Earlier this week I proposed a 14 ETF portfolio intended to replicate the popular Permanent Portfolio mutual fund, PRPFX. My original 14 ETF portfolio was intended to replicate PRPFX as closely as possible using liquid ETFs. The 14 positions could realistically be reduced to 8 while still maintaining a high correlation to the original 14 ETF portfolio.
The original 14 ETFs are listed below:
|FXF||Swiss Franc CurrencyShares||10.00%|
|GLD||SPDR Gold Shares||20.00%|
|HYG||iShares iBoxx High-Yield Corp Bond (4-5yr)||5.00%|
|IEF||iShares Barclays 7-10 Yr Treasury (7-8yr)||5.00%|
|IGE||iShares S&P N. Amer Nat. Resources||5.00%|
|VUG||Vanguard MSCI U.S. LargeCap Growth||7.50%|
|IWO||iShares Russell 2000 Growth||7.50%|
|LQD||iShares iBoxx Invest Grade Bond (7-8yr)||5.00%|
|RWX||SPDR DJ International Real Estate||5.00%|
|SHY||Barclays Low Duration Treasury (2-yr)||5.00%|
|SLV||iShares Silver Trust||5.00%|
|TIP||iShares Barclays TIPS (4-8yr)||10.00%|
|TLT||iShares Barclays Long-Term Trsry (15-17yr)||5.00%|
|VNQ||Vanguard MSCI U.S. REIT||5.00%|
If we consolidate the stock and bond holdings, we are left with an 8 ETF portfolio that still closely maintains the stated portfolio structure and asset allocation of PRPFX and, as we will see below, has been highly correlated to the 14 ETF portfolio:
|AGG||iShares Barclays Aggregate Bond (4-5yr)||35%|
|FXF||Swiss Franc CurrencyShares||10%|
|GLD||SPDR Gold Shares||20%|
|IGE||iShares S&P N. Amer Nat. Resources||5%|
|RWX||SPDR DJ International Real Estate||5%|
|SLV||iShares Silver Trust||5%|
|VNQ||Vanguard MSCI U.S. REIT||5%|
|VUG||Vanguard MSCI U.S. LargeCap Growth||15%|
Using ETFReplay.com, we see that both portfolios have shown a high correlation since 2008:
The 8 ETF portfolio had CAGR of 8.4% and a max drawdown of -25.25%. When we compare the 8 ETF portfolio to a 50/50 portfolio consisting of 50% SPY and 50% AGG, we see that the Permanent 8 portfolio significantly outpaced a 50/50 portfolio since 2008 with about the same volatility:
One of my favorite tools for potentially reducing portfolio volatility and drawdown is to use the 10 month simple moving average strategy, popularized in recent years by Mebane Faber in The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.
For example, the Permanent Portfolio has a 20% allocation to Gold, which is in the midst of a bull market. When and if Gold begins a bear cycle, it could be a significant drag on the portfolio. By using a long-term moving average signal, we could potentially reduce portfolio drawdown created when any one of the holdings enters a bear market.
The results for a 10 month moving average system on the 8 ETF Permanent portfolio are below (2008-present). When an ETF in the portfolio was below its 10 month moving average at month-end, the position was sold and held in “cash” (SHY was used as the cash position). When it closed the month above its 10 month moving average, the ETF was purchased and held until the close of the next month:
The results were not as dramatic as I expected. Portfolio drawdown was reduced to -16% versus -25.25% for buy and hold of the same portfolio. Volatility was reduced slightly to 11.5% and total return actually increased slightly to 41.4%. An improvement in all areas, yes, but not significant.
Finally, what if we simply purchased the 2 ETFs with the strongest momentum within the Permanent 8 ETF portfolio? This is a similar strategy used in my monthly ETF Replay Portfolio. Purchasing the 2 ETFs out of the 8 with the highest 6 month returns and rebalancing monthly yield the following results (2008-present):
If we purchased the top 2 ETFs as gauged by a combination of their 6 month return, 3 month return, and 3 month volatility, and rebalanced monthly, the results are below:
If we reduce the time frame to a 3 month return, 20 day return and 20 volatility, the historical results are better:
Holding only 2 ETFs increases portfolio volatility, which should be expected, but did not necessarily increase returns versus buy and hold or the 10 month simple moving average system.
The goal here is not to identify “the best” solution, since past results are no guarantee of future returns. It is to propose a relatively simple ETF portfolio to mimic PRPFX and to explore and test additional risk management and trading techniques within the ETF portfolio.
Note: All return calculations provided by ETF Replay. All returns are hypothetical and exclude commissions and taxes.