.

1. The concept of 'Smart Beta' is a repackaging of ideas that are 40+ years old.  They are now offered as a middle road between index and fully active approaches which are cheap.  Although rapidly growing, they are still a drop in the capital markets ocean.  It has really taken off post GFC.  It comes via the insto channel first as they are better resourced to grasp the merits of the idea and make a determination about their suitability. 

3. The standard market indices like the S&P/ASX 200 are capitalization weighted.  As a result, except for index reconstitutions (names coming in and out, rights issues...) portfolios indexed to them never need to be rebalanced.    The argument follows that when a stock goes up in price relative to another, there is a fair chance that it has just become more expensive relative to another.  If so, you should rebalance back towards where they were to some degree to capture this effect.  The Smart Beta crowd argues that, given the indices do not allow for this, they are inefficient.

4. This is really tough.  If the thread develops on alternative weighting schemes, we can get into it.  However, from a wider sweep, if you rebalance to anything other than price movement (which does not need to be rebalanced), you can expect to profit versus the index before fees, t-cost and expenses are considered.  That is, you will very likely beat an index alternative over time if you rebalance to something else.  This something else can be just about anything: equal weights, weights that take into account relative volatilities, based on dividends / sales / cashflow / book value...or much more sophisticated.  Rebalancing helps you to sell stocks whose price has moved up and buy those which have moved down.  Because the market is characterized by excess price movement, this is expected to produce a superior outcome through time relative to the index alternative.

5. There is a lot of debate around this exact issue.  This is called Smart Beta for a reason.  Alpha is seeking to produce returns over and above those which can be generated from simple highly diversified portfolios which could be built without insight to specific situations. Smart Beta does not aim to make a return from knowledge of specific situations at all.  Beta is the exposure to some bulk risk (say, equity) that is expected to yield a risk premium for bearing it. You buy this in pure form via index funds. Smart Beta is little twists on that theme that seeks to find certain premia that are more refined which produce an even better risk-reward tradeoff than bulk beta.  Hence, it sits somewhere between passive and full-bore active.  I'd say that it is an active fund seeking to beat the benchmarks via tilts to factors (eg dividends) that produce superior risk/reward outcomes to an index alternative.

6. Rob Arnott and Jason Hsu have been pushing the barrow for a while and have built an enormous business.  Their approach is very simple and KTP could build the original in a few days (if that). You can find out more stuff from their website.  They are the leading proponents of the practice in terms of AUM.  However, there is fierce rivalry and debate of the type you might find here in ASF that goes on between participants.  RAFI has good stuff on what is Smart Beta.  If you want to get up the curve a bit more, then EdHec is a deeper source of info.

10. Smart beta is becoming more common now amongst insto.  DFA is smart beta.  RAFI offshoots also do this.  Within many active managers are permanent style tilts which are actually Smart Beta.  That is, they are charging you fees as if they are fully alpha, yet a large part of the outperformance is available cheaply via Smart Beta.  In many cases, if you strip out the Smart Beta, you end up with nothing left over or value destruction.  This is one reason why Smart Beta is gaining traction at the expense of active management.  For example, State Super Financial Services uses it.


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## systematic (9 December 2014)

DeepState said:


> Any views?




Mine are:

As a concept
Nothing new here.  It's factor tilting.  Agree with your later comment about repackaging old ideas.

As a product
Possibly a bit too expensive for what you are getting.  Due to number of holding etc some of these get close to closet indexing.  

As an investment
Possibly a good one:  for the person who (a) wants to go a little bit beyond "buying the market" in their equity investing, but (b) do not want to touch active investing themselves.


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## DeepState (9 December 2014)

The Falcon said:


> RY, this is what I was referring to as not so smart beta, after initially being attracted to the headline numbers, a bit of digging around shows that all that glitters, in the hands of the investor post tax, is not gold. Rules based ETFs create lots of friction, which usually just damages after tax outcomes for investors...I read somewhere that Vanguard had to cut the rebalancing on their high yield fund from quarterly to twice annually, as the rebalancing was creating far too much non discounted capital gains.
> 
> Obviously its a much bigger subject than just this, but this is just one aspect that people need to consider and is often, conveniently from a managers perspective overlooked.
> 
> For mine, I have decided to stay with the dumb and cheap market weight ETFs (VAS and VTS) for my index component, and look for outperformance myself.....at least then I can control the tax events! I have some thoughts on the Small Cap tilt thing as well but have to get on a flight shortly so have to run...if I have time i'll post on that from Boracay, otherwise next week




I had to look up Boracay.  Nice!

On the same page as you.  The net of tax outcome is what you want.  If you are investing on max tax rate, it's hard to justify any turnover at all in capital account assets, for the most part. That Russell ETF probably torched a stack of franking as well. You can control tax to a large degree (except the law).  Everything else is just a promise.

Have a great time.


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## Faramir (9 December 2014)

Thank you DeepState. Thank you for your efforts. It will take me a while to take all of the info in but you have helped immensely. I just realised that this thread is in response to a Myer Holdings (MYR) thread. I am not surprised that some 'active' fund managers claim that they are actively trying to beat the index and charging for it but they are 'cheating' by using Smart Beta. If I ever buy an Index Fund, I have to be careful. Not just look at returns results. I must look at Fees, methods that they use. I wonder if they would disclosed the fact that they use Smart Beta? So much information for me to take in.


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## luutzu (9 December 2014)

Woah!

Quite a racket the finance and investment industry got going. 

It's incredible how people openly admit they aren't that good at their job, are only figuring out ways to not stand out among the herd, then charge cart loads for "expertise" in getting around the same rate as the entire market would.

Can't wait for Smart Beta Max


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## TPI (9 December 2014)

I like the smart beta concept. I've been reading the blog posts/articles from the Research Affiliates website in the last 6 months or so and it all seems quite logical to me. Though I haven't read any opposing views on this approach yet. My own share portfolios are DIY versions of a smart beta portfolio, with a few different rules and fundamental tilts created by myself based on my reading of what works in investing.


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## luutzu (10 December 2014)

TPI said:


> I like the smart beta concept. I've been reading the blog posts/articles from the Research Affiliates website in the last 6 months or so and it all seems quite logical to me. Though I haven't read any opposing views on this approach yet. My own share portfolios are DIY versions of a smart beta portfolio, with a few different rules and fundamental tilts created by myself based on my reading of what works in investing.




Whatever happen to aligning one's portfolio with stocks that actually earn money as measured by such things as it actually earning money from doing real businesses?

I really feel sorry for people trying to sell something to institutions that require them to do real work.

Anyway... let's not complain too much when others are trying to help you


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## DeepState (10 December 2014)

TPI said:


> I like the smart beta concept. I've been reading the blog posts/articles from the Research Affiliates website in the last 6 months or so and it all seems quite logical to me. Though I haven't read any opposing views on this approach yet. My own share portfolios are DIY versions of a smart beta portfolio, with a few different rules and fundamental tilts created by myself based on my reading of what works in investing.




Good stuff. I like their (RAFI) work as well.  Please note...you need to rebalance.

Main detractions:
1. What seems smart beta might actually be stupid beta.
2. It is an active tilt from index despite trying to ignore the index.  As a result, it cannot absorb an enormous amount of money before the idea asymptotes to zero. 

What's new?


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## TPI (10 December 2014)

I think for most part-time/non-professional stockmarket investors who are fundamentally inclined, there is no choice but to use some form of ‘’smart beta’’ or ‘’factor tilting’’, or whatever label you want to give it, to move the odds of positive performance in your favour.

If you have limited time and limited depth of knowledge/experience/analytical skills then to me it makes sense to at least tilt your portfolio towards things that have been shown to give some sort of performance edge over the long-term.

I think most of us do this to some extent even if unintentionally, but perhaps sometimes tilting towards the wrong areas, including myself.

Personally, with my investing approach I rarely read annual reports in great detail, usually only the first few pages, and rarely break down financial statements in great detail either, due largely to the limitations mentioned above.

With this in mind, if I am going to pick stocks by myself, I need to at least have a few portfolio construction and stock picking rules that are going to help me tilt the odds in my favour, along with some basic level of diversification to protect me from bad stock picks.

In broad terms for me this means things like:

Low volatility stocks (which usually leads me to an overall large and mid-cap tilt)

Dividend yield and dividend growth

Low P/E and/or discount to some measure of intrinsic value

High ROE

Low debt/equity and/or high interest cover

High margins

Positive earnings and earnings growth

Use of some leverage in the portfolio

About 10-15 stocks in the portfolio (a balance between concentration and diversification)

Notwithstanding the above, I still have some small cap and speculative stocks as well, though Research Affiliates recently posted an article saying that the small cap premium no longer exists, which I found interesting… 

And tax considerations are always important, so outside super I tend to have a much lower turnover portfolio than inside super, and my small cap and speculative tilts are greater within super and with no leverage used here.

And I usually try and top-up on under-represented stocks in dips rather than sell-down others to rebalance, though I did sell down some bank shares recently as I felt I was too top heavy here.

In terms of what is and isn't smart beta, from what I read low volatility, value and market factors are considered smart beta (which my criteria includes). Momentum is another but I don't use this very much in my process just yet. And various quality definitions, presumably like high ROE, low D/E, high interest cover, high margins etc., are not - nonetheless it still makes sense to me so I still use these to filter through stocks!

And there is also a illiquidity premium which is meant to be significant I think, but I'm not quite sure what this refers to?


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## TPI (10 December 2014)

luutzu said:


> Whatever happen to aligning one's portfolio with stocks that actually earn money as measured by such things as it actually earning money from doing real businesses?




Nothing, that's your smart beta, just how much time and depth of study you devote to establishing what these businesses are will determine whether it is now a more active process. 

And whether the academic papers say it is smart beta or dumb beta is another thing!


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## DeepState (10 December 2014)

TPI said:


> And there is also a illiquidity premium which is meant to be significant I think, but I'm not quite sure what this refers to?





If an asset is not tradable readily, it will cost you more to get in and out.  Your opportunity costs are also high because it prevents you from readily deploying the capital to higher return purposes due to the transaction frictions.  Hence, you need to charge a higher return for transaction costs and for opportunity costs even in a regular steady state situation.  If these assets are purchased with leverage or are otherwise affected by cyclic demand, then there is even more risk because you can't get out when you are most likely to need to get out.  A greater margin of safety is required again.

For these reasons, two assets, one listed and the other not will trade at different prices despite identical underlying operations.  You can infer the price from looking at various similar securities whose underlying is similar but whose market characteristics are different for market micro-structure reasons.  This occurs even in US treasuries.  The difference is the (il)liquidity premium.


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## KnowThePast (10 December 2014)

My limited experience tells me that the concept makes a lot of sense, and seems like a relatively easy thing to do. After all, you only need to make a couple of decisions to "tilt" your portfolio in areas where you are confidence of better performance.

In practice, it rarely happens that way. Meddling with an index, or automated strategy, tends to worsen the performance, not improve it.

I remember reading a few books on automated strategies that talked about this phenomenon as well, but I don't remember which. The reasons given, I think were psychological, and exclusion of "unlikely outliers".

My 2c.


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## luutzu (10 December 2014)

"The way that can be defined is not the Way."
- Lao Tzu


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## TPI (11 December 2014)

DeepState said:


> If an asset is not tradable readily, it will cost you more to get in and out.  Your opportunity costs are also high because it prevents you from readily deploying the capital to higher return purposes due to the transaction frictions.  Hence, you need to charge a higher return for transaction costs and for opportunity costs even in a regular steady state situation.  If these assets are purchased with leverage or are otherwise affected by cyclic demand, then there is even more risk because you can't get out when you are most likely to need to get out.  A greater margin of safety is required again.
> 
> For these reasons, two assets, one listed and the other not will trade at different prices despite identical underlying operations.  You can infer the price from looking at various similar securities whose underlying is similar but whose market characteristics are different for market micro-structure reasons.  This occurs even in US treasuries.  The difference is the (il)liquidity premium.




Thanks RY, for stocks does this apply to stocks that are liquid vs ones that are less so eg. small caps with low volumes and large bid/offer spreads? So is it better to invest in more liquid stocks to capture this premium or the opposite?


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## DeepState (11 December 2014)

TPI said:


> Thanks RY, for stocks does this apply to stocks that are liquid vs ones that are less so eg. small caps with low volumes and large bid/offer spreads? So is it better to invest in more liquid stocks to capture this premium or the opposite?




Here's some US data:




The liquidity premium exists across all size bands.  That means that you do not have to tilt to small caps to get the effect.  You can, but you do not have to.

Interesting to see the small cap premium in the data.  Interesting also that the relationship does not exist for the most liquid quartile and is monotonically in the opposing direction.  

Much of this smart beta stuff is actually finding rewarded risk premia. It's not that the returns are there for nothing.  It's just that you may be in a better position to absorb these risks than others in the market and hence get the rewards that come with it.  Ultimately, the secondary market is a risk transfer mechanism. 

Seriously impressed by the thought you have put into this BTW.


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## tech/a (11 December 2014)

What sort of return is expected from this?
Which is how much more than a return claimed
Without it?

How would this affect someone who runs their own SMSF.

Why would I care?


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## DeepState (11 December 2014)

tech/a said:


> What sort of return is expected from this?
> Which is how much more than a return claimed
> Without it?
> 
> ...




The difference between the first and fourth columns highlights the return you can get from buying illiquid stocks and selling the liquid ones, sorted by size/capitalization quadrant.  The table reports that this one idea has generated somewhere between 3-12% per annum pre t-cost, borrow and finance margin, depending on what you would have wanted to buy and sell assuming you held a fully self financing portfolio which is long $X of illiquids and short $X of liquids against it.   That is without (net) leverage.  The long-short portfolio would have lower risk than one just invested in equities without leverage. Long short portfolio returns would be added to the cash rate to obtain a sense of total return from a dollar-matched, hedged, portfolio.

There are many ways to utilize this idea, if you wanted to do so.  A long-short portfolio rebalanced annually is only one.  It can be applied to an SMSF or any other type of investment vehicle. Either outright or as part of a wider investment strategy.

I don't know why you would care or not.  It's up to you.  It's only money.


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## tech/a (11 December 2014)

Well from what I see the risk of being in an illiquid number of trades where there could be very large slippage if I needed to liquidate and the risk of delisting not normally attributed to the more liquid stocks----seems to be larger than the added reward over time.
I'd also suggest that any outlier shock in the market would see the illiquid stocks take longer torecover if indeed they did at all.


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## DeepState (11 December 2014)

tech/a said:


> Well from what I see the risk of being in an illiquid number of trades where there could be very large slippage if I needed to liquidate and the risk of delisting not normally attributed to the more liquid stocks----seems to be larger than the added reward over time.
> I'd also suggest that any outlier shock in the market would see the illiquid stocks take longer torecover if indeed they did at all.




The sorts of risks outlined above are why people shy away from those situations and why the return from them exists.  It is a rewarded risk.  It's up to you as to whether the reward is sufficient for the risk borne.  Reward for risk bearing has been reported.  As much as anything, the reward arises because people think in terms of scenarios as above without necessarily considering actual attaching probabilities accurately or otherwise developing these from small samples, hold concentrated portfolios where liquidity risk is more material for adverse developments, consider that they have strong alternative uses for capital and have short time horizons.  There is nothing wrong with that per se.  It is what you have described.

For those that can invest in a broader portfolio of stocks that allows diverse exposure to the concept where good and bad breaks happen and wash out over time and/or accept the fact that rewards to this concept reveal themselves unevenly but with higher confidence through time and can hack the journey....the concept is more appealing.

What's the reward?  What's it worth....to you?  Maybe it's not worth it for you.  That's fine.

One possible way of thinking about this, which I think has validity, is that liquidity is relative.  A small portfolio whose holdings match that of another monster portfolio do not require the same degree of premium for bearing illiquidity risk.  The price for risk differs.  There is a price for this and it would imply that smaller portfolios should hold relatively less liquid stocks on average....all else equal.  They are in a better position to take this risk than large portfolios.  As I said before, the market is a risk transfer mechanism.  The premium exists with high certainty.  As with investments generally, it's a question of what that actually means for you.


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## DeepState (11 December 2014)

TPI said:


> In broad terms for me this means things like:
> 
> Low volatility stocks (which usually leads me to an overall large and mid-cap tilt)


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## luutzu (11 December 2014)

DeepState said:


> View attachment 60680




Doesn't that article just state the obvious?

That if a fund is low-volatility... first, it is defined low on price volatility because it does not "volatate" (my word) far from the market/index; that a high volatile fund/stock would move up or down more "volatile-ly" than a low one.... So of course a low-volatile fund would do well during highly volatile periods.

Sorry to interrupt. 

Can I ask a serious question?

Do you guys, or institutional investors and professionals... do you guys look at beta and alpha and macro data, market/industry forecasts and the like... do you guys look at these because you have already looked at the annual reports, already know the company very well and this macro analysis is to give you that extra edge?

Or do you only have some familiarity with the individual business but think that that's not where your focus should be; your focus ought to be with things beyond the company... for that's where the edge is?

In other words, do you already know the business to a great extend (almost to the level of its executives), but that is not enough? Or do you reckon a top down approach is the way to go because statistically, through probability... if the macro is right, the rest doesn't really matter.


Might be a joke of a question but you know what they say, no such thing as s dumb question.


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## DeepState (11 December 2014)

luutzu said:


> Doesn't that article just state the obvious?
> 
> That if a fund is low-volatility... first, it is defined low on price volatility because it does not "volatate" (my word) far from the market/index; that a high volatile fund/stock would move up or down more "volatile-ly" than a low one.... So of course a low-volatile fund would do well during highly volatile periods.




You are mashing absolute volatility with tracking error without realizing they are different or knowledge of how total volatility relates to tracking error. 



luutzu said:


> Sorry to interrupt.
> 
> Can I ask a serious question?
> 
> ...




Different strokes for different folks. 




luutzu said:


> Might be a joke of a question but you know what they say, no such thing as s dumb question.




How does that Yin and Yang thing go again?


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## TPI (11 December 2014)

DeepState said:


> Here's some US data:
> 
> View attachment 60670
> 
> ...




Thanks RY, to clarify, from this chart do you infer that small cap with low liquidity gives you the best outcome?

I might read that paper in more detail over the weekend.


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## DeepState (12 December 2014)

TPI said:


> Thanks RY, to clarify, from this chart do you infer that small cap with low liquidity gives you the best outcome?
> 
> I might read that paper in more detail over the weekend.




Yes.  It has given the best outcome in terms of return.


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## TPI (12 December 2014)

DeepState said:


> View attachment 60680




I think low-vol is a relatively boring concept so concerns that this space is getting overcrowded maybe overdone. 

I think human nature will bias us towards more exciting tilts to let this unexciting one persist for longer.


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## luutzu (12 December 2014)

DeepState said:


> You are mashing absolute volatility with tracking error without realizing they are different or knowledge of how total volatility relates to tracking error.
> 
> Different strokes for different folks.
> 
> How does that Yin and Yang thing go again?




Anyway... back to seeking wisdom... from the Tao Te Ching.




> The supreme good is like water,
> which nourishes all things without trying to.
> It is content with the low places that people disdain.
> Thus it is like the Tao.
> ...


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## TPI (12 December 2014)

DeepState said:


> The sorts of risks outlined above are why people shy away from those situations and why the return from them exists.  It is a rewarded risk.  It's up to you as to whether the reward is sufficient for the risk borne.  Reward for risk bearing has been reported.  As much as anything, the reward arises because people think in terms of scenarios as above without necessarily considering actual attaching probabilities accurately or otherwise developing these from small samples, hold concentrated portfolios where liquidity risk is more material for adverse developments, consider that they have strong alternative uses for capital and have short time horizons.  There is nothing wrong with that per se.  It is what you have described.
> 
> For those that can invest in a broader portfolio of stocks that allows diverse exposure to the concept where good and bad breaks happen and wash out over time and/or accept the fact that rewards to this concept reveal themselves unevenly but with higher confidence through time and can hack the journey....the concept is more appealing.
> 
> ...




RY, in broad terms what are the things that you consider to be smart beta and dumb beta, and which do you incorporate into your own portfolio construction? 

And also, which of these if any do you giver greater weighting/significance too?

With regards to the liquidity premium, from my interpretation of it now and looking at my own portfolios, I find that my larger family trust portfolio (which is about 5 x the value of my SMSF portfolio) has relatively little exposure to this (partly due to it being leveraged), whereas my much smaller SMSF portfolio has a lot more exposure to this... which seems to fit with what you are saying here I think.


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## TPI (12 December 2014)

DeepState said:


> Yes.  It has given the best outcome in terms of return.




I guess that's the main thing isn't it?

Would this be different for risk-adjusted return and where a low-vol approach does better?


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## DeepState (12 December 2014)

TPI said:


> I guess that's the main thing isn't it?
> 
> Would this be different for risk-adjusted return and where a low-vol approach does better?




There is a Yank saying that "you can't eat risk".  So that's possibly right.  Given you are prepared to utilize leverage though, it might be better to consider risk adjusted returns, find the most suitable idea based on that and lever up to get the risk you want.  That's the way to the best outcome ultimately....if you can get it right.  That particular segment might not produce the best risk-adjusted returns. 

There are some instos out there who lever the low-vol process back to general equity market levels for example. Leverage is used in risk-parity portfolios for similar reasons.


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## DeepState (12 December 2014)

TPI said:


> RY, in broad terms what are the things that you consider to be smart beta and dumb beta, and which do you incorporate into your own portfolio construction?
> 
> And also, which of these if any do you giver greater weighting/significance too?
> 
> With regards to the liquidity premium, from my interpretation of it now and looking at my own portfolios, I find that my larger family trust portfolio (which is about 5 x the value of my SMSF portfolio) has relatively little exposure to this (partly due to it being leveraged), whereas my much smaller SMSF portfolio has a lot more exposure to this... which seems to fit with what you are saying here I think.




At present, I use diversification-based approaches to generate additional stuff.  It's essentially rebalancing on heat.  It is a mathematical property that requires no explanation from behavioural or market micro-structure sources.  You can check its existence from the fact that prices move at all.  So the source of edge is pretty clear and visible.

Smart beta is a bulk exposure to a concept that you can readily replicate without knowledge of specific circumstance.  That concept must expectationally yield a superior outcome.  The six bulk betas in the smart beta space for equities are Small Cap, Size, Low Vol, Momentum, Liquidity, Value.  

Dumb beta is anything without a very strong a testable hypothesis for believing in a positive expected outcome.  Sometimes smart beta is renamed dumb beta "Gee that was dumb".

It is also worthwhile checking to see if the premia still exist.  Ex post realization can lead you astray.  Strong and sustained excess returns from value can indicate that the forward looking premium has been eroded.  Similarly, are low-vol stocks getting super expensive?

I am looking at smart betas in currency right now. I like these because they exist for reasons that can seen. The drivers are large scale and can be confirmed via hard data.

Although these equity bulk betas are useful in an expectations sense, they also segment the market in terms of dynamics.  In other words, combinations of these ideas result in habitats where stocks have vastly different characteristics.  It's like having different industries.  This can be important to people like pair traders....

Smart beta is a marketing label which runs the chance of encouraging investors to believe that investing in accordance with it makes you smart automatically. Including momentum, all of these smart betas are rewards for risk bearing.  You get paid because you are the insurer and charge a premium for the service.  It is smart to ask what the size of that premium actually is from time to time and whether that risk is worth it.


----------



## TPI (12 December 2014)

DeepState said:


> There is a Yank saying that "you can't eat risk".  So that's possibly right.  Given you are prepared to utilize leverage though, it might be better to consider risk adjusted returns, find the most suitable idea based on that and lever up to get the risk you want.  That's the way to the best outcome ultimately....if you can get it right.  That particular segment might not produce the best risk-adjusted returns.
> 
> There are some instos out there who lever the low-vol process back to general equity market levels for example. Leverage is used in risk-parity portfolios for similar reasons.




Thanks RY, my family trust portfolio is predominantly low-vol with only a little bit of small cap exposure and a general value overlay, plus with conservative leverage. 

The use of leverage, particularly margin lending, tends to push the portfolio towards low-vol stocks.


----------



## DeepState (12 December 2014)

TPI said:


> Thanks RY, my family trust portfolio is predominantly low-vol with only a little bit of small cap exposure and a general value overlay, plus with conservative leverage.
> 
> The use of leverage, particularly margin lending, tends to push the portfolio towards low-vol stocks.




Nice work, TPI.  Your investment portfolio is in secure hands....

If 'conservative leverage' refers to a screen on company selection, then you are also picking up another bulk beta which I did not name.  That's the quality phenomenon.  If interested, Novy-Marx, Sloan & Richardson and Piotroski are worth checking out.  They are not in RAFI processes.  Novy-Marx is with DFA along with a lot of other clever people who combine theory and evidence-based practice.  You'd be at home there.


----------



## TPI (12 December 2014)

DeepState said:


> It is also worthwhile checking to see if the premia still exist.  Ex post realization can lead you astray.  Strong and sustained excess returns from value can indicate that the forward looking premium has been eroded.  Similarly, are low-vol stocks getting super expensive?
> 
> ...
> 
> It is smart to ask what the size of that premium actually is from time to time and whether that risk is worth it.




Fair enough, worth checking and being aware of.



			
				DeepState said:
			
		

> Although these equity bulk betas are useful in an expectations sense, they also segment the market in terms of dynamics.  In other words, combinations of these ideas result in habitats where stocks have vastly different characteristics.




That's interesting, maybe best not to get too fancy with the combinations then!


----------



## TPI (12 December 2014)

DeepState said:


> Nice work, TPI.  Your investment portfolio is in secure hands....
> 
> If 'conservative leverage' refers to a screen on company selection, then you are also picking up another bulk beta which I did not name.  That's the quality phenomenon.  If interested, Novy-Marx, Sloan & Richardson and Piotroski are worth checking out.  They are not in RAFI processes.  Novy-Marx is with DFA along with a lot of other clever people who combine theory and evidence-based practice.  You'd be at home there.




Yeah conservative leverage is also part of the stock selection screen.

I have not heard of Novy-Marx, Sloan & Richardson and Piotroski, but thanks I will look them up and read further.


----------



## TPI (12 December 2014)

luutzu said:


> Do you guys, or institutional investors and professionals... do you guys look at beta and alpha and macro data, market/industry forecasts and the like... do you guys look at these because you have already looked at the annual reports, already know the company very well and this macro analysis is to give you that extra edge?
> 
> Or do you only have some familiarity with the individual business but think that that's not where your focus should be; your focus ought to be with things beyond the company... for that's where the edge is?
> 
> In other words, do you already know the business to a great extend (almost to the level of its executives), but that is not enough? Or do you reckon a top down approach is the way to go because statistically, through probability... if the macro is right, the rest doesn't really matter.




luutzu, I'm not sure about others, but I just consider these as two separate areas, one being portfolio construction and another being stock selection.

They are not mutually exclusive and both have their place, and I don't think you need to achieve absolute mastery in both areas.

You are right that at the end of the day knowing the business and stock selection is the important and harder part, but as you buy a handful of stocks you are creating a portfolio, and having some extra ideas and concepts to help you build that overall portfolio into something cohesive and sensible to me seems useful.

You are already doing it without thinking when you make decisions about the number of stocks to hold, position sizes and whether or not your portfolio should be too exposed to banking or resources sectors etc..


----------



## luutzu (12 December 2014)

TPI said:


> luutzu, I'm not sure about others, but I just consider these as two separate areas, one being portfolio construction and another being stock selection.
> 
> They are not mutually exclusive and both have their place, and I don't think you need to achieve absolute mastery in both areas.
> 
> ...




Seriously, what you are doing is very admirable. I'd do the same thing. To search and learn from others, see different point of view and take what is useful... what can be better than that? And RY is one of the guys you'd want to talk to.... could save you an entire university degree in finance and investment.


----------



## TPI (14 December 2014)

TPI said:


> I have not heard of Novy-Marx, Sloan & Richardson and Piotroski, but thanks I will look them up and read further.




I had a read about the fundamental quality criteria researched by these authors, eg. gross profit to total assets, accruals ratios and the Piotroski score etc.. It's reassuring to read that there is some research and evidence-base to ones basic portfolio construction and investment approach, and this gives me some confidence. While there is debate about the reliability of different quality factors, the basic premise of merging value with quality sounds sensible, and just common sense really.

This article sums it up well:

https://www.researchaffiliates.com/...s/259_The_Moneyball_of_Quality_Investing.aspx

As I'm not a purely quantitative investor, and apply a qualitative filter to all my stock selections, I probably won't go too overboard with all the different fundamental ratios used to filter quality stocks and just stick to the ones that I can look up easily on my online brokerage account without delving too far into financial statements and having to manually extracting data and perform calculations. Or do so only on a case-by-case basis when wanting to delve deeper into a particular stock.

In any case if I were to use a predominantly quantitative approach, I think I would need to hold a lot more stocks and have a much larger portfolio, and only do so in a low-tax account like super, to minimise costs and CGT implications from the rebalancing effect.


----------



## TPI (14 December 2014)

luutzu said:


> Seriously, what you are doing is very admirable. I'd do the same thing. To search and learn from others, see different point of view and take what is useful... what can be better than that? And RY is one of the guys you'd want to talk to.... could save you an entire university degree in finance and investment.




Thanks luutzu, yeah I think I would skip the university degree and just get the practically applicable knowledge any day!


----------



## TPI (15 December 2014)

This old article on Buffett, referencing a Yale paper, is interesting:

http://www.telegraph.co.uk/finance/...n-Buffetts-success-unveiled-by-academics.html

http://www.econ.yale.edu/~af227/pdf/Buffett's Alpha - Frazzini, Kabiller and Pedersen.pdf

_"Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks."_

So the article suggests to me the use of leverage along with tilts to value ("cheap"), low-volatility ("safe") and quality factors.

The main difference for individual investors though is that the cost of leverage is likely to be much higher than for Buffett, but at the present time still at historically low levels (eg. home loan variable rates <5% and negotiated margin loan variable rates <5.5%).


----------



## DeepState (15 December 2014)

TPI said:


> This old article on Buffett, referencing a Yale paper, is interesting:
> 
> http://www.telegraph.co.uk/finance/...n-Buffetts-success-unveiled-by-academics.html
> 
> ...




Yes....Buffett is a Smart Beta investor.  His genius was realizing which betas to hunt within from very early on. Well before the idea was even expressed as anything like it.  He then overlayed  these with his own specific analysis....just like you (well, kinda sorta).  I'm so very glad you found this paper.  I hope it adds conviction to your path.


----------



## luutzu (15 December 2014)

TPI said:


> This old article on Buffett, referencing a Yale paper, is interesting:
> 
> http://www.telegraph.co.uk/finance/...n-Buffetts-success-unveiled-by-academics.html
> 
> ...




Buffett's leverage is not debt. As in, he doesn't go and borrow money to invest.

The leverage the article refers to is the "float" from his insurance companies or banks/finance companies like Amex. While these floats are technically liabilities and can be seen as debt/leverage, they're more like free money loaned to his companies as insurance premium (ones that may never need to be repaid if no claims are made) or floats from travellers cheques that earn interests while it's not yet drawn or lost cheques etc.

So while technically the article might be right that Buffett uses leverage/debt, I think a proper way to see these liabilities is it being him buying good businesses that, in the medium/long term, actually earn most of their floats/"liabilities"... or at least get to use it before it is actually theirs.

That I think is very different from the traditional definition of debt and leverage where the company simply borrow money.

---

What modern finance tend to do, and all academics and "scientific" approaches tries to do, is to quantify observations and create models and formulae... So they look at Buffett and either see his achievements as outliers and so not statistically significant; that or like these guys and look at the leverage his businesses provide and see it as simply debt so then conclude that leverage and debt plays an important part in his success and not the business.. then like here, say he focuses on value, take more risks... then define value as something like P/B ratio or P/E ratio; define risk as fluctuations against an index's price movements... then if that fails, try a smarter version.

It's basic in finance and accounting that whether a number or ratio is good or bad "depends"... it depends on the context, the various other factors and their impact on the business... and if we were to make proper sense of the factors that influence the performance of a particular business/investment, we might as well look at the individual business and its various influences.

I mean, it's good to buy valuable businesses at reasonable prices... but it's much better to buy them at bargain prices. How do we know when a business is a real bargain if we do not know it thoroughly? How do we get the courage to really commit on the rare few occasions when the market is really really wrong if we don't know enough?

If a company we kinda sorta is familiar with were to drop by 50%... and we don't really know the business, chances are we'd either abandon or hold on and pray. It's just common sense to follow the herd when you don't know what's going on. 

---

General investment principles, general market trends, general influences from macro/political policies... all these most of us could kinda guess as to its influence - generally. But if we want to be generally right, might as well buy an index fund and go fishing. I don't know of any great fortunes or great businesses that were build from general understanding.


Take a general rule of thumb about Enemy at the Gates.

If you're the commanding general in a castle with 100 troops and an army of 200 000 is at your gates... what would you do?

Rule of thumb is you either surrender and may save some civilian lives; that or lock the gates and fight to the death. But the wisest thing to do may be to open the gate and act as if nothing is happening. It all depends on the situation.

If the enemy is Genghis Khan or Santa Anna at the Alamo, opening the gates will just end you very quickly and very painfully. But if your enemy is Sima Yi and you're Zhuge Liang, opening the gate wide and play a nice tune atop the walls will save your entire city.


----------



## The Falcon (16 December 2014)

This is a great thread and one that I will come back to. Really trying to get a handle on whether any of the strategy ETFs actually cut the mustard in a taxable environment. Earlier in the thread pointed out that RVL (Russell Australia Value) has an unacceptable turnover, essentially killing its "on paper" advantage over a dumb index, now I have also looked at Market Vectors QUAL product, fees of 75bps and turnover of 25% p.a. suggest that it will struggle to beat the dumb indexes too. Really seems that value or quality tilts are hard to make work in ETF form, in a taxable environment. Appreciate feedback from RY and others on this.


----------



## DeepState (16 December 2014)

The Falcon said:


> This is a great thread and one that I will come back to. Really trying to get a handle on whether any of the strategy ETFs actually cut the mustard in a taxable environment. Earlier in the thread pointed out that RVL (Russell Australia Value) has an unacceptable turnover, essentially killing its "on paper" advantage over a dumb index, now I have also looked at Market Vectors QUAL product, fees of 75bps and turnover of 25% p.a. suggest that it will struggle to beat the dumb indexes too. Really seems that value or quality tilts are hard to make work in ETF form, in a taxable environment. Appreciate feedback from RY and others on this.




Welcome back.  Hope you had a great break.  

What is the tax environment that you house your investments within?


----------



## The Falcon (16 December 2014)

Cheers RY, I've attached a quick iphone Pano shot of White Beach, Boracay, right in front of EPIC/D'Mall....for you  , also a bit of time in Manila for work but not so photogenic as you can imagine. 

Two environments ;

- SMSF
- Family Trust, lowest tax beneficiary approx. 30% at the moment, probably max in a couple of years though due to distributions from private company shareholding.


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## TPI (16 December 2014)

luutzu said:


> Buffett's leverage is not debt. As in, he doesn't go and borrow money to invest.
> 
> The leverage the article refers to is the "float" from his insurance companies or banks/finance companies like Amex. While these floats are technically liabilities and can be seen as debt/leverage, they're more like free money loaned to his companies as insurance premium (ones that may never need to be repaid if no claims are made) or floats from travellers cheques that earn interests while it's not yet drawn or lost cheques etc.
> 
> ...




Sure I appreciate that, but the basic premise of using some form of leverage still makes a lot of sense to me. For Buffett it maybe free or low cost, but for the rest of us who don't own insurance businesses then we just have to accept that it will come at some cost, that is just reality. If you use leverage that is not subject to margin calls that is of course even better, and will make you more likely to withstand large drawdowns without fire sales just as Buffett has.


----------



## TPI (16 December 2014)

DeepState said:


> Yes....Buffett is a Smart Beta investor.  His genius was realizing which betas to hunt within from very early on. Well before the idea was even expressed as anything like it.  He then overlayed  these with his own specific analysis....just like you (well, kinda sorta).  I'm so very glad you found this paper.  I hope it adds conviction to your path.




Thanks RY, yeah this is also what the authors suggest about Buffett in the paper.


----------



## DeepState (16 December 2014)

The Falcon said:


> 1.  I've attached a quick iphone Pano shot of White Beach, Boracay, right in front of EPIC/D'Mall....for you  , also a bit of time in Manila for work but not so photogenic as you can imagine.
> 
> 2. Two environments ;
> 
> ...





1. 





2.

In comparison to Vanguard VAS which charges 0.15% fees and has about 4% underlying turnover based on annual reports...just as an indication...I know this is domestic and you are looking at international, but I can get the annual reports for this one...

These Alternative Betas are expected to generate something like 1-2% per annum over the standard indices over time.  Global developed market indices have lower yield than domestic equivalents.  When you work it out, it falls into the grey zone for 30% tax.  I would call it a wash if the comparative funds are massive and everything else you are saying is taken as given.  It is more likely to be sensible for a SMSF environment and looks likely to be a positive, if incremental, move to make.

However, in the particular instance of MarketVectors, the ETF you are looking at is tiny.  Market maker movements into and out of the unit will create very large turnover beyond index related movement.   In an expectations sense, that pushes it out of the grey zone for me and into the avoid-like-the-plague zone.  Perhaps you can get cheaper and larger versions listed elsewhere.  These may be listed in the US or UK for example.

Basically, you have the tools to work it out.  The bulk betas are worth about 1-2% per annum before tax and fees.  A switch from index will make more sense if the fees are at or lower than ~50bps per annum for SMSF environments.  If those conditions are met, there is a reasonable chance that smart beta will add value in the aggregate if the underlying ETF is well behaved in terms of unit creation/destruction with underlying turnover in the range that you have specified.


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## DeepState (16 December 2014)

TPI said:


> Sure I appreciate that, but the basic premise of using some form of leverage still makes a lot of sense to me. For Buffett it maybe free or low cost....




Good of you to raise the float costs.

This float is a form of working capital for insurance companies.  Every insurance company has them.  The valuation of premiums takes into account the fact that some investment income is earned on them.  Hence, if you expect that you will need to pay out $100 in a year, the premium you will require is less than that (expenses etc aside).  So, the absence of an explicit interest charge emanating from the float against the company in an explicit sense doesn't make it non-existent.  

The float actually isn't free by any means. You can infer the cost of it from looking at other more traditional insurance companies if you like.  That is actually the charge against Buffett's investment earnings for using these assets.   For greater clarity, Buffett's investment earnings should really be broken down into a "covering the float opportunity cost" component and a "surplus performance" component.

Whilst the cost of float would be lower than what the average person on the street could get on a loan, the margin between their leverage costs and Buffett's is not as large as often assumed once it is realized that the float cost is most certainly not zero.


----------



## TPI (16 December 2014)

luutzu said:


> What modern finance tend to do, and all academics and "scientific" approaches tries to do, is to quantify observations and create models and formulae... So they look at Buffett and either see his achievements as outliers and so not statistically significant; that or like these guys and look at the leverage his businesses provide and see it as simply debt so then conclude that leverage and debt plays an important part in his success and not the business.. then like here, say he focuses on value, take more risks... then define value as something like P/B ratio or P/E ratio; define risk as fluctuations against an index's price movements... then if that fails, try a smarter version.
> 
> It's basic in finance and accounting that whether a number or ratio is good or bad "depends"... it depends on the context, the various other factors and their impact on the business... and if we were to make proper sense of the factors that influence the performance of a particular business/investment, we might as well look at the individual business and its various influences.
> 
> ...




luutzu, you are right that specific and deep understanding and insight into a business is important, and in an ideal world we would all aim to achieve this for all the stocks we choose to own.

But we all have different constraints on our time that limit our capacity to do this to the fullest extent possible and to the level of mastery that you are perhaps suggesting.

You seem to be advocating an all or nothing approach, but I'm not sure how realistic that is, particularly for part-time stockmarket investors?

Even the know nothing approach of using index funds/ETFs may not achieve the right outcome in terms of tax efficiency and also income requirements if that is important to you.

In any case at the end of the day, investing is not rocket science either, so I think there is some merit in thinking broadly and strategically and in not over-complicating things as well.

And I believe that you can gain a broad and deep insight into the important and material drivers of a business without necessarily going into enormous minutiae in your research and analysis.

In doing this of course you have to accept a level of risk and that you may lose your capital in doing so, but you just have to choose the right position size, diversify, watch your investment closely and take corrective action early if you need to (ie. not buy, hold and pray)... all pretty basic stuff really.

If you're not comfortable with this risk, then fine, there is always residential property, commercial property, hybrids, bonds etc...


----------



## luutzu (16 December 2014)

TPI said:


> luutzu, you are right that specific and deep understanding and insight into a business is important, and in an ideal world we would all aim to achieve this for all the stocks we choose to own.
> 
> But we all have different constraints on our time that limit our capacity to do this to the fullest extent possible and to the level of mastery that you are perhaps suggesting.
> 
> ...




Yea, there is the cost-benefit tradeoffs. Phillip Fisher raised this very same issue you're saying in his book. That an ideal level of understanding would require an investor/analyst to look over the accounts year by year; study the trade journals, analyse the impact of costs and competition etc. etc. Who have time for that? I agree.

I can't remember what his suggested solution was exactly but it seem sensible to not go into too much detail yet not then just speculate either. That if you want to guess the guy's weight, you got to at least look at him a bit and not just ask what his age and ethnicity is and blindly assume it ought to be around the average of that group.

So you're right that there ought to be a balance. But I think that if the balance is between knowing the business "enough" and leaning towards general macro or other generic fundamental measures like beta or smart beta... to me I would lean more towards understanding the business itself.

I mean, you could spend enormous amount of time balancing and rebalancing your portfolio so it doesn't fluctuate too wildly against the market; or too far off from some index or variables...  I'd rather devote more time to knowing the business and its industry because I found that once I know enough about the particular business, I could make decisive judgment about its value in the future without too much fuss - once you've studied a big business in detail, it tend not to change that much and so when the price is right, you'd just know it.

I think Fisher was saying that of the 100 companies he look at, he might be interested in two. Of the two he's interested in, he might only like one after a visit to management. We might be luckier and like 20 out of 100, but the prices are often either too high or not interesting enough... and so we wait until it get interesting. 

Anyway, I just do what I can with the tools and resources I have, so yea.


----------



## TPI (16 December 2014)

luutzu said:


> Yea, there is the cost-benefit tradeoffs. Phillip Fisher raised this very same issue you're saying in his book. That an ideal level of understanding would require an investor/analyst to look over the accounts year by year; study the trade journals, analyse the impact of costs and competition etc. etc. Who have time for that? I agree.




Exactly, who has the time for this?! 

And speaking of Phillip Fisher, I have a Phillip Fisher book on my list of books to read, but haven't bought or read it yet as I'm still not finished reading a book by Peter Lynch I bought 6 months ago! Back in my university days I would have knocked these over in a few days. I first started reading about stocks when I was 19, then stopped soon after and started only reading about property and only investing in property for the next decade+. I only got back into reading and investing in shares in the last few years. If I hadn't have been so single-minded in my choice of investment vehicle I might have read a few more books on shares by now, but it's still not too late and hopefully I will get around to reading these classics over the next few years!



			
				luutzu said:
			
		

> So you're right that there ought to be a balance. But I think that if the balance is between knowing the business "enough" and leaning towards general macro or other generic fundamental measures like beta or smart beta... to me I would lean more towards understanding the business itself.




Me too, I think we are on the same page here. With the smart beta stuff, once you know what it's about that's it, it may influence your broad portfolio construction/portfolio strategy if you agree with it but that's about it, so shouldn't really consume any ongoing time.



			
				luutzu said:
			
		

> I'd rather devote more time to knowing the business and its industry because I found that once I know enough about the particular business, I could make decisive judgment about its value in the future without too much fuss - once you've studied a big business in detail, it tend not to change that much and so when the price is right, you'd just know it..




Agreed, that sounds sensible.


----------



## luutzu (16 December 2014)

I do my reading while on the throne    So there's a book I've been reading for a year now and it's only half way. 

Try audio books from torrent or download them from YouTube. I listen while working so sometimes I missed half or miss completely... but it tend to make up after a few repeats.


----------



## TPI (16 December 2014)

DeepState said:


> Whilst the cost of float would be lower than what the average person on the street could get on a loan, the margin between their leverage costs and Buffett's is not as large as often assumed once it is realized that the float cost is most certainly not zero.




Good point and if you look at margin loan interest rates on US stocks in USD, they are now as low as 1.12% pa for loans between 100k and 1M with Interactive Brokers, which to me is pretty close to zero anyway.


----------



## TPI (16 December 2014)

luutzu said:


> I do my reading while on the throne    So there's a book I've been reading for a year now and it's only half way.
> 
> Try audio books from torrent or download them from YouTube. I listen while working so sometimes I missed half or miss completely... but it tend to make up after a few repeats.




Haha, thanks yeah I might look into a few audio books for the drive to work and back.


----------



## DeepState (16 December 2014)

TPI said:


> Good point and if you look at margin loan interest rates on US stocks in USD, they are now as low as 1.12% pa for loans between 100k and 1M with Interactive Brokers, which to me is pretty close to zero anyway.




Unbelievable.  What am I missing?  From IB you can finance a portfolio of stock more cheaply than you can borrow money for a residence in Australia??? The IB loan rate for Aus is 3% for $1-20m.  The RBA survey rate for discounted variable mortgages out of the banks is 5.1%.  The mortgage is not tax deductible either.

https://www.interactivebrokers.com/en/index.php?f=interest&p=schedule2


----------



## TPI (17 December 2014)

DeepState said:


> Unbelievable.  What am I missing?  From IB you can finance a portfolio of stock more cheaply than you can borrow money for a residence in Australia??? The IB loan rate for Aus is 3% for $1-20m.  The RBA survey rate for discounted variable mortgages out of the banks is 5.1%.  The mortgage is not tax deductible either.
> 
> https://www.interactivebrokers.com/en/index.php?f=interest&p=schedule2
> 
> View attachment 60776




Yeah, our rates are pretty expensive by comparison! The main difference is that in the US your shares are not held in your own name, they are held in the name of the broker in trust for you or something like this. So there is some risk if the broker goes bust, which is not the case here in Aus with our CHESS system. But they have an insurance policy through the "SIPC" that covers them for this to some extent. Some investment banks in Aus use a similar structure to give margin loan rates around 4% or so, but still not as cheap as Interative Brokers. There's a few other differences, like no margin calls, ie. they can just sell the shares when you breach the max LVR without telling you and the max LVR is about 50%, so much lower than you can get here. They recently just stopped offering margin to Aus investors due to some licensing issue in Aus, but only for accounts in your own name, trust accounts were still ok the last time I checked. I would consider using them for only a portion of my lending, but for peace of mind have stuck with regular Aus margin lenders to date.


----------



## The Falcon (17 December 2014)

DeepState said:


> 1.
> 
> View attachment 60768
> 
> ...




1. Ha. 

2. Cheers RY. Great info and appreciate your confirmation of what I was thinking. I've come to;  if you are going to index..then index. So, a portfolio with ETFs at its core might look like; VAS and VTS (I am leary on Europe long term), then pick up the "smart Beta" from larger tilts to US Small Caps and Emerging markets, via cheap, dumb index ETFs.


----------



## DeepState (17 December 2014)

TPI said:


> Yeah, our rates are pretty expensive by comparison! The main difference is that in the US your shares are not held in your own name, they are held in the name of the broker in trust for you or something like this. So there is some risk if the broker goes bust, which is not the case here in Aus with our CHESS system. But they have an insurance policy through the "SIPC" that covers them for this to some extent. Some investment banks in Aus use a similar structure to give margin loan rates around 4% or so, but still not as cheap as Interative Brokers. There's a few other differences, like no margin calls, ie. they can just sell the shares when you breach the max LVR without telling you and the max LVR is about 50%, so much lower than you can get here. They recently just stopped offering margin to Aus investors due to some licensing issue in Aus, but only for accounts in your own name, trust accounts were still ok the last time I checked. I would consider using them for only a portion of my lending, but for peace of mind have stuck with regular Aus margin lenders to date.




Something just isn't right.  Here's Merrill Lynch's US margin rates for comparison.




They enjoy the same S&P rating as IB (via BofA).  

..and for Chase (JP Morgan)




JP Morgan has a 1yr CDS spread of slightly over 50bps.  IB lends for a 50bp margin over that to stock speculators? Really?  What do you get for the price?  Or, from another perspective, what did you have to give away to receive that price?  Consider that IG charges a spread more than twice that figure...

There looks to be some very significant risk being taken somewhere that is not immediately evident.   On a quick scan, I don't exactly know where it is.  Absence of proof is not proof of absence though. The price of debt as quoted tells me it almost certainly exists.  Just be careful with your dough.  The SIPC is very specific about what it protects and mixing of assets on a net basis, securities not held in your exact account etc... are all issues.  Check out the term re-hypothecation (which is going on)....and ask what it means not to have the stock in your account in your name...just for example.  I think the super cheap rates arise from taking risk on IB and then IB's stock lending counterparties and then their counterparties etc.  This is something that would not happen in more vanilla arrangements.  The mechanics of these things in a blow up are terribly messy and could mean client losses are large without recourse to SIPC because all you had was a swap arrangement with the broker...the underlying assets were never in your name.  This is not theoretical.


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## TPI (17 December 2014)

Yeah their rates do seem too good to be true, and as you say may reflect underlying risks not so apparent. There's a thread in the brokers sub-forum here where others currently using IB may be able to offer their thoughts.


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## craft (6 February 2015)

Warren Buffett adds to his lead in $1 million hedge-fund bet

http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/


I guess the moral of the story is smart beta ideas the hedge funds employ just don't return enough to justify the fees charged.

See bet details here.

http://longbets.org/362/

Broad based, low cost, low turnover, non synthetic - ahead at the 7 year mark.


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## ROE (6 February 2015)

Classic human behavior  people like sexy and complex stuff

hedge fund sound cool because of what they do, they get head line of 100% return or massive double return every so often and this draw in the crown 

but history has proven boring and simple stuff usually works best.
Which one sound more sexy? 

I am a stock market traders and I make 10%  gain today or 
I am a investor invest in business for yield, sound pretty ****ty and low return no mentioned of capital gain


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## Ves (6 February 2015)

craft said:


> Warren Buffett adds to his lead in $1 million hedge-fund bet
> 
> http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/
> 
> ...



I'm not surprised by all of this.  The passive alternatives have a lot of merits.

What I'm interested in,  and this may belong in another thread, is some views from DeepState and yourself,   about indexing and other passive alternatives in Australia.    My main concern with such a strategy is that our major indexes are highly skewed towards a small amount of companies (Big 4 banks,  big mining companies, Telstra, and the two consumer discretionary conglomerates).  I don't think the S & P 500 has this feature.  With passive investment,  it appears that most would not question that,  and up until now it has worked fabulously well,    but is there a way to alleviate the reliance of these companies for future index returns?  I realise you can buy ETFs for international exposure as well,  and that would be part of any good strategy.

Obviously there is always risk and you (hopefully) get rewarded for bearing it.


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## craft (6 February 2015)

Ves said:


> I'm not surprised by all of this.  The passive alternatives have a lot of merits.
> 
> What I'm interested in,  and this may belong in another thread, is some views from DeepState and yourself,   about indexing and other passive alternatives in Australia.    My main concern with such a strategy is that our major indexes are highly skewed towards a small amount of companies (Big 4 banks,  big mining companies, Telstra, and the two consumer discretionary conglomerates).  I don't think the S & P 500 has this feature.  With passive investment,  it appears that most would not question that,  and up until now it has worked fabulously well,    but is there a way to alleviate the reliance of these companies for future index returns?  I realise you can buy ETFs for international exposure as well,  and that would be part of any good strategy.
> 
> Obviously there is always risk and you (hopefully) get rewarded for bearing it.




As you have indicated the large market caps have outperformed the rest of the market recently as people chase "safe yield" you just need to compare XJO against XSO to see it clearly. If you expect this to mean revert - then somewhere ahead lays underperformance for a market weight ETF vs an Equal weight ETF.  However if your time frame is long enough - you can safely ignore this, you will catch both sides as the relevant performance swings.  

To me the risk with an equal weight index for the very long term passive approach is that there is a risk that you will not capture the full economic growth of the society which you are trying to gain exposure too and that outweighs any rebalancing benefit that such a fund may achieve.  

International exposure for broad based passive ETFs - The core questions for me are what economies do I want to gain exposure too? What economies produce the goods and services I want to consume over my lifetime.


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## Ves (6 February 2015)

Another way of looking at it possibly.    The top 10 on the ASX is about 35-40% of the entire market from what I recall.  The S & P website seems to indicate roughly the same  (top 20 is 46% of market cap,  top 10 is 81% of the top 20).

So if the top 10 lost 30% due to some kind of drastic mean reversion....   the whole index would only fall about 12%   (making the big assumption that there was no mean reversion in either direction for the balance of the constituents).

Is this basically where you were going with the limited impact on an investor with a very long time horizon?


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## craft (6 February 2015)

Ves said:


> Another way of looking at it possibly.    The top 10 on the ASX is about 35-40% of the entire market from what I recall.  The S & P website seems to indicate roughly the same  (top 20 is 46% of market cap,  top 10 is 81% of the top 20).
> 
> So if the top 10 lost 30% due to some kind of drastic mean reversion....   the whole index would only fall about 12%   (making the big assumption that there was no mean reversion in either direction for the balance of the constituents).
> 
> Is this basically where you were going with the limited impact on an investor with a very long time horizon?




What you lose when the pendulum of relative performance swings one way, you pick up when it swings back the other way. See enough swings and an awful lot of relative performance volatility is neutralised in the wash. Be around for only a swing one way and where you get on and off maters a lot. ie if you are only investing for a few years the possibility of the big market caps reverting to some sort of lower mean of relative performance is a big deal. Over the long term it matters a lot less.


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## TPI (6 February 2015)

craft said:


> Warren Buffett adds to his lead in $1 million hedge-fund bet
> 
> http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/
> 
> ...




The smart beta ideas spoken about here in this thread are in the context of passive index funds or ETFs, they are just slight variations on Vanguard's approach, still broadly diversified, low cost, low turnover and passive. As distinct to the actively managed, higher cost, higher turnover, alpha-seeking hedge funds. So not sure about this comparison you make here...


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## luutzu (6 February 2015)

craft said:


> Warren Buffett adds to his lead in $1 million hedge-fund bet
> 
> http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his-lead-in-1-million-bet-with-hedge-fund/
> 
> ...





I heard that Buffett said "Beta doesn't tell you a dam thing."

So beta = "doesn't tell you a dam thing."

Smart beta = smarter way of not telling you a dam thing (and will charge extra for it).


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## The Falcon (28 February 2015)

RAFI US 1000 now on asx, ticker QUS for those interested

http://www.betashares.com.au/products/name/ftse-rafi-u-s-1000-etf/#each-overview


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## galumay (28 February 2015)

luutzu said:


> I heard that Buffett said "Beta doesn't tell you a dam thing."
> 
> So beta = "doesn't tell you a dam thing."
> 
> Smart beta = smarter way of not telling you a dam thing (and will charge extra for it).




There are plenty of other studies that show that Beta is not a good measure of risk, its not a metric I look at after reading the research.


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## The Falcon (28 February 2015)

TPI said:


> Yeah their rates do seem too good to be true, and as you say may reflect underlying risks not so apparent. There's a thread in the brokers sub-forum here where others currently using IB may be able to offer their thoughts.




Very keen to understand these custodian account risks, the margin rates are very sharp. Through Deutsche Bank OZ private wealth 4.9% AUD and 3.3% USD are available on $1m facilities (min initial draw down 250k) I hear. No doubt available elsewhere too.


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## Faramir (20 March 2015)

Picture taken from Smart Investor Magazine April 2015, Page 64. Article written by James Frost.

I can't find a website to the article.

If anyone brought Australian Financial Review today and received the magazine insert, please read the article and comment on its relevance to this thread.

Russell Investments High Dividend Australian Shares ETF (RDV) 3.44% (1 year)
Russell Investments Australian Value ETF (RVL) 2.04% (1 year)

Thank you.

These are two paragraphs that I can understand:

"Smart beta strategies run a filter over the benchmark index and tweak allocations according to a formula. They typically charge a basis point or two more than index funds, and product-makers like to say they deliver alpha for the price of beta."

"The moral is investor can't afford to take claims at face value. For every impressive performer there is an equally underwhelming underperformer. Buying a product marked as "smart beta" is no guarantee you will get what you pay for."


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