Not to flame another Cman/MJG war, but there is definitely another side to this story. Fama-French factors have come into some pretty compelling criticism lately, and it is no longer clear there is a SCV premium or historical outperformance.
First, a graphic example. (edit: Sigh, looks like M* won't allow you to link to the period I had originally input. To look at that chart, use 6/25/1979 as the start date. The values I listed are correct.)
Those are the returns of a $10,000.00 investment in each of VFINX ($474,278.66), NAESX ($434,025.38), SCV ($524,319.28), and LCV ($411,828.31) over the past 35 years, approximately the time horizon of a retirement portfolio.
Second, the CAPM model assumes the most efficient portfolio is one that contains all the securities in a market, and that any excess return comes from increased risk. Fama-French expands that by explaining where you find that risk (beta). You aren't increasing your diversification by adding SCV to a portfolio of domestic stocks (if you doubt this, check a correlation table between VFINX and VISVX). You are adding risk in hope of greater returns.
So two questions:
1) Where are the excess returns for the small cap and value premia; and
2) if this investor didn't get greater returns, why did he/she accept greater risk?
As a lot of us probably know this, I'll just link these articles and let people ruminate on their own.
Sam Lee from M* explains Fama-French factors well here and here. He also explains his problems with Efficient Market Theory here. You can find the original paper describing the small-cap premium by Rolf Banz here.
Turns out, however, that there has been no return premium for small cap stocks since the data was gathered by Banz in 1979. How can that be? Explanations for problems with the Fama-French assumptions, start with their own recent paper explaining how the three factors are actually five. Ask yourself after, "where does this stop?"
From there you can read:
Sam lee on the Five-Factor model. ("I think this should be a come-to-Jesus moment for those who've taken the F-F model as the gospel truth. Fama and French admit that their original three-factor model was not motivated by theory. They chose value and size because they worked better than other characteristics in back-tests. Grounded in the efficient-market hypothesis, they came up with risk-based stories for these patterns. Small-cap stocks provided excess returns because they're more vulnerable to the business cycle. Value stocks did so because they were distressed.
However, since then, the size factor is no longer considered a significant source of excess returns by many academics and practitioners. Rolf Banz's original 1981 study showing a huge size premium was marred by survivorship bias. After it was corrected in the mid-1990s, back-tests showed a much smaller premium. Moreover, whatever excess returns small-cap stocks provided were driven by the smallest, least liquid securities.")
John Rekenthaler on problems with supposed historical premia. ("To the extent that smaller companies do outperform, those gains likely owe to a liquidity premium. Smaller-company shares have lower trading volume, which increases the chance of moving the stock price by putting in a trade order, and which hampers the investor’s ability to rapidly enter or exit a position. Low liquidity is a real cost that deserves to be compensated with a real return. This is fine--but properly speaking, it’s not a small-company effect.")
Finally these are articles from Advisor Perspectives, a commentary/newsletter service for FAs: 'The Small Cap Falsehood' ("The supposed outperformance of small cap stocks is a foundational precept on which many respected asset managers have staked their expertise over the years – foremost among them, Dimensional Fund Advisors (DFA), the famed fund company that has gained a near-religious following since they popularized small cap indexing three decades ago. A growing body of research, however, shows no such advantage for the last 30 years and, now, a new study seems to have proven that the supposed small-cap advantage may have never existed in the first place.");
and 'A Test for Small Cap and Value Stocks' ("In a recent talk, Stanford professor and Nobel economist Bill Sharpe challenged advocates of smart-beta strategies, including overweighting small-cap and value stocks, to respond to two questions. Can the strategy be adopted by all market participants, or does it have a practical limit in terms of assets that can be invested? If it has a practical limit, then one should expect the premium to decrease over time.
For small-cap stocks, for example, it is obvious that the answer is "no" – eventually the dollars pursuing those stocks would make them mid- or large-cap stocks. The same is true for value stocks; the money pursuing them will eventually drive prices up and erase their risk premium.
In an email exchange, [Larry] Swedroe essentially agreed.")
It should be pointed out that Merriman has an agenda here: he sells DFA funds that are uniquely based on the Fama-French factors. To be fair, those funds have done very well since inception. It is worth asking, however, if the small cap premium is based in liquidity and not size, whether an index is the best method of including this asset class in a portfolio.
It should also be said that the one factor that is predictive of future performance is valuation as measured by Shiller CAPE. And right now, US small caps have historically high valuations.
So should someone include SCV? That depends on what their horizon and goals are. But if they do weight to SCV, they should be aware they are accepting increased risk with no guarantee of increased returns.

The Shiller Enhanced CAPE fund (DSENX) seems more in the Db'line wheelhouse, vs. a straight actively-managed equity fund. It's a formulaic sector-rotation stock strategy represented by derivatives, backed by a Gundlach bond strategy ... broadly similar to the Pimco PLUS funds.
P.S. Anyone who's ever had athlete's foot won't have any trouble remembering the ticker ...

FYI: Copy & Paste 6/21/14:
Regards,
Ted
A well-thought-out exit strategy is vital to the success of a mission, as the recent events in Iraq demonstrate quite dramatically.
Given that unfortunate example, it might be well that the Federal Reserve appears to be thinking about the consequences of the end -- and eventual reversal -- of its massive experiment in monetary stimulation. Last week, the Financial Times reported that the central bank is mulling exit fees on bond mutual funds to prevent a potential run when interest rates rise, which, given the ineluctable mathematics of bond investing, means prices fall. Quoting "people familiar with the matter," the FT said that senior-level discussions had taken place, but no formal policy had been developed.
Those senior folks apparently didn't include Fed Chair Janet Yellen. Asked about it at her news conference on Wednesday, she professed to be unaware of any discussion of bond-fund exit fees, adding that it was her understanding that the matter "is under the purview" of the Securities and Exchange Commission.
That nondenial denial leaves open the possibility that some entity in the U.S. financial regulatory apparatus is indeed mulling bond-fund exit fees. The Financial Stability Oversight Council established by the Dodd-Frank legislation oversees so-called systemically important financial institutions, or SIFIs, which include nonbank entities. And, indeed, the FSOC has considered designating asset managers as SIFIs, as Barron's has noted previously ("Why Fund Firms Aren't Too Big to Fail," June 2).
To Dan Fuss, the longtime chief investment officer at Loomis Sayles, the exit-fee story seemed like a "trial balloon." But, he added, "from a practical point of view, I don't think it has a snowball's chance in hell, given the resistance from the retail distributors of mutual funds."
Still, he continued, "it won't make me very popular -- but I think it's a good idea." That's from someone whom I would call the Buffett of bonds. Like his fellow octogenarian in Omaha, Fuss has lived through more than a few market paroxysms and has been able to take advantage by putting money to work opportunistically during panics. Unlike the head of Berkshire Hathaway, Fuss also has had to contend with outflows from his flagship Loomis Sayles Bond fund and the firm's other corporate-bond funds, as happened during the 2008 financial crisis. For staying the course during those dark days, Fuss was named Morningstar's Fixed-Income Manager of the Year in 2009.
The latter vantage point no doubt informs his endorsement of the concept of exit fees for bond funds. As the FT quoted former Fed Governor Jeremy Stein, bond funds give investors "a liquid claim on illiquid assets." That is most acute for open-end, high-yield bond funds, Fuss says, and extends to exchange-traded funds "in less liquid areas," which would apply to junk-bond and bank-loan ETFs.
It is a fact of financial life that most bonds are relatively illiquid, in part owing to their bespoke nature; every bond has its own unique coupon rate and maturity, plus possible features such as call options, seniority, and security, even among the same issuer. In contrast, every common share of most companies is identical (with exceptions for stocks with multiple share classes). Multiple buyers and sellers of the same item is economists' definition of a perfect market, as with a commodity such as wheat. Big, listed stocks come close; bonds, given their granular nature, don't.
The problem of liquid claims on illiquid assets is etched into American culture in the Christmas-time classic film, It's a Wonderful Life. Faced with a run on his savings-and-loan, Jimmy Stewart pleads with his depositors that there's little cash in the till because the money is invested in the townfolks' mortgages and businesses. The practical solutions to this conundrum: deposit insurance and having central banks act as lenders of last resort.
Those facilities don't apply to bond funds now, and didn't to money-market funds in 2008. Following the Lehman bankruptcy, the Reserve Fund "broke the buck," with its net asset value falling below $1 a share. The resulting run on that money fund and others exacerbated the crisis as this source of funds to the money market dried up.
Officials fear that bond funds could represent "shadow banks," the FT writes, intermediaries subject to runs but without resort to the backstops available to banks. Yet, the irony is that the rush into bond funds is a result of the Fed's own policies of pinning interest rates to the floor, which spurred investors to seek income wherever they could find it. As a result, bond funds have ballooned to $3.5 trillion -- with a T -- according to the most recent data from the Investment Company Institute. That's close to the Fed's securities holdings, which total $4.1 trillion.
Statistical evidence of that reach for yield comes from a research paper from Bank of Canada economists Sermin Gungor and Jesus Sierra (which was passed along by Torsten Slok, chief international economist at Deutsche Bank Securities).
Not surprisingly, low rates spurred bond funds to increase the credit risk in their portfolios to boost returns. Canadians, it's safe to assume, are no less desirous of maintaining investment income than are their neighbors to the south.
But with investors having stampeded into bond funds, would exit fees be effective at keeping them from stampeding for the exits at the first sign of higher yields and lower prices? Research suggests otherwise. And, ironically, it comes from within the Fed itself.
According to a New York Fed staff paper by Marco Cipriani, Antoine Martin, Patrick McCabe, and Bruno M. Parigi (and surfaced by Zerohedge.com), impediments to redemptions could actually spur bond-fund investors to sell first and ask questions later. In other words, exit fees or "gates" to discourage redemptions could backfire.
In Sartre's No Exit, hell is famously defined as "other people." The crisis that might ultimately await bond-fund investors is the prospect of being stuck with their fellow shareholders as yields rise and prices fall, rather than paying a ransom to escape. The existential choice facing bond-fund investors is whether to stay and face that prospect, or exit while they can -- if they are not prepared for a long-term commitment.
THE SUMMER SOLSTICE just arrived in the Northern Hemisphere, putting the sun highest in the sky. And, appropriately, the major stock-market averages closed the week at records, notably the Standard & Poor's 500 and the Dow Jones Industrial Average, which approached another round-number milestone: 17,000.
The latest liftoff came after Fed Chair Janet Yellen made clear that neither rising inflation nor soaring asset prices would deter the central bank from monetary tightening. She called the uptick in the consumer-price index, which is running above the Fed's 2% inflation target (admittedly using a different gauge, the personal consumption deflator), "noisy." But it's hurting Americans' budgets more than their ears.
In essence, Yellen endorsed the view espoused by hedge fund mogul David Tepper a couple of years ago, that the course of monetary policy "depends" on the economy. If growth is sluggish, policy will remain accommodative, which is bullish for risk assets. Interest-rate hikes won't come until there is strong growth, which also is bullish. And as long as the monetary authorities have their back, investors have little reason to worry. So, volatility premiums collapsed in the options market; if the Fed is offering free insurance, why pay for it with hedges?
This benign environment is spurring investors to vote with their portfolios. Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, notes a big, $13 billion inflow into equity mutual funds in the latest week and the first outflows from bond funds, totaling $2.3 billion, in 15 weeks.
Have fund investors finally been infused with animal spirits? Hard to say, given that the equities data showed a record influx into utilities, some $1.2 billion, which Hartnett suggests indicates some chasing of that group's torrid past performance, up some 16% in 2014. Utility stocks are viewed as first cousins to bonds; income is their primary allure, but with the prospect of dividend growth, that should trump fixed coupons.
Still, public participation in the stock market has yet to evince irrational exuberance, notes David Rosenberg of Gluskin-Sheff. In other words, the market has yet to violate rule No. 5 of Bob Farrell, the legendary market analyst at Merrill Lynch -- that the public buys most at the peak and least at the lows.
Tops, Rosenberg explains, typically show a melt-up of a heady 11% over 30 days, which represents a first peak. A pullback lures neophytes and momentum chasers "hook, line, and sinker," to form twin peaks. That pattern was apparent in November 1980; August-October 1987; June-July 1990; April-September 2000; and July-October 2007, he points out.
To quote every parent of young kids, we're not there yet. But, Rosenberg relates, there also is Farrell's rule No. 7: Markets are strongest when they are broad and weakest when they narrow to a handful of blue chips.
Another veteran market maven, John Mendelson of International Strategy & Investment Group, last week pointed to the declining number of New York Stock Exchange stocks trading below their 200-day moving averages, a sign of waning momentum in the broad market that he says represents a "negative divergence." That is especially so with the major averages notching records.
So, easy money continues to float Wall Street's yachts. Belatedly, the gold market also has noticed, with the metal surging 3% on the week, and mining stocks leading the advance. Gold may be sending the true signal, above the supposed noise from the inflation indexes.

Yes, I'm also keeping my eye on GVAL. Especially after reading Mebane Faber's book Global Value. Also keeping my eye on CAPE and DSENX

There is a related exchange traded note, symbol CAPE.
Not a Doubleline product, but deserves comparison to the DSENX.
Both deserve study, as the Shiller CAPE ratio is being talked about more and more each day.

Has anyone bought any of the newer Doubleline Funds? I am interested in any thoughts on their new stock funds. I am especially interested in the Shiller Enhanced Cape DSENX. He is basically a bond guy, but he always has something to say about an individual stock, or section of the stock market.

Well, I think we all realize that if there is one important space in the mix we have yet to fill with a satisfying pick then dis is it. And that makes us needy, and that can lead to reading more into the numbers than is warranted. Hope is not an investment strategy.
I'm with cman; based on the data, BPLEX is really all we have that comes close to measuring up. Perhaps there are other funds on the current landscape that will prove their worth, and the markets since 2009 have been pretty lousy for most L/S strategies to show this. And so we watch and wait, and not give in?
And maybe, just maybe, our patience will be rewarded, and something like the Robertson Stevens Global L/S fund of the late 1990s will come along [damn, was that gal good].

Hi Guys,
The most likely answer to Ron’s question about the morphing of Marc Faber from Mr. Doom to Mr. Happy is never. He is committed to his own worldview and the present circumstances and data are nearly irrelevant.
In the financial community he exhibits all the characteristics of a Mr. No. I use the term Mr. No to conveniently contrast his behavior with a dedicated Mr. Yes. In many circles, adventurer Richard Branson is fondly called Mr. Yes. His most famous saying is “Screw it. Let’s do it”. That aggressive motto has earned him innumerable successes, and an occasional backslide.
I don’t buy into these pre-judgments, these by-gosh-and-by-golly pre-commitments. I think of them as lazy folly. It sure eases the decision process. Although that’s attractive in many commonplace instances, it can get an investor into deep hot water. Although the markets do reflect a cyclical behavior, each cycle differs from past experience sufficiently to merit a separate review and evaluation.
The marketplace is far too complex to be modeled by overly simplistic correlations. As Albert Einstein cautioned “Everything Should Be Made as Simple as Possible, But Not Simpler”. Oversimplification introduces the possibility of allowing the really significant market drivers to escape detection.
Perhaps this is the logic that InvesTech’s Jim Stack uses in his multidimensional set of market direction criteria. He adjusts his portfolio holdings incrementally as the various signals penetrate their threshold levels. I do buy into that conservative multi-criteria approach.
The last quarter’s GDP growth numbers were dismal. Over the long haul, academic and industry research find zero or nearly zero correlation between market returns and GDP growth values. But more recent and more nuanced studies, that introduced a wider array of independent parameters, suggest otherwise. The more nuanced assessment includes parameters like inflation, policy stance, and interest rates to augment GDP growth rate data.
Here are Links to a sample of the longer-term GDP growth study data, a GDP growth per capita data set, and the more nuanced findings:
http://www.businessinsider.com/correlation-between-equity-returns-gdp-growth-2013-11
http://www.businessinsider.com/equity-returns-and-gdp-per-capita-2014-2
http://www.schroders.com/staticfiles/schroders/sites/Americas/US Institutional 2011/pdfs/Equity-Returns-and-GDP.pdf
All of this is good stuff. They might well serve as partial signals to help guide your portfolio asset allocation decisions. I would never suggest that these are decisive by themselves. The issue is much more complex.
For example, I have always included some measure of the equity markets Price to Earnings ratio (P/E or more recently CAPE) as part of my decision making process. Today, that signal is above its historical average, but it’s been in that dangerous zone for quite some time now. This bit of evidence supports the Faber assertion. At some point he will be proven correct, but who knows the unknowable timetable?
Today, I’m still into equities at my long-term percentage. But I am getting a little queasy, a little antsy. I’m taking no immediate action. I’m waiting for more evidence, one way or the other. As a general rule, I am not a market timer.
Stay loose guys. Don’t prejudge like either Faber or Branson. Let the accumulating data and whatever criteria you deploy be your final guide. Good luck to all of us.
Best Regards.

Thanks for the advice, all of you. FSICX had escaped my notice. Beats the bogey M* selected for it. Thanks, cman.
Since FAIGX has 70% equity and costs 1.16%,, I'll just slump back in my rocking chair on the porch, Ted. (Or did you mean FAGIX?)

I really do want Cman to continue his informative postings. I agree with MFOer davidrmoran that his postings are often elliptical, but when decoded with care and when the unsupported proclamations are discarded, the submittals are substance intense and useful.

Time to conclude with the same deniability of a personal attack against a credible opponent and a repetition of the back handed compliments reinforcing the take away points you started with so the jury leaves with that impression.

I’m positive that Cman will respond; that’s his nature and it’s fully expected and respected.

It is also useful to prepare for a rebuttal that you obviously expect for such attacks so next time you can start with my opponent has responded predictably... To imply that it was already expected and considered to diminish the response for the jury. You can do that regardless of what your opponent rebuts with.

Cman likes to morph simple problems into multilayered complex problems.

Another useful approach is to try to bait the opponent into an irrational outburst because that always diminishes the opponent's argument. Patronizing statements, back handed compliments, passive aggressive attacks are all good candidates when done carefully so as not to antagonize the jury in the process. May not work against all opponents but works against most.

Remember the classic WWII submarine movie titled “The Enemy Below”. It starred Robert Mitchum and Curt Jurgens as competing captains. The movie plot revolved around the “if I do this, he’ll do that, but he knows I know that so I’ll alter my tactics, but he’ll anticipate that change, so I’ll …..” endless logic circle.
In the meantime the adversary escapes, at least momentarily in this film classic. At some point the circle must be broken and a decision must be forthcoming (no action is part of the decision options). Studies have a diminishing returns aspect to them.
In the investment world, decisions must be made with incomplete information and always with an uncertain future. Further study and delay adds no value. So just do it or not, given a current assessment of the circumstances. I hope my positions on this matter are not elliptical.

Ending with a reference to popular culture is always a jury awakener that brings them into a blissful state if they can identify with it and focus on it and the repeated take away points and not the manipulative techniques used.
It is also useful to slip in the mischaracterization of the opponent for a final take away point. The opponent is only providing a choice between endless loops and action now. This will obfuscate and hide the opponent's constructive suggestion of a study that will more realistically prove or disprove the same claims to replace a flawed evidence. Jury may be excused for losing track of that by this time.

Best Wishes to everyone, and especially to Cman.

Always a good idea to end with a gentlemanly and passive aggressive conclusion to obscure the real intent and motivation. :-)
Look forward to writing the next chapter of the "Illustrated Guide to Lawyering tactics".
There are still many tools left to use in a lawyer's arsenal to influence the jury such as righteous indignation, befallen misfortunes in getting to the court, Jury nullification, etc. :-)
I hope @mjg will oblige by providing further illustrative examples.

Hi Guys,
This post is very difficult for me. It demands a delicate balanced set of thoughts that just might be beyond my competency reach.
I really like Cman’s submittals. In general I agree with almost 100% of the informational content although I don’t subscribe to his lack of documentation. My admiration ends when he interjects opinions and assertions that are not supported by any analysis or references.
I believe Cman really tries to educate us. Most of my postings are similarly directed. However, I also think that his posts tend to be pedantic; so do mine. As the old saw goes “It takes one to know one”.
I know why mine are so oriented. I spent the larger part of my working experience trying to win competitive contracts. If I wasn’t absolutely positive of my positions, I lost the competition. Perhaps Cman faced the same daunting challenge.
But the Cman and my educational pathways bifurcate at the documentation juncture. Typically, his postings are full of assertions and opinions that are devoid of supportive references, studies, or actual data. It is impossible to judge the merits of these assertions if you are not intimately familiar with the subject matter. I try to be meticulous in this area; hence I’m pedantic.
Mark Twain was on target when he said that “All generalizations are false, including this one “.
Given the lack of supportive documentation, a fair observer might conclude that Cman has fallen victim to the behavioral handicap of Overconfidence.
His judgments are far too rash. He uses pejorative descriptors such as “Junk Science” and “Garbage In, Garbage Out” without describing the junk science elements or the garbage inputs. Garbage Out is an individual reviewer judgment and depends on his personal assessment of the work quality.
During my college years, I was infrequently exposed to “the proof is assigned to the student” charge. I hated that assignment then, and I still dislike it today, especially in the investment world. My interpretation: That assignment either comes from a lazy educator or one that is not confident in his own knowledge or capabilities.
Acting as an educator, Cman often fairly presents both sides of an issue. That’s great, although there are limitations. President Harry Truman detested two-handed economists. He particularly despised the “On the one hand this” and “On the other hand that” type of advice. He pleaded for a one-handed economist who proffered a plain decision.
Denials notwithstanding, Cman and really all MFOers do have a pony in the active-passive race. Costs and results do matter to everyone. The debate is NOT a done deal. Claiming an early closure is equivalent to proclaiming a victory while the battle is still raging. That mostly works to an opponent’s advantage.
No standalone active-passive fund management study is conclusive by itself. The issue has far too many dimensions to permit a single, all-inclusive analysis to address and to resolve all the multitude of issues. Since no universal investment Ironclad laws exist, all studies are empirical in nature. All models are simplifications of reality; hopefully they still capture the governing elements of that reality. They are all imperfect.
Selecting bias free data and study timeframes will always influence findings. That’s specifically why numerous studies are needed and will continue to yield more realistic insights. The MIG study fits into that grouping.
I believe the MIG team did an honest job. I even think they were somewhat surprised by their findings. I’m nudged in that direction by the way they presented their findings. Their very first table shows that 4 of their 6 major fund categories delivered positive Alpha before costs. But nobody invests without costs.
In the same paragraph, MIG adjusts for costs and concludes that : “When comparing the median outperformance to the median fee for each asset class, the gross outperformance of the median manager has not justified the historical median fee. In other words, it seems that in the asset classes where active managers have added value, the median level of fees negated any advantage.”
Cman emphasized the “no cost” result to the detriment of the overarching negative Alpha after fees conclusion. That’s a little disingenuous, especially if you proclaim to have no ponies in the race.
Yet Cman elects to destroy the credibility of MIG’s efforts with ad hominem attack words like Junk Science and GIGO. All research is subject to errors ranging from incomplete data collection to poor practices to flawed data interpretations. But an honest attack requires full documentation, not merely shaky comprehensive assertions.
It is not at all clear why MIG would have incentives to prepare a defective report since their reputation is at risk. They do have much skin in the game.
The MIG team that Cman so firmly criticized has over 600 billion dollars under management, has been in the consulting business since 1978, and has recently been awarded a competitively bid contract from the California State Teachers’ Retirement System (CalSTRS). I’m sure they have been on the wrong side of some investment advice, but so has everyone else. As a minimum, MIG has demonstrated staying power.
I really do want Cman to continue his informative postings. I agree with MFOer davidrmoran that his postings are often elliptical, but when decoded with care and when the unsupported proclamations are discarded, the submittals are substance intense and useful.
I’m positive that Cman will respond; that’s his nature and it’s fully expected and respected. Cman likes to morph simple problems into multilayered complex problems. Remember the classic WWII submarine movie titled “The Enemy Below”. It starred Robert Mitchum and Curt Jurgens as competing captains. The movie plot revolved around the “if I do this, he’ll do that, but he knows I know that so I’ll alter my tactics, but he’ll anticipate that change, so I’ll …..” endless logic circle.
In the meantime the adversary escapes, at least momentarily in this film classic. At some point the circle must be broken and a decision must be forthcoming (no action is part of the decision options). Studies have a diminishing returns aspect to them.
In the investment world, decisions must be made with incomplete information and always with an uncertain future. Further study and delay adds no value. So just do it or not, given a current assessment of the circumstances. I hope my positions on this matter are not elliptical.
Best Wishes to everyone, and especially to Cman.

Hi mrdarcy,
I appreciate your extra effort to secure a copy of Professor Kaushik’s report.
I suspect you and I are in substantial agreement that study findings are always tightly coupled to its methodology. Details just don’t simply matter, they matter greatly, and can reverse conclusions. In reviewing all research work, one conundrum is to identify which studies are of sufficiently high quality to accurately reflect the real world marketplace.
Even with our current shortfall with regard to some details of Kaushik’s procedures and data qualifying techniques, it is clear that his data preferences depart from those used by S&P and by the MIG organization.
For example, Kaushik used Morningstar as his primary data source for the small cap category; MIG used the Russell 1000 Value category benchmark. S&P typically accesses the University of Chicago CRSP data. By itself, the data source benchmark can invert conclusions. Here is a Link to a fine summary paper, “Lessons Learned from SPIVA”, generated by the Journal of Indexes that supports that observation:
http://www.etf.com/publications/journalofindexes/joi-articles/11140-lessons-learned-from-spiva.html
I direct your attention specifically to Lesson 6, Benchmark Choice Matters in the Active-Passive Debate. In this instance for Small Caps, the active managers outperformed its Russell 2000 benchmark by a smidgen for the time period considered, but active managers underperformed when measured against the S&P Small Cap 600 standard.
The referenced article has a wealth of actionable conclusions. Please access it.
The S&P summary review and the earlier mentioned MIG report both document that any active fund management excess returns is very time dependent, and erode as the timeframe expands. Managers enjoy momentary success, but that success crumbles to negative integrated outcomes relative to a benchmark. The referenced S&P paper also addresses this issue.
Persistent positive Alpha performance escapes all but a few active managers. The most devastating illustration of that overarching conclusion is provided as the Manager 5-year Persistence graph near the end of the MIG report. No trend-line, no pattern is discernable; it is a shotgun blast.
As stressed previously, the MIG release provides superb charting evidence of active managers volatile performance relative to their benchmarks. Indeed, active management can enhance outcomes, but they also can substantially detract. Subtraction is hard to take. This time dependent data is included as Appendix C in the MIG paper.
Since we are focusing on Small Cap results, please examine the chart titled “Russell 1000 Value”; it is located on page 20 of the report. It depicts aggregate SCV active manager outcomes measured against their benchmark. The data is displayed from 1979 to 2012. Note the random and spiky nature of the curve, and that it shows mostly negative relative performance years.
Also note that the SCV curve had a respectable positive bump in the 1999-2002 and the 2007-2009 timeframes. These were the glory years for active managers in that fund category. That glory has faded recently. The persistency handicap strikes once again. It’s a tough marketplace for active fund management.
I find the empirical evidence undeniable. Sure some active managers will outdistance their benchmark during short periods. But that advantage is ephemeral for almost all survivors.
In their 2012 SPIVA report, S&P concludes that “The annual league tables over the past 10 years demonstrate that short-term outcomes (such as one-year performance figures) of the index versus active debate are less consistent than longer-term outcomes.” Some things remain fairly stable. For completeness, here is the Link to that S&P document:
http://www.spindices.com/documents/spiva/spiva-us-year-end-2012.pdf
I never tell folks how to invest; that’s always their personal choice. However, I have no qualms about presenting them with the relevant statistics. It is their job to weigh the odds and the expected excess Alpha potential.
It is a daunting task to identify consistent fund manager winners. Perhaps dedicated and well informed mutual fund buyers can discover a glittering gem in the treacherous terrain. Good luck to them, and even to myself since I plan to do a little of that dubious exploration.
Best Wishes and Happy Easter.

Just finished his book Global Value (Kindle for PC).
I was impressed with the book.
He says that the U.S. stock market is the most overvalued stock market in the world now, based on the CAPE ratio. The CAPE for the U.S. is roughly 25.
He says that at a minimum, we should have 50% of our equities outside the U.S., since that is a market cap weighting. But.....a global GDP weighting would only have 20-40% of the equities as U.S. stocks.
However, to have an equity allocation aligned with the theme of his book, he states: "Similarly, ponder a value approach to your equity allocation. Consider overweighting the cheapest countries and avoiding the most expensive ones. Currently, this would mean a low, or zero, allocation to US stocks. Note: This does not mean simply picking one or two countries, but rather a basket of the cheapest countries – 10 is a reasonable number."
Looks like his Cambria Global Value, GVAL would accomplish that.

@Ted. Really good!
At heart of ragging debate these days, seems like.
Been going on for a while now...since probably 2011 until November. Resumed in 2012. And, of course, all the CAPE_Crusaders would have missed 2013 run up in US stock market, if they had timed their allocation based on P/E valuations.
I suspect CAPE_Crusaders would argue P/E valuation predictions are longer-term, based on following five-ten year returns. So, 2013 is just a blip here.
Another thing is that looking back at all the P/E plots, like Exhibit 1 below from Mr. Montier's paper, there have been many continuous years of "inflated" P/Es, like 50-60s and 80-90s. Would really hate to miss those years.

That said, though we've had pull backs, it's been a while since we had sustained period of "cheap" P/E, like the painful '70.
The conclusion then from all these folks is low expectations for real returns in foreseeable future, as summarized in GMO's latest forecast. (Site requires registration, but it is free...and void of pop-ups, etc...I highly recommend it.)

Yes, very interesting. And it seems that Mebane Faber is doing something that John Templeton used to do, that is, find undervalued stock markets around the world. Robert Shiller was on WealthTrack a few weeks ago, and said that he invested in I believe it was Italy this year, based on the stock market in Italy being very cheap based on the CAPE. Seems to be in some sense the global application of the principles of Ben Graham.

Hi MarkM,
Thank you for your rapid response.
My overarching takeaway from your various replies is that you have discovered the magic elixir that permits a respectable estimate of market-wide FMV, at least one focused on longer-term projections. Even given your stated reservations, such a discovery deserves a substantial Wow exclamation. That’s an impressive accomplishment that warrants attention.
A reliable and reasonably accurate FMV methodology has eluded even the very best individual minds (guys of the caliber of Benjamin Graham and his student Warren Buffett) and institutional entities (Vanguard, JP Morgan, Morningstar) for decades. Congratulations.
Again from your posting, I realize that you have been hampered by some difficulties in fully implementing the approach. For example you stated that: “Frankly, its hard as hell to adopt this approach when the market moves away from you and hard as hell again when markets fall and there seems to be no good reason to place money at risk!” and later “Long term it works but is very difficult to execute.”
I’m puzzled by these comments. They certainly are suggestive of significant holes in your approach given these limitations. Also, why the procedure would be “difficult to execute “ totally escapes me. Could the mathematics be that gory? I doubt it. Most investors, including a high percentage of professional wizards, are actually mathematically phobic.
Additionally, it is worrisome that your FMV signal has a “momentum concession” given that you use it as a longer term forecasting tool. Momentum is a dissipative force. I’m uncomfortable with any momentum adjustment that is purportedly operative a decade into the future. Market momentum effects usually disappear in less than 3 years.
Your reservations seem to point to a highly idiosyncratic technique. I hope it is not that individual and distinctive. If it is so, I understand your unwillingness to discuss any of its details whatsoever. It offers little value to MFO members or an even wider audience.
Under these circumstances I would be circumspect about anticipating successful applications in the future. These types of formulations that have benefited from heavily restricted success have a dismal persistency record and are hazardous as projection tools. Professionals relearn this hard lesson time and time again.
However, if you judge the approach to not be idiosyncratic, I strongly urge you to consider formally documenting it. You could be “Famous by Friday” as California tennis coach Vic Braden often proclaimed. The investment world needs a semi-reliable 10-year forecasting tool. History will remember you if you develop such a tool.
I would not simply reveal the method specifics on this fine website. MFO has too limited a membership. Rather, I suggest you submit an outline to a respected financial and/or business journal. If accepted after peer review, your accomplishment will be widely circulated, enthusiastically received, and your contribution firmly acknowledged for all time.
Regardless of the present state of your still undefined, mysterious approach, and its general application, I wish you well in your forecasting efforts. If what you do is too complex or conditionally fragile, I would likely choose not to deploy it for my purposes. Everyone chooses their own investment poison.
I am a satisfied member of the simplicity is better cohort. That philosophy keeps my costs low, permits me to stay the course under challenging circumstances since I understand my strategy, and allows me to eschew risky investments that test foolish boundaries.
I wish you continued success and good luck in your future investments and all your financial matters.
Best Regards.

Scott,Maybe a lot of investors saw your video post!Thanks for your timely takes on
investment opps and current trends and long term ideas.
Aeropostale -12.3% AH on FQ4 miss, guidance, $150M financing deal
Aeropostale (ARO) is guiding for FQ1 EPS of -$0.70 to -$0.75, well below a -$0.17 consensus. The forecast doesn't account for expected consulting fees or "potential accelerated store closures."
The apparel retailer has obtained $150M worth of credit facilities - a 5-year, $100M term loan facility, and a 10-year, $50M term loan facility - from P-E firm Sycamore Partners.
The deal includes an apparel sourcing arrangement with Sycamore-affiliated MGF Sourcing, and also gives Sycamore preferred stock good for buying 5% Aeropostale's common stock at a price of $7.25. If converted, the shares would raise Sycamore's stake to 12.3%.
Aeropostale was previously reported to be weighing investment and sale options. The company ended FQ4 with $106.5M in cash/equivalents, and no debt.
Aeropostale now plans to close 52 stores in FY14 (ends Jan. '15), while opening 7 and remodeling 10. The FY14 capex budget has been lowered to $22M from $35M; FY13 capex was $84M.
Comparable sales (inc. e-commerce) fell 15% Y/Y in FQ4, the same as FQ3. Gross margin fell 680 bps Y/Y to 13%

Hi Vert,
Thank you for investing your valuable time to respond to my post. Alternate viewpoints are always welcomed, encouraged, and respected. It’s how a vibrant marketplace works its price discovery magic.
I have never met either Warren Buffett or Benjamin Graham. So my insights into their investment concepts come either from their personal writings, their direct quotes, and/or financial writers interpretations of their perceived wisdom. Certainly my own personal investing proclivities, education, and style influence the manner in which I translate and interpret these various sources. Others will surely internalize divergent takeaways from these same word sources.
I’m very happy that you took time to express your personal opinions. I suspect that you and I will never quite see eye-to-eye on this matter, but that's okay by any standards. Thirty years ago I was a solely active investor. Most recently I decided that passive Index investing offers the likelihood, never the guarantee, of superior portfolio rewards. Therefore, without completely abandoning active fund management, I decided to weight my portfolio much more heavily in the Index direction.
I admire the pugnaciousness and tenacity of active investors. With total disregard for their own efficiency, that cohort makes the overall marketplace a more efficient world with their constant trading. Passive investors gain the advantages of the efficient market without paying the casino croupier. I plan to take full advantage of this almost free lunch. I wish all these energetic active investors the best of luck.
I do insist that I reported the quotes from Mauboussin and Graham without either error or omission. I did not do selective pruning to distort or misrepresent their positions on these important matters.
I like Michael Mauboussin for his multi-discipline investment approach and his explanatory clarity. I do not see the verbal contradictions that you observed. To paraphrase, he said that by concentrating on good process, the likelihood of good results is improved, but without guarantees since outcomes are uncontrollable.
I do not doubt that self-generated contradictions exist. Over time, everyone makes statements that are not totally consistent. I surely do. Warren Buffett has and continues to do so. It is a human failing. I accept these minor inconsistencies and push ahead.
Speaking of Buffett, his current shareholders letter supports many of the insights referenced by Mauboussin and Graham as quoted in my initial posting. Here are two extended extractions from that shareholders letter as summarized in the Motley Fool website:
On the simplest, best investment strategy for individual investors: "My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. ... My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions or individuals -- who employ high-fee managers."
And,
On avoiding market (mis)timing: "The 'when' [of investing] is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs' observation: "A bull market is like sex. It feels best just before it ends.") The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the 'know-nothing' investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.”
This complete Motley Fool summary is titled “25 Must-Read Quotes from Buffett’s Letter to Shareholders” and is authored by Alex Dumortier. Here is the Link to the entire review:
http://www.fool.com/investing/general/2014/03/08/25-must-read-quotes-from-buffetts-letter-to-shareh.aspx
The investing principles advocated by both Benjamin Graham and his student Warren Buffett have certainly changed over time. Those changes are most likely the result of better informed marketplace participation groups (now mostly smart institutional investors). Although it is often credited to John Maynard Keynes, it is more likely that Professor Paul Samuelson said: “Well when events change, I change my mind. What do you do?”
The Graham extended quote that I referenced was just such a reevaluation of the investor environment and opportunities in the early 1970s. The job of identifying underpriced stocks was simply becoming harder.
I’m a bit bemused how your interpretation of that paragraph differs so dramatically from mine. You ignore the consistent thrust throughout the paragraph and glom onto the innocuous phrase “To that very limited extent" as a salient part that describes his mistrust of passive Index investing. I disagree.
That escape clause was added to simply acknowledge that some investors are superstars and do outperform market average returns. Certainly his students did for years, and when he made those comments, Graham was with a group of these investors. Graham was merely recognizing that the marketplace was more efficient and that finding exceptional undervalued stocks (his cigar butt one-puff theory) was probably beyond the capabilities of most, but not all, investors. This was an unexpected eureka moment in his life that must have shocked Buffett.
The fundamental meaning of the referenced paragraph is abundantly clear: excess returns are more difficult to find. It is definitely not an amateur’s (average investors) game.
I enjoyed your perspective on these topics and thank you again for your thoughtful contribution.
Best Wishes.

Wintergreen 2013 Annual Report:

Dear Fellow Wintergreen Fund (Trades, Portfolio) Shareholder,
2013 seemed to be the year when the quality, valuations, and risks of businesses ceased to matter to most stock market participants. The Standard & Poor's 500 Composite Index ("S&P 500 (INDEXSP:.INX)") remarkable rise for the year was its best return since 1997 during the run-up of the technology bubble. The ten best performing names in the S&P 500 had extremely high returns, while carrying an average price-to-earnings multiple of 58. Among these top performers were a struggling retailer (Best Buy Co., Inc. (NYSE:BBY)), a recently bankrupt airline (Delta Air Lines, Inc. (NYSE:DAL)), a brokerage still digging itself out from the finanacial crisis (E TRADE Financial Corporation (NASDAQ:ETFC)), a biotechnology company (Celgene Corporation (NASDAQ:CELG)), and two poster children of a potential new internet bubble (Netflix, Inc. (NASDAQ:NFLX) and Facebook Inc (NASDAQ:FB)). We believe the extraordinary returns on securities we view as highly speculative names are a microcosm of the broader market in 2013 - market participants moving down the quality spectrum in search of returns, without regard for and understanding of risks and valuations. We believe overseas securities languished and emerging markets became the scapegoat of popular opinion.The widespread appetite for risk has been fueled in part by years of artificially low interest rates in most developed markets around the world. When safe high-quality assets yield a fraction of one percent, it isn't surprising to see many investors flock to high-risk, high-reward investments, be it junk bonds or speculative equities. This is exemplified by high-yield bond spreads approaching historical lows, sub-prime mortgages being bid up 17% in the past year, and speculative equities posting triple-digit gains. Classic fundamental analysis of business values, a keystone in true investing, was replaced with an insatiable desire for returns at any cost and often a failure to acknowledge the inherent risk of many investment vehicles.
There is a popular Wall Street notion that momentum trading (i.e., buying stocks that have recently risen in price solely because they have recently risen in price) allows someone to hop from trend to trend as if they are a surfer riding the crest of a wave, and that this will enable one to trade their way to wealth. This "quick and easy" approach to speculating, which has been sold to investors in a relentless media blitz accompanying the latest bull market, is seldom successful in the long-run. More often, people don't get just wet, but financially soaked.

http://www.wintergreenfund.com/downloads/wintergreen_fund_annual_report_20131231.pdf

FYI:
Regards,
Ted
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