Fundamental Indexing

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ClosetIndexer
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Re: Fundamental Indexing

Post by ClosetIndexer »

DenisD wrote:Blackrock Announces Change to CWO
Effective on or about July 1, 2012, CWO will seek to replicate the performance of the FTSE RAFI Emerging Markets Index
MER for CWO is 0.73%, PowerShares PXH is 0.85%. OTOH, CWO has some ETFs in its top 10 holdings. CWO has $74,000,000 assets, PXH has $345,000,000.
Also, being Canadian-domiciled, CWO will save you approximately 30bps on withholding taxes in a taxable account (or TFSA). Don't like seeing those ETFs in the top holdings though; will likely lead to significant tracking error (in which direction, who knows, but I don't like uncertainty...) CIE was fairly ugly while they were sampling their index. I don't see a reason not to expect the same here. Not that PXH is any better; it's had negative tracking error of over 1.5% more than its MER since inception around 5 years ago. Until I see evidence of that improving or CWO doing better, I'm going to have to stick with VWO, as much as I wanted to like this fund (given the dearth of quality EM value).
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Re: Fundamental Indexing

Post by DenisD »

ClosetIndexer wrote:CIE was fairly ugly while they were sampling their index. I don't see a reason not to expect the same here. Not that PXH is any better; it's had negative tracking error of over 1.5% more than its MER since inception around 5 years ago.
That's been a concern of mine as well. And I've owned CIE and the Powershares non-US ETFs since shortly after inception. But it hasn't cost me much compared to the alternatives. Here are some 4 year returns in CAD to the end of 2011.

Code: Select all

Name                                    Symbol    2008   2009   2010   2011   4 Yr
TD Canadian Index - e                            -32.9   34.6   17.2   -8.9   -0.7
iShares CDN Composite Index             XIC      -33.0   34.5   17.3   -8.9   -0.8
iShares CDN LargeCap 60 Index           XIU      -31.1   31.5   13.6   -9.2   -1.3
Claymore CAN Fundamental Idx ETF        CRQ      -31.6   44.3   13.7   -8.3    0.6
iShares CDN Value Index                 XCV      -33.9   43.8   16.0   -5.0    0.9

TD International Index - e                       -27.9    9.5    1.7  -10.0   -6.3
iShares MSCI EAFE Index                 EFA      -30.1   13.3    1.8  -10.2   -6.3
Vanguard Europe Pacific                 VEA      -27.9   10.8    2.6  -10.6   -6.0
Claymore Intl Fundamental Idx ETF       CIE      -30.7   15.6   -0.2  -13.1   -7.0
PowerShares FTSE RAFI Dvlpd Mkts ex-US  PXF      -31.8   22.9    0.6  -13.5   -6.1
iShares MSCI EAFE Value Index           EFV      -31.1   15.4   -2.2  -10.2   -6.9

iShares MSCI EAFE Small Cap Index       SCZ      -35.9   26.2   15.8  -13.0   -4.0
PowerShares FTSE RAFI Dvp Mkts exUS S/M PDN      -27.7   33.0   11.9  -10.2   -0.7

CIBC Emerging Markets Index                      -39.0   42.3   10.5  -16.8   -4.4
iShares MSCI Emerging Markets Index     EEM      -38.5   48.1    9.7  -17.1   -3.7
Vanguard Emerging Markets               VWO      -42.1   52.1   12.6  -16.8   -3.8
PowerShares FTSE RAFI Emerging Markets  PXH      -34.5   47.7    7.0  -17.6   -3.1

TD US Index - e                                  -21.7    6.7    8.4    4.1   -1.2
iShares Russell 1000 Index              IWB      -23.3   10.8    9.7    3.6   -0.7
Vanguard Large Cap                      VV       -22.6   10.3    9.6    3.8   -0.6
PowerShares FTSE RAFI US 1000           PRF      -26.4   22.1   13.1    1.9    0.7
Vanguard Large Cap Value                VTV      -21.2    3.3    8.3    3.4   -1.8

iShares Russell 2000 Index              IWM      -18.5    9.7   19.9   -2.0    1.0
Vanguard Mid Cap                        VO       -28.6   21.3   18.8    0.3    0.6
Vanguard Small Cap                      VB       -21.5   17.6   21.0   -0.5    2.1
PowerShares FTSE RAFI US 1500 Small-Mid PRFZ     -24.4   34.9   22.1   -4.0    3.6
Vanguard Mid Cap Value                  VOE      -22.1   18.9   15.3    1.9    1.7
Vanguard Small Cap Value                VBR      -16.6   12.7   18.3   -1.9    1.8

FTSE RAFI® 1000                                  -26.3   22.5   13.5    2.3    0.9
S&P 500                                          -22.6    9.1    8.9    4.4   -0.8
Russell 1000                                     -23.3   10.8    9.9    3.8   -0.6
FTSE RAFI® US 1500                               -24.2   34.4   22.4   -3.8    3.7
Russell 2000                                     -18.6    9.7   20.0   -2.0    1.0
FTSE RAFI® Developed ex US 1000                  -31.1   24.3    1.8  -12.4   -5.2
MSCI World ex US Large Cap                       -30.4   16.9    4.0   -9.5   -5.2
FTSE RAFI® Developed ex US Mid Small             -29.2   31.8   10.6  -10.2   -1.5
MSCI World ex US Small Cap                       -34.6   23.6   13.0  -13.6   -4.6
FTSE RAFI® Emerging Markets                      -37.7   56.9   11.9  -16.0   -1.7
MSCI Emerging Markets                            -44.1   54.5   12.8  -16.3   -4.0
Taken from this Google spreadsheet
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Re: Fundamental Indexing

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IMO it's the performance compared to a fund's underlying factor loadings that really matters. Unfortunately, the other international developed value fund, EFV, is even worse in terms of capturing its factors efficiently (maintaining alpha near zero in Fama-French 3-factor regressions), so it doesn't provide a great comparison. They may do fine compared to the general market when value does well, but they will under-perform when it does poorly. If they consistently lag their index by a large amount, and therefore also lag their expectation based on their factor exposures, they will assuredly fall behind in the long term.

I find a similar market with the Canadian options for small or value tilts. It looks to me like any potential premiums compared to a broad fund like XIC or VCE will likely be swallowed by the added expenses and the indexes inability to capture their factor loadings effectively.
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Re: Fundamental Indexing

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The Winner's Curse By Rob Arnott, Lillian Wu
For investors, top dog status—the No. 1 company, by market capitalization, in each sector or market—is dismayingly unattractive. We find a statistically significant tendency for top companies in each sector to underperform both the overall sector and the stock market as a whole. In an earlier U.S.-only study, we found that 59 percent of these top dogs underperformed their own sector in the next year, and two-thirds lagged their sector over the next decade. We found a daunting magnitude of average underperformance, averaging between 300 and 400 bps per year, over the next one to 10 years.

In this study, we have broadened the test to examine whether the "top dog" phenomenon is prevalent elsewhere. We find the same phenomenon in each and every market, with no exceptions. Indeed, outside the United States, the sector top dogs generally underperform their own sector even more relentlessly than in the United States!

It would appear that our top dogs, the most beloved and winningest companies in each sector or country, are typically punished—often severely—in subsequent market action.
Check out Canada. :(
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Re: Fundamental Indexing

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PowerShares Cuts Fees On Six ETFs
Fees on my PowerShares FTSE/RAFI ETFs reduced by 35 – 40%. :thumbsup:
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Re: Fundamental Indexing

Post by ig17 »

O'Shaughnessy Asset Management:

Combining the Best of Passive and Active Investing

The paper looks at alternatives to market cap indexing.

You may need to register to download the PDF.
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Re: Fundamental Indexing

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I don't think anyone has mentioned the Schwab fundamental index ETFs which became available recently. Mostly, they cover the same asset classes as the PowerShares fundamental index ETFs at a slightly lower cost. The 2 companies use different fundamental index algorithms. But both are supplied by Research Affiliates, Rob Arnott's firm.

Tempting because cost is lower and the algorithm uses stock buybacks. :wink:

Schwab Launches Fundamental ETFs

Bogleheads discussion: http://www.bogleheads.org/forum/viewtop ... 1#p1648541
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Re: Fundamental Indexing

Post by parvus »

Interesting. I wonder about the justification for stock buybacks.
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Re: Fundamental Indexing

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Re: Fundamental Indexing

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How Many Monkeys Does it Take to Find a Successful Strategy?
Michael Edesess and Kwok L. Tsui wrote:Nevertheless, some purveyors of investment strategies have managed to promote the idea that most or even all randomly generated stock portfolios are above average. Let’s call this the Wobegon Heights effect.

This begins with a pseudo-mathematical argument, which is usually worded as follows: A capitalization-weighted index overweights overvalued stocks and underweights undervalued stocks. Therefore it will underperform, and any other index is better.

This statement is virtually never proven by translation into true mathematical form. When stated rigorously, it is easily shown to be false. Nevertheless it has had a certain marketing appeal that has carried it – and the investment strategies that are sold based on it – surprisingly far.

The same school of thought has argued that “alternative” indices – which have come to be called “smart beta” – will be superior to market-capitalization-weighted indexes. For example, advocates of so-called “fundamental indexing” – which tilts toward value stocks by weighting stocks with lower market-to-book ratios more heavily – have tried to argue that the strategy will work for theoretical reasons, not just because they expect past performance to persist.

The tilt toward value and small-cap

A large quantity of historical data has shown that the past performance of “value” (low market-to-book ratio) and small-capitalization stocks has been superior over long periods of time to that of the market as a whole. Some speculate that value and small-cap stocks may have risk characteristics that are not fully revealed by conventional measures. (We believe it may also be due to the fact that finance researchers almost always use holding-period returns in their regressions instead of continuously-compounded returns – i.e., log-returns – which would correct for the skewness in returns distributions. The two alternatives produce very different results.)
Have not delved enough to say whether they are right or not...
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Re: Fundamental Indexing

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adrian2 wrote:How Many Monkeys Does it Take to Find a Successful Strategy?
Michael Edesess and Kwok L. Tsui wrote:Nevertheless, some purveyors of investment strategies have managed to promote the idea that most or even all randomly generated stock portfolios are above average. Let’s call this the Wobegon Heights effect.

This begins with a pseudo-mathematical argument, which is usually worded as follows: A capitalization-weighted index overweights overvalued stocks and underweights undervalued stocks. Therefore it will underperform, and any other index is better.

This statement is virtually never proven by translation into true mathematical form. When stated rigorously, it is easily shown to be false. Nevertheless it has had a certain marketing appeal that has carried it – and the investment strategies that are sold based on it – surprisingly far.

The same school of thought has argued that “alternative” indices – which have come to be called “smart beta” – will be superior to market-capitalization-weighted indexes. For example, advocates of so-called “fundamental indexing” – which tilts toward value stocks by weighting stocks with lower market-to-book ratios more heavily – have tried to argue that the strategy will work for theoretical reasons, not just because they expect past performance to persist.

The tilt toward value and small-cap

A large quantity of historical data has shown that the past performance of “value” (low market-to-book ratio) and small-capitalization stocks has been superior over long periods of time to that of the market as a whole. Some speculate that value and small-cap stocks may have risk characteristics that are not fully revealed by conventional measures. (We believe it may also be due to the fact that finance researchers almost always use holding-period returns in their regressions instead of continuously-compounded returns – i.e., log-returns – which would correct for the skewness in returns distributions. The two alternatives produce very different results.)
Have not delved enough to say whether they are right or not...
A random selection of stocks would absolutely have a tilt toward small caps, simply because there are many more small caps than large caps out there. (Something like the largest 10% of stocks make up the upper 50% of the market by market cap.) It would probably also capture a small amount of value for a related reason, because the very largest stocks tend to be growth stocks, and are unlikely to be selected. The reasoning that the index itself overweights overvalued stocks seems flawed to me though, based on any definition of 'value' I've read. Just because a stock has a higher market cap, it doesn't mean it's "overvalued". By definition, the market cap-weighted index doesn't overweight or underweight anything.
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Re: Fundamental Indexing

Post by Park »

http://www.forbes.com/sites/rickferri/2 ... he-market/

Rob Arnott and Research Affiliates have a paper about monkeys beating the market.

"the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results. The process replicated 100 monkeys throwing darts at the stock pages each year. Amazingly, on average, 98 of the 100 monkey portfolios beat the 1,000 stock capitalization weighted stock universe each year."


A group at the Cass Business School have a similar paper about monkeys beating the market.

http://www.ft.com/intl/cms/s/0/abd15744 ... z2ivhmTMay


As mentioned above, the results are due to the small cap/value tilt in the portfolios studied. Also, there would be a benefit from annual rebalancing. When two assets have similar return, volatility that isn't significant and don't correlate well, returns will be increased by annual rebalancing.

To get a small cap value tilt, one can use DFA funds. Another idea might be to get cheap beta with regular market cap index funds, and create your own small cap value fund by purchasing individual stocks. In the smaller Canadian market, this makes more sense yet.
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Re: Fundamental Indexing

Post by parvus »

FWIW: A compelling alternative to plain-vanilla indexing
A somewhat rudimentary G&M piece.
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Re: Fundamental Indexing

Post by ig17 »

Rob Arnott on WealthTrack with Consuelo Mack.

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