Are Vanguard Index Funds/ETFs improperly weighted?

[Jeff W]

I'm researching the funds I want to move the vast majority of my liquid assets into(taxable account). I stumbled on these two articles:

http://www.altruistfa.com/dfavanguard.htm

FundAdvice.com DFA vs. Vanguard

I don't think it makes sense for me to go with DFAs because of the effective 1.44% ER(0.9% from investment advisor), but the criticisms of the Vanguard Small Cap funds not being weighted toward small companies enough and the Value funds not being weighted enough toward Value seem reasonable to me.

Altruist FA recommends using purer ETFs in place of their Vanguard counterparts. The Altruist portfolio would look something like this:

Fund (Symbol), ER, Asset Type

Vanguard Large-Cap (VV), 0.07, Domestic Large Balanced
Rydex S&P 500 Pure Value (RPV), 0.35, Domestic Large Value
Bridgeway Ultra-Small (BRSIX), 0.66, Domestic Small Value
Rydex S&P SmallCap 600 Pure Value (RZV), 0.35, Domestic Small

Fidelity Spartan International* (FSIIX), 0.10, Foreign Large
iShares MSCI EAFE Value (EFV), 0.40, Foreign Large Value
WisdomTree International SmallCap** (DLS), 0.58, Foreign Small
????, ????, Foreign Small Value
Vanguard Emerging Markets (VWO), 0.30, Emerging Markets Large

*: Vanguard has comparable offerings in this asset class(Split between European and Pacific funds).

**: Vanguard has no offerings at all in this asset class.

Is the advantage of better diversification through more concentrated assets worth what I'm losing by having to pay higher ER or should I just stick with Vanguard where possible(impossible for International SmallCap)?

Are there complications with bid-ask spreads when buying some of those smaller ETFs?

Let me know if I'm missing any important asset classes. Most seem to ignore mid cap funds.

[gull]

Actually, the guy who owns altruistfa.com wrote an article that addresses your question (somewhat) here:

http://www.altruistfa.com/Haas%20Exp...ng%20paper.pdf

Essentially, yes, the higher fees are worth it. Lower fees are a very good rule of thumb to go by since so many funds cost more than they should. However, in some cases those fees may add value.

[Jeff W]

I read the article. I think I get the gist of it--you must evaluate the EV of added fees in terms of how much they increase your risk adjusted-returns. I'm not sure it's practical for me to do the calculations for a complex portfolio(especially since you have to make some assumptions about EV and the Rydex ETFs are very young).

What do you think of the suggested portfolio(even split between all the listed funds)? I might replace FSIIX with DODFX or the Vanguard Pacific/European split and I need to find a suitable Small Value Foreign fund if possible.

[Jeff W]

Informative Interview with BRSIX manager

[Tupacia]

You seem to know what you're talking about Jeff and know how to perform due dilligence, so why not build a portfolio of individual stocks instead?

[MatthewRyan]

Jeff, are you sure that you want an extremely value tilted portfolio? Yes, value has outperformed recently, but who knows the next 50 years.

[Jeff W]

[ QUOTE ]
You seem to know what you're talking about Jeff and know how to perform due dilligence, so why not build a portfolio of individual stocks instead?

[/ QUOTE ]

My impression is that you have to work every day at picking stocks. I strongly suspect my time is better spent playing poker and putting money into funds.

[Jeff W]

[ QUOTE ]
Jeff, are you sure that you want an extremely value tilted portfolio? Yes, value has outperformed recently, but who knows the next 50 years.

[/ QUOTE ]

I'm not sure. I could adjust the value tilt by putting bigger percentages in the blended than in the value stocks.

What do you mean by recently outperforming? I know that there is no gaurantee that value stocks will continue to beat growth stocks--we may have just been in a 70-year period very favorable to Value:

<font class="small">Code:</font><hr /><pre>Figure 8: Equity Premiums from 1926 to June 30, 2003

Value Premium 1-Yr 5-Yr 10-Yr 15-Yr 20-Yr 25-Yr
Best 89.3% 127.6% 203.1% 266.1% 304.6% 394.4%
Average 4.3% 22.4% 53.4% 96.6% 146.4% 206.1%
Worst -42.8% -53.8% -49.0% -40.7% -17.1% 10.6%
Reliability 62.1% 78.3% 91.1% 94.6% 99.6% 100.0%</pre><hr />

Source (Figure 8)

The reliability number indicates how often the Value premium existed in a given time period. For example, if you took a random 1-yr sample, Value&gt;Growth 62.1% of the time. The other numbers indicate the best, worst, and average premium sizes for the given time periods.

[Jeff W]

Okay, I think I'm getting pretty close to my final portfolio. Here is my rough idea(The foremost choices in each category are the ones I'm leaning toward):

15% Small/Micro Cap - BRSIX .66 ER

15% Small Cap Value - I don't like any of my options for a taxable account. I'm going to do some research on BRSVX Bridgeway Small Cap Value N (0.77% ER)--it has 100% tax efficiency in the last 3 years. I think it's tax managed. I don't love BRSVX because it's brutally volatile and I think there is significant overlap with BRSIX.

I considered RZV but it's got even more uncertainty than RZV tax-efficiency wise. Another possibility here is an active fund like NOSGX(1.0%).

20% Large Cap - VV or BRLIX (Bridgeway Blue Chip 35 Index Fund ER 0.15).

20% Large Cap Value - VTV (Considered RPV but it's probably not worth the trouble because of possibility of liquidation and lack of tax efficiency history--altruistfa.com recommends it, though).

30% International Large Cap/Emerging Markets - DODFX

XX% International Small Cap - DLS is my only option in index funds and I'm not enthused with it. I might just skip this asset class altogether or go with an active fund with low ER. I'm not sure how critical Int. Small Cap diversity is.

That AA is pretty aggressive(Strong Value tilt and Small Cap which are historically higher EV) and a bit more slanted towards Large companies than I'd like, but hopefully it should be diverse enough for the most part.

I want to avoid the Vanguard Small Cap Funds because of various problems--either future tax inefficiency for the ETFs or the 1% charge for selling shares less than 5-years old for the Tax Managed Index Fund which might hinder tax-loss harvesting as well just generally constricting my freedom.

The International Small Cap is really a bitch. I wish I could buy DFAs and this portfolio would be a no brainer. I'm fishing for ideas for this one.

I'm also not 100% sold on the Domestic Small Caps. I'm going to look at active funds with low ER. Especially for Small Cap Value, something like TASVX is only .03% higher ER than BRSVX and it's beaten its category every year for 10 years running(unfortunately it loses &gt;2% per year to tax inefficiency).

Let me know what you think.

[Jeff W]

Made a little more progress. Posting this to keep my thoughts organized but I'd love some input.

I have a portfolio which I'm pretty comfortable with:

11% BRSIX 0.66 Small/Micro Cap
11% BRSVX 0.77 Small Cap Value
22% VV 0.14 Large Cap
22% VTV 0.11 or BRLVX 0.84 Large Cap Value
34% DODFX 0.66 Foreign Large Cap/Emerging Markets

Both Small Cap Stocks are tax managed which is a real plus because, generally, the high turnover of Small Cap funds makes them unsuitable for for a taxable portfolio. Both of those Bridgeway funds are notoriously volatile(as small cap value and microcap funds inevitably are), but with only 22% of my portfolio invested I should be able to ride out the variance.

I don't see better options with the possible exception of the Vanguard Tax-Managed Small Cap fund (VTMSX)--of course it has the redemption fee problem: You're precluded from tax-loss harvesting for 5 years--I.E. Selling shares of VTMSX at a loss in order to strategically declare capital losses for tax purposes.

For the same reason I'm eschewing VMCAX for the Large Cap Balanced. I think Large Caps have fewer tax efficiency problems historically, but it's all a bit beyond my understanding--involves dividend payouts etc etc but at the very least lower turnover improves tax efficiency. Should I go with a tax managed fund instead even if it compromises tax loss harvesting?

I am concerned with the Large Cap Value category as I expect tax cost ratios &gt;1% in the future Link. I guess I'll have to look around for tax managed alternatives in this asset class before I finalize my portfolio. I'm going to look at Bridgeway Large-Cap Value N BRLVX but I don't like the high ER for a Large Cap fund(0.84) even though it's tax-conscious. Plus I feel like I'm overallocating to the Bridgeway funds--I have a nagging paranoia about their quant models but I really like their attention to tax efficiency.