Weekend Readings

Below are investment-related articles on my reading list:

AlphaClone has updated their blog with the 10 Best Performing Hedge Fund Clones in 2012

QE Isn’t Working & TV Isn’t Working – The Idea Farm

The Tax Bite of Top Mutual Funds (hat tip Mebane Faber) – Scott Cendrowski, Fortune

What Countries Set to Outperform in 2013? Mebane Faber

Aspirin for a Broken Femur – John Hussman

Why Don’t Bad Ideas Ever Die? Barry Ritholtz

Modern Portfolio Theory is for Nitiots –  Mercenary Trader

Looking on the Bright Side and US Birth Rate Hits New Low (pdf) – John Mauldin

Check out out the MarketClub Holiday Special before it expires!

Ivy Portfolio Update

Early in 2012  Scott’s Investments added a daily Ivy Portfolio spreadsheet. This tool uses Google Documents and Yahoo Finance to track the 10 month moving average signals for two of the portfolios listed in Mebane Faber’s book The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. Faber discusses 5, 10, and 20 security portfolios that have trading signals based on long-term moving averages.

This month’s update is a trading day early (markets will be open on the 31st) than a typical end of month update.  It also comes at a time when the long-term moving average strategy has struggled and is under scrutiny. John Hussman notes that since 2009 the S&P 500 Index has actually performed better when below its 200 day moving average than when it has been above the 200 day moving average.  He also notes the recent performance is contrary to the longer-term success of a moving average strategy:

“…since 2010, the S&P 500 has gained just 1.5% annually when it has been above its 200-day moving average, versus a striking 46.3% annual return when it has been below. Needless to say, this pattern is not necessarily indicative of how the S&P 500 will behave in the future, and is in fact contrary to the historical pattern”

Hussman focuses on one index, the S&P 500. With hundreds of markets to trade, some will follow the historical trend while others, like the S&P 500 may buck the trend for months, years, or perhaps forever. The key is not to focus or trade one market with one strategy – the S&P 500 is not the market but rather one index among many, and its asset class (US equities) one among many.

The Ivy Portfolio spreadsheet tracks the 5 and 10 ETF Portfolios listed in Faber’s book. When a security is trading below its 10 month simple moving average, the position is listed as “Cash”. When the security is trading above its 10 month simple moving average the positions is listed as “Invested”.

The spreadsheet’s signals update once daily (typically in the evening) using dividend/split adjusted closing price from Yahoo Finance. The 10 month simple moving average is based on the most recent 10 months including the current month’s most recent daily closing price.  Even though the signals update daily, it is not an endorsement to check signals daily. It simply gives the spreadsheet more versatility for user’s to check at their leisure.

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The page also displays the percentage each ETF within the Ivy 10 and Ivy 5 Portfolio is above or below the current 10 month simple moving average, using both adjusted and unadjusted data.

If an ETF has paid a dividend or split within the past 10 months, then when comparing the adjusted/unadjusted data you will see differences in the percent an ETF is above/below the 10 month SMA. This could also potentially impact whether an ETF is above or below its 10 month SMA. Regardless of whether you prefer the adjusted or unadjusted data, it is important to remain consistent in your approach.

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I do not track these portfolios as hypothetical portfolios like I do with other portfolios on the site but do periodically backtest the strategy. For the most recent test results, please view last month’s update.

The current signals based on November 30th’s closing prices are below.  International equities and international real estate are the strongest sector in terms of their percent above their 10 month moving average.  Commodities and US REITs are the weakest sectors.

The first table is based on adjusted historical data and the second table is based on unadjusted price data:

Dual Momentum Investing, Part 2

Last week we explored a simple dual momentum strategy using three portfolios consisting of three mutual funds.  The strategy was inspired in part by Gary Antonacci’s  ”Risk Premia Harvesting Through Dual Momentum” paper available on Optimal Momentum.

The first article generated interest and several readers emailed questions. To reiterate, mutual fund were used strictly because of their longer trading histories. Since most mutual funds have trading restrictions, a real-world application of the strategy would be better served with exchange-traded funds (ETFs) that do not have many of the same trading restrictions. However, with ETFs come commissions, which will reduce overall returns.

The portfolios in the first article were not meant as optimal portfolios but there was a rational behind the security selection. Funds were grouped into three asset classes – equities, bonds, and real assets – that historically perform differently in different economic conditions. Within each asset class two funds were selected that have historically low correlations, although there have been extended periods of time where US and emerging equities, for example, have been highly correlated.

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The results from the first article were impressive when tested from 2003-present. However, results over the past two years have been more tempered. The recent returns are one example of why it is important not to rely on one test, portfolio, or time-frame to draw broad-based conclusions.

What happens if we modify the portfolio holdings? Does the dual momentum strategy hold up well? Also, what if we just equally weight the portfolio and re-balance annually? Does the dual momentum strategy still out-perform? I attempt to answer those questions in the tables below.

The strategy for the backtests involves purchasing one mutual fund in each portfolio and equal weighting the three portfolios to create a “complete” portfolio. Purchases are determined by the one fund in each portfolio which has the highest trailing 6 month returns. The strategy rebalances each month, selling the current holding if it is no longer the top ranked fund in its portfolio and replacing it with the fund which has the highest momentum.

You will notice a short-term treasury fund is in each portfolio. Combining absolute and relative momentum means a mutual fund outperforms a risk-free asset class such as cash in addition to outperforming all of the other asset classes in the portfolio Thus, for the purposes of this test I added a short-term treasury fund to each portfolio to represent a risk-free asset and to act as a comparison point for absolute momentum.

Portfolio #1 consists of the same securities as my first article:

Portfolio #1
Equity Basket Symbol
Emerging Market VEIEX
US Total Stock Market VTSMX
Short Term Treasury VFISX
Bond Basket
Emerging Market Bond PREMX
Long-Term Investment Grade US VWESX
Short Term Treasury VFISX
Real Asset Basket
Precious Metals & Mining VGPMX
MSCI REIT VGSIX
Short Term Treasury VFISX

Portfolio #2 consists of the following securities:

Portfolio #2
Equity Basket Symbol
Emerging Market VEIEX
US Total Stock Market VTSMX
Short Term Treasury VFISX
Bond Basket
Emerging Market Bond PREMX
Long-Term Investment Grade US VWESX
Short Term Treasury VFISX
Real Asset Basket
GSCI Index GTY
MSCI REIT VGSIX
Short Term Treasury VFISX

Portfolio #3 consists of the following securities:

Portfolio #3
Equity Basket Symbol
Total International Stock VGTSX
US Total Stock Market VTSMX
Short Term Treasury VFISX
Bond Basket
Emerging Market Bond PREMX
Long-Term Investment Grade US VWESX
Short Term Treasury VFISX
Real Asset Basket
GSCI Index GTY
MSCI REIT VGSIX
Short Term Treasury VFISX

The returns for the different portfolios and different strategies are in the next table. The time-frame for the tests is 2003-December 21st, 2012. Two benchmarks have been added, a 60/40 Balanced Vanguard Fund (VBINX) and the SPDR S&P 500 Index ETF (SPY).

The equally weighted portfolios all have 7 positions weighted at 14.285% and include one position in the Vanguard Short-Term Treasury Mutual Fund (VFISX). The equally-weighted portfolios include results with an annual rebalance of each position back to 14.285%.

In each case, the dual momentum strategy still out-performs on an absolute and risk-adjusted basis its equally-weighted portfolio and the benchmarks.  All test results courtesy of ETFReplay.com:

Strategy Total Return CAGR Sharpe Volatility Max Drawdown
Portfolio #1 Dual Momentum Strategy 398.50% 17.50% 1.09 12.80% -18.50%
Portfolio #1 Equally Weighted, Annual Rebalance 196.30% 11.50% 0.66 13.60% -42.02%
Portfolio #2 Dual Momentum Strategy 357.30% 16.50% 1.14 11.50% -13.40%
Portfolio #2 Equally Weighted, Annual Rebalance 153.10% 9.80% 0.61 11.60% -40.94%
Portfolio #3 Dual Momentum Strategy 320.20% 15.50% 1.12 10.90% -13.10%
 Portfolio #3 Equally Weighted, Annual Rebalance 126.20% 8.50% 0.53 11.40% -40.79%
60/40 (VBINX) 98.20% 7.10% 0.39 12.20% -35.97%
SPY 97.20% 7.10% 0.3 20.70% -55.20%

Dual Momentum Investing With Mutual Funds

Gary Antonacci’s  “Risk Premia Harvesting Through Dual Momentum” paper available on Optimal Momentum first piqued my interest in using absolute and relative momentum to invest in small groups of asset classes. Antonacci states that “relative momentum looks at price strength with respect to other assets, while absolute momentum looks for an asset’s own positive excess return over a given look back period.”

Using ETFReplay.com I created three portfolios to test the efficacy of a strategy similar to the one outlined at Optimal Momentum.  The portfolios were constructed using mutual funds (a new feature of ETFReplay) as opposed to ETFs, due to the longer trading histories of many mutual funds. My objective was to create three portfolios representing three unique asset classes.

The first portfolio is an equity portfolio consisting of the following:

Vanguard Emerging Markets – VEIEX

Vanguard Short-Term Treasury – VFISX

Vanguard Total Stock Market – VTSMX

The second portfolio is a bond portfolio consisting of the following:

T. Rowe Price Emerging Markets Bond – PREMX

Vanguard Long-Term Investment Grade – VWESX

Vanguard Short-Term Treasury – VFISX

The third portfolio is a real asset portfolio consisting of the following:

Vanguard Short-Term Treasury – VFISX

Vanguard Precious Metals & Mining – VGPMX

Vanguard REIT – VGSIX

The strategy for the backtests involves purchasing one mutual fund in each portfolio and equal weighting the three portfolios to create a “complete” portfolio. Purchases are determined by the one fund in each portfolio which has the highest trailing 6 month returns. The strategy rebalances each month, selling the current holding if it is no longer the top ranked fund in its portfolio and replacing it with the fund which has the highest momentum.

In other words, the complete portfolio equally weights the top one holding in the three portfolios outlined above. At most the complete portfolio will have three holdings – an equity, bond, and real asset. In some months, such as late 2008, VFISX has the highest 6 month trailing returns in all three portfolios; therefore, the complete portfolio could have less than three positions depending on market conditions.

You will notice a short-term treasury fund is in each portfolio. Combining absolute and relative momentum means a mutual fund outperforms a risk-free asset class such as cash in addition to outperforming all of the other asset classes in the portfolio Thus, for the purposes of this test I added a short-term treasury fund to each portfolio to represent a risk-free asset and to act as a comparison point for absolute momentum.

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The benchmark for the tests is the Vanguard 60-40 Balanced Fund (VBINX) which offers a better representation of  a complete portfolio when compared to a pure equity benchmark like SPY.  The strategy detailed above has offered strong historical returns at comparable volatility and much lower drawdowns compared to a balanced 60/40 mutual fund. Also note the Sharpe Ratio in excess of 1:

The results above since 2003 are impressive. However, before we announce to the world our discover of the holy grail, the strategy has under-performed a 60/40 investment over the past two years:

Recent under-performance offers us a lesson – strategies can work well for years and then struggle for months, years or never again. Prolonged periods of relatively low returns will test the patience of a strategy’s followers.  Has the tide shifted for good on the strategy outlined above? Or going forward can we expect something similar to the results from 2003-2010?

Weekend Readings

Below are some articles I am reading this weekend:

Getting Coal in Your Stocking – Chris Vermeulen

Should You Secular Market Time? Rick Ferri

Gundlach, Japan & the US – Mebane Faber

SuperInvestors & Simple Arithmetic – The Idea Farm

Sorting Out the Decade (pdf) – John Mauldin

PowerShares Lists VIX-Hedged S&P ETF – IndexUniverse

Trend Following – Optimal Momentum

Projected 15-Year S&P 500 Returns – Turnkey Analyst

Attend a free Benzinga Webinar Looking At Q1 2013 From a Cross-Asset Point of View  “Join Serge Berger to discuss seasonal strength through February, cyclical stocks v. non-cyclicals, and commodities, bonds, and dollar point to reflations that support stocks in the medium term.”

 

High Yield Momentum Portfolio – December Update

Once per month I update a high yield dividend stock momentum portfolio on Scott’s Investments.  The portfolio is comprised of the highest yielding stocks in the S&P 500 with high price momentum.

The portfolio is a simple quantitative strategy and begins by screening the S&P 500 for stocks yielding greater than 4%. The results are then ranked by their 6 month returns.  The top stocks are then added to a hypothetical portfolio and tracked publicly on Scott’s Investments.  This month there were 57 results, 5 less than last month due in part to the recent equity market sell-off resulting in higher dividend yields.

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Per a previous article, the highest momentum, high-yield stocks have historically out-performed lower yielding, lower momentum stocks.  The screen is more of a trading strategy and less of a passive income strategy, although the dividends do play an essential component in the overall returns. Thus, turnover could be high and the strategy is not for everyone but I have added one modification to the strategy to minimize turnover.

In order to limit turnover stocks with yields that have fallen below 4% due to share price appreciation will remain in the portfolio. Stocks will only be sold when yield falls below 4% due to dividend cuts or when the six-month performance would otherwise lag the top 12 stocks in the screen.

The portfolio has turnover in two positions for December. Verizon (VZ) was sold at a loss of 1.94% since its purchase on July 11th, 2012. DTE Energy (DTE) was sold for a .64% gain and was purchased two months ago. While the portfolio tracks dividends as a whole, discussions of Individual security returns exclude dividends.

The proceeds were used to purchase positions in Cablevision Systems (CVC) and Seagate Technology (STX).

The High Yield Momentum Portfolio was designed to be fully invested at all times regardless of market conditions. However, as part of a larger portfolio there may be additional steps an investor can take to reduce risk and diversify strategies.  For example, the Ivy Portfolio uses a 10 month moving average to dictate an invested or cash position (signals are updated daily at Scott’s Investments and many equity indices are currently very near their 10 month average). An investor could hedge long positions by shorting (or purchasing an inverse ETF) an equity market index such as the S&P 500 when it trades below a long-term moving average.

Below are the top 15 high yield momentum stocks as of December 10th.  Keep in mind that only 10 stocks are held in the portfolio, the current holdings can be viewed on the right-hand side of Scott’s Investments and in the second table below.

Data source: Finviz

Ticker Company Trend Dividend Yield Performance (Half Year)
GCI Gannett Co., Inc. Trend Analysis 4.48% 43.72%
FTR Frontier Communications Corporation Trend Analysis 8.49% 42.30%
LEG Leggett & Platt, Incorporated Trend Analysis 4.34% 32.89%
CVC Cablevision Systems Corporation Trend Analysis 4.19% 26.28%
STX Seagate Technology PLC Trend Analysis 5.26% 26.19%
HRB H&R Block, Inc. Trend Analysis 4.34% 22.27%
LMT Lockheed Martin Corporation Trend Analysis 4.98% 13.57%
CINF Cincinnati Financial Corp. Trend Analysis 4.02% 12.94%
AEP American Electric Power Co., Inc. Trend Analysis 4.33% 11.63%
HCP HCP, Inc. Trend Analysis 4.41% 11.20%
COP ConocoPhillips Trend Analysis 4.56% 9.77%
HCN Health Care REIT, Inc. Trend Analysis 4.96% 9.34%
KMI Kinder Morgan, Inc. Trend Analysis 4.28% 8.90%
WMB Williams Companies, Inc. Trend Analysis 4.16% 8.44%
FII Federated Investors, Inc. Trend Analysis 4.85% 8.26%

Current Holdings:

Position Purchase Price Purchase Date Percentage Gain/Loss Excluding Dividends Current Yield
LEG 26.72 11/9/2012 -0.04% 4.34%
CVC 14.32 12/10/2012 0.00% 4.19%
CINF 34.45 2/10/2012 17.79% 4.02%
FTR 4.71 8/9/2012 0.00% 8.49%
LLY 46.52 9/10/2012 7.74% 3.91%
HRB 17.77 11/9/2012 3.83% 4.34%
HCP 46.28 9/10/2012 -1.97% 4.41%
STX 28.91 12/10/2012 0.00% 5.26%
GCI 16.3 9/10/2012 9.51% 4.48%
AEP 43.39 9/10/2012 -0.05% 4.33%

 

Since inception the portfolio is up 10.39% including dividends. Returns exclude commissions and taxes. Given the high turnover of the strategy, the results to this point are underwhelming. The chart below compares the returns of this strategy to SPDR S&P 500 ETF (SPY) and AOR, the iShares S&P Growth Allocation ETF:

Sunday Night Articles

I am spending this snowy Sunday reading the following investment articles:

Siegel’s Shortfall (pdf) and Looming Crisis: State Budgets Soon to be Under Siege (pdf) – Crestmont Research

Stock Values and Earnings May Bamboozle Buyers – MarketWatch, Satyajit Das

Media and Google: The Impact of Information Supply and Demand on Stock Returns – Turnkey Analyst

How Important is the Fiscal Cliff to Investors? Hint: Not Very – Barry Ritholtz

Investors’ 10 Most Common Behavioral Biases – J Hagan Warren

Tactical Alpha: The Case for Active Asset Allocation – Advisor Perspectives

Forecasting Equity Returns in the New Normal – The Idea Farm (citing PIMCO)

Are These the Next Warren Buffetts? Market Folly

Secular Bear Markets – Volatility Without Return – John Hussman

High Yield Dividend Champion Portfolio for December

In December 2010, I created a screen/hypothetical portfolio called the “High Yield Dividend Champion Portfolio.” The screen is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott’s Investments (see the right hand column for a link to the spreadsheet).

Like many of the screens, strategies, and portfolios I track and prefer, the High Yield Dividend Champion Portfolio uses a small number of historically relevant ideas to create a simple, yet powerful investment plan. As I previously detailed, “Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields.”

The High Yield Dividend Champion Portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to gauge the “best” high yield/low payout stocks. The screening process for this portfolio starts with the “Dividend Champions” as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years

We first rank the Dividend Champions based on yield – the highest 1/3 yielding stocks are kept and the rest are eliminated. With the remaining high yielding stocks we eliminate the half with the highest payout ratio. The remaining stocks are then assigned a rank based on the ratio of their dividend yield to payout ratio (the same as a trailing earnings/price ratio, or the inverse of the trailing P/E ratio).

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The top 10 stocks based on this ratio make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 12 (to limit turnover) and are replaced with the next highest rated stock.

For December 6th there were three changes to the portfolio.  The 651 shares in Questar Corp (STR) were sold at a loss of 2.74%, 463 shares in Sonoco Products (SON) at a 5.21% gain, and 356 shares in Sysco Corp. (SYY) for a 1.21% gain.

Three new positions were purchased:  Chevron (CVX),  Mercury General (MCY), and WGL Holdings (WGL). CVX yields 3.41% with a sub 30% payout ratio, MCY yields 5.89% with a 63% payout ratio and WGL yields 4.10% with a 59% payout ratio.

Weekly charts courtesy of Finviz:

The top 18 rated stocks based on this portfolio’s criteria are listed below:

Name Symbol Yield Payout %Ratio E/P Analysis
Universal Health Realty Trust UHT 5.05 40.13 0.1258 Trend 
Chevron Corp. CVX 3.41 29.53 0.1153 Trend
Universal Corp. UVV 4.01 36.63 0.1094 Trend
Mercury General Corp. MCY 5.89 62.98 0.0935 Trend
Diebold Inc. DBD 3.81 42.86 0.0889 Trend
Community Trust Banc. CTBI 3.85 44.06 0.0874 Trend
Eagle Financial Services EFSI 3.58 44.71 0.0800 Trend
WGL Holdings Inc. WGL 4.10 59.04 0.0694 Trend
Consolidated Edison ED 4.34 63.52 0.0683 Trend
Tompkins Financial Corp. TMP 3.90 60.08 0.0649 Trend
McDonald’s Corp. MCD 3.54 58.00 0.0610 Trend
California Water Service CWT 3.50 57.80 0.0606 Trend
Questar Corp. STR 3.47 58.12 0.0596
Sysco Corp. SYY 3.54 59.57 0.0594
Kimberly-Clark Corp. KMB 3.45 62.32 0.0554
Clorox Company CLX 3.35 61.69 0.0544
Emerson Electric EMR 3.26 61.19 0.0534
UGI Corp. UGI 3.25 63.91 0.0509

 

The equity curve of the portfolio is plotted below and since inception it is up 35.97%, including dividends but excluding commissions and taxes. The SPDR S&P 500 ETF (SPY) and iShares S&P Growth Allocation ETF (AOR) are also shown for comparison:

 

A note regarding Eagle Financial Services (EFSI). The stock is a Dividend Champion but trades over the counter and has very low volume. Any entry/exits in this stock should be treated with caution and limit orders are highly recommended.

Monday Readings

Below are several investment reads to start your week (and probably keep you busy throughout the week):

AlphaClone has updated their blog with backtests and current top institutional holdings.

S&P 500 at Crucial Level – David Banister

How to Build a Time Machine – John Hussman

Tactical Asset Allocation Series: Part 3 (Equal-Weight with Moving Averages) – Turnkey Analyst

Volatility-Based Asset Allocation – Empiritrage

Is the Stock Market Cheap? Doug Short

Satyajit Das: Return of the Age of Gold

GMO’s James Montier has a new paper, The 13th Labour of Hercules: Capital Preservation in the Age of Financial Repression

Popular Delusions: The bull case for safe havens (pdf) – John Mauldin’s Outside the Box

The Superiority of Dividends: A  Comparison of Value Strategies – Geoff Considine

ETFReplay.com Portfolio for December

This month’s ETFReplay.com Relative Strength ETF Portfolio has been updated at Scott’s Investments and includes turnover in two out of four positions.

I previously detailed here and here how an investor can use ETFReplay.com to screen for best performing ETFs based on momentum and volatility.   I select only the top ETFs out of a static basket of 25 ETFs and re-balance the portfolio monthly.

The portfolio strategy is to purchase the top  ETFs based on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking) and the average of  the 3 month return, 20 day return, and 20 day volatility.  I refer to these two different sets as “6/3/3″ and “3/20/20″.  The top 2 ETFs in the 6/3/3 ranking and top 2 in the 3/20/20 ranking are purchased each month.  When there are duplicates in the top 2, I look to the third ranked ETF in the 3/20/20 and, if necessary, the third ranked ETF in the 6/3/3.  The strategy always holds 4 ETFs. 

I track this strategy as a public portfolio on Scott’s Investments.  As of the close November 30th the hypothetical portfolio was up 13.9%, since inception on January 1st, 2011. Returns include dividends but exclude commissions and taxes and all trades are hypothetical so real results will differ.  For some backtests on these strategies please see a recent post here.

For November 30th the portfolio sold its positions in iShares S&P US Preferred Stock Index (PFF) and  iShares iBoxx Invest Grade Bond (LQD).

The proceeds were used to purchase SPDR Int’l Govt Infl-Protect Bond (WIP) and PowerShares DB G10 Currency Harvest (DBV).

Top 50 Trending Stocks

Minor fluctuations in rankings may not always justify selling positions each month. For example, if one ETF drops from the second highest rated to the third or fourth highest rated, it may not warrant selling the position. An investor could only sell a position when it drops out of the top 4 or 5 at the end of the month. This type of modification could be used when someone is looking to limit turnover; however, I think it is important to have whatever rule you prefer to use in place prior to making the investment decision in order to avoid discretionary or emotional decision making.
Below are the top 6 ranked ETFs for this month, using both the 6/3/3 and 3/20/20 strategy:
6mo/3mo/3mo

PCY PowerShares Emerging Mkts Bond
RWX SPDR DJ International Real Estate
SCZ iShares MSCI EAFE Small Cap Index
WIP SPDR Int’l Govt Infl-Protect Bond
EFA iShares MSCI EAFE
DBV PowerSh DB G10 Currency Harvest

3mo/20day/20day

PCY PowerShares Emerging Mkts Bond
WIP SPDR Int’l Govt Infl-Protect Bond
DBV PowerSh DB G10 Currency Harvest
DBB PowerShares DB Base Metals
RWX SPDR DJ International Real Estate
EFA iShares MSCI EAFE

Below is a performance graph of the portfolio (green) versus SPY (SPDR S&P 500 ETF) and AOR (S&P Growth Allocation) from the portfolio’s inception until November 30th, 2012.