All posts by oyenscott

Mid-Week Reads

Below is a short list of investment articles I’m reading this week:

Stop Thinking About Markets as if They Were Human – Bloomberg View

From Meb Faber: A Summary of Global Asset Allocation

Momentum vs Moving Averages – Newfound Research

From The Reformed Broker:

The World Gets Serious About Climate Change
My Views on Gold: Setting the Record Straight
The Next Big Short…

Pick a Valid Strategy, Stick With It – The Aleph Blog

Swedroe: It’s OK To Ignore Your Portfolio – ETF.com

The Problem With Bond Indexing & A History of Gold Returns– A Wealth of Common Sense

From Alpha Architect:

Eureka! A Valuation-Based Asset Allocation Strategy that Might Work
Market timing with Value and Momentum

Back to Fundamentals – Dual Momentum

Buyback Extravaganza – The Investor’s Field Guide

The Worst Mutual Fund in the World – Fund Reference

Research Affiliates has updated their Asset Allocation tool, definitely worth a look!

More on this topic (What's this?)
Optimizing Your Asset Allocation
2014-Q4 Performance Review
Read more on Asset Allocation at Wikinvest

Sunday Investment Articles

Below are some of my favorite investment related articles from the past several days:

Three Years Down in a Row System – Meb Faber

7 Reasons Google Exploded – The Reformed Broker

From A Wealth of Common Sense:

Luck vs. Skill in Active Management
Why Momentum Investing Works
15 Problems With Real World Portfolios
World Class Comedy or Investing: Are They Teachable?

Alpha Architect:

Our Free Tools Are Updated: Do-It-Yourself Investors Unite
A Live Lesson in Value-Investing: The Energy Meltdown

Decoding The Myths Of Managed Futures 2015 – Seeking Alpha

ETF.com:

Swedroe: Fund Construction Matters
Swedroe: The Truth About The Carry Trade

A Random Ass Kicking of Wall Street – Following the Trend

Lessons from a Crystal Ball – Newfound Research

How To End Index Gaming – The Aleph Blog

All Strategies “Blow Up” – GestaltU

Adding a VIX Signal to Momentum – Econompicdata

Value and Momentum are Correlated – Dual Momentum

The Observation Model is the Best Defense – Blue Sky Asset Management

The Whole Story: Factors + Asset Classes – Research Affiliates

Diverse Momentum – Can We Do Better?

A Diverse Momentum System Using Vanguard Allocation Funds generated a plethora of feedback.  Can we improve or simplify the system? And does it hold up well if variables are changed?

The systems tested in the original article rarely held the Moderate Growth  (VSMGX), which allocate 60% stocks/40% bonds, or Conservative Growth (VSCGX), with a 60% bonds/40% stock allocation.  The majority of returns were generated by the Growth (VASGX), Income (VASIX), and S&P 500 Fund (VFINX).  VASGX’s objective is to hold 80% equities and 20% bonds and VASIX’s objective is to hold 80% bonds and 20% equities.

For example, you can see below the returns of the dual momentum 12 month system without VSCGX or VSMGX.  The system rotated between VFINX, VASIX, VASGX, and cash:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $60,384 9.66% 10.46% 33.21% -6.73% -17.29% 0.71 1.09
Equal Weight Portfolio $10,000 $40,025 7.37% 10.71% 23.23% -27.31% -38.97% 0.5 0.71
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

These returns are largely in line with the original test which included all 5 funds and cash:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $59,952 9.62% 10.45% 33.21% -6.73% -17.29% 0.71 1.09
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

Thus, we are left with a system which largely generated returns based on an 80/20, 20/80, 100% equity, or, with the dual momentum systems, cash (which does not generate a return, but improved risk-adjusted performance by avoiding crashes). I found similar results with the 5 month relative strength and dual momentum systems – dropping the 2 moderate funds had minimal impact on results.

However, another option is to employ a volatility adjusted momentum system to the strategy.  This gets us  closer to the Hoffstein paper referenced in the first article, which compares on a monthly basis, the Sharpe Ratio over a  look-­back period and invested in the option with the greatest risk-adjusted return.

Portfolio Visualizer allows users to make a “volatility adjustment” to momentum tests, whereby the “performance number can be volatility adjusted, in which case the model adjusts the asset return performance by calculating the average daily return over the timing period divided by the standard deviation of daily total returns over the volatility window period.”

When adding a volatility adjustment to our momentum strategy we would expect a more diverse source of returns in our 5 fund model.  Since we are no longer ranking the funds based purely on momentum and instead on their risk-adjusted returns, the moderate funds should have a greater representation in our back-tests. Moderates funds will tend to generate lower pure momentum because they are less concentrated in either stocks or bonds, but their risk-adjusted returns may score higher at times because they have greater balance and potentially lower volatility than the funds more concentrated in stocks or bonds.

In addition to adjusting for volatility, we can also add a 100% bond fund, the Vanguard Intermediate-Term Treasury Fund (VFITX) to our tests, to offset our (potential) exposure to 100% stocks via VFINX. In addition, this gives us the full spectrum of stock/bond allocation, from 0-100%.

A relative momentum system with a 5 month look-back period for returns and volatility adjustment (essentially a  sharpe ratio calculation, excluding the risk-free rate, which is a mute point since we are ranking funds relative to each other) in our 6 fund portfolio of VFINX, VASIX, VASGX, VSMGX, VSCGX and VFITX generates the following:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $49,837 8.59% 6.82% 24.77% -1.70% -11.01% 0.89 1.49
Equal Weight Portfolio $10,000 $37,503 7.01% 8.08% 19.13% -19.10% -29.10% 0.59 0.86
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

A 12  volatility adjusted momentum system on the same portfolio generates the lowest standard deviation and drawdown of any system tested yet:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $49,085 8.50% 6.48% 23.09% 0.36% -4.88% 0.92 1.64
Equal Weight Portfolio $10,000 $37,503 7.01% 8.08% 19.13% -19.10% -29.10% 0.59 0.86
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

 

12 month adj

In both the 5 and 12 month volatility adjusted system we also see much greater representation of all funds, unlike the momentum-only system.

We could test variations of this strategy almost indefinitely. However, two final tests  are relevant for today’s article.  What if we exclude the conservative growth and moderate growth funds in our volatility-adjusted system? Can we simplify things without impacting results? A 5 month volatility adjusted system and a portfolio of VFINX, VFITX, VASIX, and VASGX generates comparable returns to the 6 fund portfolio:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $50,103 8.62% 7.00% 22.79% -1.49% -11.01% 0.87 1.46
Equal Weight Portfolio $10,000 $38,487 7.16% 7.86% 19.66% -17.15% -27.12% 0.62 0.91
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

And the 12 month system and 4 fund portfolio also generates comparable returns to the 6 fund portfolio:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $51,111 8.73% 6.67% 27.77% 0.36% -6.12% 0.93 1.67
Equal Weight Portfolio $10,000 $38,487 7.16% 7.86% 19.66% -17.15% -27.12% 0.62 0.91
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

4 fund

In both cases the 4 fund system had only slightly higher volatility but comparable risk-adjusted returns.

Hopefully these tests, while not intended to be exhaustive, provide some insight into the potential for a Diverse Momentum strategy. My initial thoughts are that a momentum system of asset allocation funds has merit. Diversification within the assets themselves appears to improved risk-adjusted returns, but the bulk of the returns is in the extremes and not in the moderate allocation funds.  In addition, using risk-adjusted returns to select assets generates superior returns compared to purely momentum systems like the ones in our first article.

Areas of further exploration could include additional asset allocation funds, such as The Permanent Portfolio (PRPFX), or other alternative allocation models, changes to the look-back period, modifications to the 100% stock and bond funds, and/or additional trend filters.

A special thanks to Portfolio Visualizer for the wonderful resource

 

A Diverse Momentum System Using Vanguard Allocation Funds

One of the criticisms of momentum systems is they are prone to crashes when momentum reverts. The system highlighted in this article can be implemented using any number of “life style” or target-risk funds or ETFs.  The system chooses from a small number of funds that reflect a range of asset allocation models.  The purpose is to employ a diverse, momentum-based asset allocation system.  Rather than allocate based on momentum to singular asset classes which increases the potential for momentum crashes, we allocate to asset allocation models themselves.

The tests were conducted using Portfolio Visualizer.  If you have not checked out their site I highly recommend this free tool.  Also, for additional research on this topic please see this award-winning paper by Corey Hoffstein of Newfound Research which served as the original inspiration for these tests.

I ran 5 tests using Vanguard Target-risk funds and the Vanguard S&P 500 Index Fund (VFINX).  The Target-risk funds used were LifeStrategy Conservative Growth (VSCGX) , LifeStrategy Growth (VASGX) , LifeStrategy Income (VASIX) , LifeStrategy Moderate Growth (VSMGX) .  According to Vanguard these funds are “a series of broadly diversified, low-cost funds with an all-index, fixed allocation approach that may provide a complete portfolio in a single fund. The four funds, each with a different allocation, target various risk-based objectives.”  The funds allocate different percentages to bonds (international and domestic) and stocks (international and domestic).

The tests consisted of two simple momentum systems I frequently use on Scotts Investments.  The first is a simple relative strength system where the best performing asset based on trailing returns is purchased.

The seconds is a “dual momentum” system that holds the best performing fund based on trailing returns.  A second filter is used, absolute momentum, to switch the best performing asset to cash if its total returns were below the risk-free rate of cash over the lookback period.  This is similar to my Dual Momentum Portfolio, which is inspired by a paper written by Gary Antonacci and available on Optimal Momentum.  Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk, also highlights his specific system  in greater detail.

The test results for the relative momentum system is below. All tests were from 1996 – present.  The first model used a single performance window of 5 months. The best performing fund was held, and trades were performed at the start of each month.  For comparison purposes an “equal-weight” version each portfolio is also provided but since these are asset allocation funds the comparison is a bit redundant (equal weight is essentially a balanced fund itself):

Timing Model Assets
Ticker Name
VSMGX Vanguard Lifestrategy Moderate Growth Fund
VASIX Vanguard Lifestrategy Income Fund
VSCGX Vanguard Lifestrategy Fund Conservative Growth Fund
VASGX Vanguard Lifestrategy Growth Fund
Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $51,597 8.78% 8.53% 24.22% -10.53% -18.49% 0.75 1.14 0.84
Equal Weight Portfolio $10,000 $35,621 6.73% 8.56% 19.57% -22.73% -32.75% 0.53 0.75 0.96
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

What if we add VFINX to the pool of potential assets? We would expect higher volatility with potentially higher returns since a 100% stock allocation is held at various times ( you will also see the equal weight portfolio has slightly higher returns/volatility because it is tilted towards stocks with its allocation to VFINX):

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $70,161 10.51% 10.21% 33.21% -10.53% -18.49% 0.8 1.24 0.82
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve

Returns and standard deviation increase, which may have been expected.  However, max drawdown and the worst year remained the same, so adding a 100% stock allocation did not impact our biggest loss.

Next, we test a dual momentum approach with a 12 month look back period.  The top 1 fund is purchased based on 12 month returns, but only if the returns are also greater than the return on the risk free rate of cash.  Testing the 4 life style funds (excluding VFINX) yielded the following results:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $49,142 8.51% 8.78% 22.26% -7.61% -16.17% 0.71 1.08 0.73
Equal Weight Portfolio $10,000 $35,621 6.73% 8.56% 19.57% -22.73% -32.75% 0.53 0.75 0.96
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

What if we include VFINX?

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $59,952 9.62% 10.45% 33.21% -6.73% -17.29% 0.71 1.09 0.73
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve 2

 

Finally, what is we use a 5 month look back period, like the relative strength tests, instead of 12 months?

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $62,456 9.85% 9.72% 33.21% -4.74% -15.38% 0.77 1.22 0.7
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve 3

 

The sharpe ratio in all 5 tests ranged from .71 – .80 and in each instance outperformed an equal weight portfolio and the S&P 500.   Investors looking for a simple, momentum based system that avoids “all-in” investments in single asset classes should consider a system using asset allocation funds.

More on this topic (What's this?)
Frontier Markets Mutual Fund
UCITS-Compliant Macro Fund of Funds
Read more on Mutual Funds at Wikinvest

Dual Momentum July Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.  Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk, also details Dual Momentum as a total portfolio strategy.

My Dual ETF Momentum spreadsheet is available here and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”.

Relative momentum is gauged by the 12 month total returns of each ETF. The 12 month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of iShares Barclays 1-3 Treasury Bond ETF (SHY). In order to have an “Invested” signal the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3, 6, and 12 (“3/6/12″) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have an average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF.

Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12″).  The test results were posted in the 2013 Year in Review and the January 2015 Update.

Below are the four portfolios along with current signals:

dual momo

As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions and the terms of their commission-free ETFs could change in the future.

More on this topic (What's this?)
How to Spot a Genuine Momentum Stock
More Sales Momentum For euNetworks in Q2
Infinera Maintained Its Momentum Through Q2
Read more on Momentum at Wikinvest

Dividend Champion Portfolio July Update

The High Yield Dividend Champion Portfolio is a publicly tracked stock portfolio on Scott’s Investments.  Its goal is to capture quality high yield stocks with a history of raising dividends.

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.  Stocks from the Dividend Champion list are then ranked on yield, payout ratio, P/E, and 3 year dividend growth rate.

Stocks are sold on the re-balance date (generally around the 5th of the month) when they drop out of the top 15 (to limit turnover) and are replaced with the next highest rated stock.

The top 15 stocks  are below and displayed in order of their overall ranking (figures are June month-end):

Name Symbol Yield Payout 3-yr P/E
Helmerich & Payne Inc. HP 3.91 42.24 116.13 10.82
Chevron Corp. CVX 4.44 46.83 10.86 10.55
ExxonMobil Corp. XOM 3.51 43.84 13.43 12.49
Eagle Financial Services EFSI 3.40 38.28 2.26 11.24
Emerson Electric EMR 3.39 49.47 7.04 14.59
Wal-Mart Stores Inc. WMT 2.76 40.08 10.98 14.51
Community Trust Banc. CTBI 3.44 47.43 1.60 13.78
Universal Health Realty Trust UHT 5.51 64.65 1.29 11.73
Cincinnati Financial CINF 3.67 54.12 2.78 14.76
Questar Corp. STR 4.02 65.63 6.55 16.34
Universal Corp. UVV 3.63 53.75 2.04 14.81
WGL Holdings Inc. WGL 3.41 54.25 4.15 15.92
Tompkins Financial Corp. TMP 3.13 48.41 4.99 15.48
Black Hills Corp. BKH 3.71 56.25 2.23 15.16
Old Republic International ORI 4.73 66.07 1.41 13.96

EFSI is not eligible for purchase due to its low liquidity.

As with last month there is no turnover in positions for May. However, since we have passed the mid way point of the year I will take this opportunity to rebalance the portfolio.  A portion of UVV, 117 shares, will be sold and the proceeds used to purchase 80 shares of CVX.  The rebalance brings UVV’s allocation to 10.22% and CVX to 10.59%.

The current portfolio is below:

 

Position Average Purchase Price Before Rebalance Initial Purchase Date Percentage Gain/Loss Excluding Dividends Before Rebalance Current Yield Current Allocation Before Rebalance
CVX 108.06 12/6/2012 -12.28% 4.52% 6.72%
CINF 52.47 3/6/2015 -0.25% 3.52% 10.03%
ORI 16.22 4/4/2014 -2.84% 4.70% 9.27%
UVV 47.3 4/8/2015 21.18% 3.63% 13.70%
TMP 44.46 8/6/2014 21.84% 3.10% 11.94%
CTBI 36.55 5/5/2014 -5.55% 3.48% 12.10%
XOM 89.01 4/5/2013 -7.28% 3.54% 8.31%
HP 90.57 10/6/2014 -27.68% 4.20% 8.01%
STR 22.8 3/6/2015 -6.01% 3.92% 9.47%
UHT 55.27 4/8/2015 -13.64% 5.36% 9.76%

I also have  a second portfolio using similar metrics as the High Yield Dividend Champion portfolio. The primary difference is it only requires 10 years of dividend increases and it also hedges the portfolio during unfavorable market conditions. Hedging requires margin, but the portfolio can also be implemented without the hedge.

The portfolio is available on Portfolio123, search for ‘Scott’s Dividend Champ Portfolio Hedged’ in the Ready-to-Go section.

Holiday Weekend Reads

Before jumping in, a reader suggested I publicize the Amazon link on the right hand side of the blog more prominently.  The Amazon link is a standard affiliate link and makes no change to your shopping experience or costs. If you use the link to do all of your shopping on Amazon (you can also use the link here) , I receive a small commission. In other words, it is a great way to support this site and it won’t cost you a cent!

Below is your holiday weekend investment reading list.

12 charts and maps that explain the Greek crisis – Vox

Three-Way Model – Meb Faber

Alpha Architect:
Long/Short Hedge Fund Factors: Low-Cost Downside Protection?
Trend Following the Greek Equity Markets
The Philosophy of Value Investing — Reject “New Paradigm” Thinking
High Dividend Stocks and Value Investing

ETF.com:
Swedroe: Mythical Emerging Market Returns
Swedroe: Remember The Nonfinancial Assets

Delusions of Future Outperformance – A Wealth of Common Sense

The Irrelevant Investor:
How Long do Investors Have to Wait Before They See the Benefits of Diversification?
How Should We Think About a 60/40 Portfolio?

The Reformed Broker:
Some stuff you should know about Greece before you lose your s***
Correlations aren’t Constant

Think MPT Doesn’t Work? Clearing Up Some Misconceptions – CSSA

Momentum Due Diligence – Dual Momentum

ETFReplay.com July Update

The ETFReplay.com Portfolio holdings have been updated for July 2015.  I previously detailed here and here how an investor can use ETFReplay.com to screen for best performing ETFs based on momentum and volatility.

The portfolio begins with a static basket of 14 ETFs. These 14 ETFs are ranked by 6 month total returns (weighted 40%), 3 month total returns (weighted 30%), and 3 month price volatility (weighted 30%). The top 4 are purchased  at the beginning of each month. When a holding drops out of the top 5 ETFs it will be sold and replaced with the next highest ranked ETF.

The 14 ETFs are listed below:

Symbol Name
RWX SPDR DJ International Real Estate
PCY PowerShares Emerging Mkts Bond
WIP SPDR Int’l Govt Infl-Protect Bond
EFA iShares MSCI EAFE
HYG iShares iBoxx High-Yield Corp Bond
EEM iShares MSCI Emerging Markets
LQD iShares iBoxx Invest Grade Bond
VNQ Vanguard MSCI U.S. REIT
TIP iShares Barclays TIPS
VTI Vanguard MSCI Total U.S. Stock Market
DBC PowerShares DB Commodity Index
GLD SPDR Gold Shares
TLT iShares Barclays Long-Term Trsry
SHY iShares Barclays 1-3 Year Treasry Bnd Fd

 

Bring Your Portfolio Into The 21st Century
Free Access – INO.com Special Report

In addition, ETFs must be ranked above the cash-like ETF (SHY) in order to be included in the portfolio, similar to the absolute momentum strategy I profiled here. This modification could help reduce drawdowns during periods of high volatility and/or negative market conditions (see 2008-2009), but it could also reduce total returns by allocating to cash in lieu of an asset class.

The cash filter is in effect this month.  SHY is the highest rated ETF in the 6/3/3 system.  Therefore, all current holdings will be sold and the proceeds used to purchase SHY.

The top 5 ranked ETFs based on the 6/3/3 system as of 6/30/15 are below:

6mo/3mo/3mo
SHY Barclays Low Duration Treasury (2-yr)
EFA iShares MSCI EAFE
HYG iShares iBoxx High-Yield Corp Bond (4-5yr)
PCY PowerShares Emerging Mkts Bond (7-9yr)
VTI Vanguard Total U.S. Stock Market

 

In 2014 I introduced a pure momentum system, which ranks the same basket of 14 ETFs based solely on 6 month price momentum. There is no cash filter in the pure momentum system, volatility ranking, or requirement to limit turnover – the top 4 ETFs based on price momentum are purchased each month. The portfolio and rankings are posted on the same spreadsheet as the 6/3/3 strategy.

The top 4 six month momentum ETFs are below:

6 month Momentum
EFA iShares MSCI EAFE
EEM iShares MSCI Emerging Markets
RWX SPDR DJ International Real Estate
HYG iShares iBoxx High-Yield Corp Bond (4-5yr)

 

(VTI), a holding since September 2014 will be sold for a 5%+ gain and replaced by (EEM).  (TLT), a holding since September 2014 will be sold for a  1%+ gain and replaced by (HYG).

The updated holdings for each portfolio are below.

6/3/3 strategy:

Position Shares Avg Purchase Price Purchase Date Cost Basis Current Value Gain/Loss Excluding Dividends Percentage Gain/Loss Excluding Dividends
SHY 149 84.86 5/29/2015 & 6/30/15 $12,644.14 $12,644.14 $0.00 0.00%

 

Pure Momentum strategy:

Current Positions Position Shares Purchase Price Purchase Date Cost Basis Current Value Gain/Loss Excluding Dividends Percentage Gain/Loss Excluding Dividends
EEM 60 39.62 6/30/2015 $2,377.20 $2,377.20 $0.00 0.00%
RWX 64 43.99 4/2/2015 $2,815.36 $2,679.04 -$136.32 -4.84%
HYG 27 88.8 6/30/2015 $2,397.60 $2,397.60 $0.00 0.00%
EFA 39 66.51 4/30/2015 $2,593.89 $2,476.11 -$117.78 -4.54%

Ivy Portfolio July Update

The Ivy Portfolio spreadsheet track the 10 month moving average signals for two 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.

The Ivy Portfolio spreadsheet tracks both 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 late 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 or trade based on daily updates. It simply gives the spreadsheet more versatility for users to check at his or her leisure.

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. My preference is to use adjusted data when evaluating signals.

Bring Your Portfolio Into The 21st Century
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The current signals based on June 30th’s adjusted closing prices are below.   As of the close May 29, (DBC) (GSG) (VNQ) and (TIP) were below their 10 month moving average.  This month those 4 ETFs remain below their moving average. In addition, (BND) (RWX) (TIP) and (VWO) are now also below their 10 month moving average.

The spreadsheet also provides quarterly, half year, and yearly return data courtesy of Finviz. The return data is useful for those interested in overlaying a momentum strategy with the 10 month SMA strategy:

Ivy10

Ivy5

I also provide a “Commission-Free” Ivy Portfolio spreadsheet as an added bonus. This document tracks the 10 month moving averages for four different portfolios designed for TD Ameritrade, Fidelity, Charles Schwab, and Vanguard commission-free ETF offers.

Not all ETFs in each portfolio are commission free, as each broker limits the selection of commission-free ETFs and viable ETFs may not exist in each asset class. Other restrictions and limitations may apply depending on each broker.

Below are the 10 month moving average signals (using adjusted price data) for the commission-free portfolios:

Commfree1 Commfree2

Backtesting – A Cautionary Example

My previous article detailed backtest results for the ETFReplay.com portfolio. Aggregate, risk-adjusted results since 2004 were impressive when compared to a 60/40 Vanguard mutual fund.  However, results over the past 2-3 years lagged the benchmark.

The test below was conducted using Portfolio123 (“P123″).  It uses a similar ranking system to the ETFReplay 6/3/3 system but has a few seemingly “minor” differences:

  • The P123 begins with a similar basket of ETFs, the only difference is the P123 system ranks 15 ETFs instead of 14, with Powershares DB Agriculture (DBA) as the extra ETF.
  • The starting date for the P123 test is 12/10/03, which differs from the ETFReplay start date of 1/1/2004.
  • The P123 system rebalances every 4 weeks,  instead of at the end of each month.
  • The ETFReplay test assumes equal holdings each month (i.e. rebalancing back to equal weight each month at no cost) while P123 lets positions run so holdings may become unbalanced over time.
  • The P123 test uses the next days closing price of each ETF for the transaction price, compared to the ETFReplay system which uses the same days closing price when each ETF is ranked.
  • Finally, and perhaps most importantly, the P123 test accounts for slippage with each transaction, which reduces returns.  The slippage for each transaction is calculated based on the average trading volume for each ETF.  This is a conservative method for calculating ETF slippage.

After accounting for these differences, we see the P123 test shows significantly lower results (as an aside, the benchmark for this test was the SPY):

Tables and charts courtesy of Portfolio123

P123 slippage

P123 slippage3

P123 slippage2

 

However, if we assume zero slippage results improve dramatically.  Total and annualized return are significantly higher yet we still see different returns and risk metrics than the ETFReplay test. This can be attributed to a slightly different pool of ETFs, and different rebalancing dates/methodology:

P123 no slippage

P123 no slippage 2 P123 no slippage 3

The point of this exercise is not to disparage backtests or historical results.  Rather, it shows the importance of considering trading costs as well as how changes in test parameters can impact results.

Focus on making your tests robust. Run them through multiple time frames with different assumptions and be mindful of data-mining.  Finally, be conscious of trading costs and fees!  Many brokers now offer commission free ETFs, but taxes and trading slippage can take a big bite out of returns.

 

 

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