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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

 

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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%

Dual ETF Momentum Portfolio – June Update & Backtests

In February I announced a new “Dual ETF Momentum” spreadsheet. The idea was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.

The spreadsheet is available on Scott’s Investment’s here. The objective of the spreadsheet is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative 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 bill ETF (a “cash” filter). 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 the cash ETF. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

I have added an “average” return signal for each ETF 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.

Below are the four portfolios along with current signals.

Return data courtesy of Finviz
Equity  ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
US Equities VTI 15.67 Invested Invested
International Equities VEU 7.68
Cash SHY 0.04
Credit Risk  ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
High Yield Bond HYG 3.41 Invested Invested
Interm Credit Bond CIU 0.38
Cash SHY 0.04
Real-Estate Risk  ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Equity REIT VNQ 6.51 Invested Invested
Mortgage REIT REM -1.37
Cash SHY 0.04
Economic Stress  ETF Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Gold GLD -15.55
Long-term Treasuries TLT -4.95
Cash SHY 0.04 Invested Invested

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.

Using Portfolio123 I backtested a similar strategy using the same portfolios and combined momentum score used above. However, to simplify the screen I did not require an ETF to be ranked above the combined return of SHY; rather, an ETF simply needed the average of its 13 week/26 week/52 week total return to be greater than 0% (the “absolute” momentum filter). Also, the portfolio re-balanced every 4 weeks as opposed to the end of each month.  No considerations were made for taxes or commissions. The test time period was 5/1/08 – 6/10/13 and the benchmark is SPY:

dual momentum test2

A four year test period is short by historical standards but the test is limited to the trading history of ETFs within the portfolio. A more robust, index-based test of the dual momentum strategy can be found on Optimal Momentum.

If you enjoy these free tools, please consider making a donation on the home page of Scott’s Investments using the Paypal link in the upper-right corner!

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ETFReplay Portfolio for June

Among the more popular portfolios on Scott’s Investments has been the ETFReplay.com Portfolio. The strategy has been revised and improved for 2013 in order to make it simpler to follow.

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 4 ETFs out of a static basket of  ETFs and re-balance the portfolio monthly. Previously, the static basket of ETFs was 25. This number of ETFs creates a high degree of turnover and also creates cross-over among ETFs that have a high correlations. For example, if you are only purchasing 4 ETFs each month and 2 or 3 of the ETFs are highly correlated, there is little benefit in holding more than 1 of the ETFs.

For 2013 the static basket of ETFs was reduced to 15. From this basket of 15, the top 4 will be selected each month. The portfolio will be re-balanced 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. I added the top 5 requirement in order to further limit turnover. ETFs will be ranked on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking).

In addition, ETFs must be ranked above the cash 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).

The top 5 ranked ETFs as of 5/31/13 are below:

VTI Vanguard MSCI Total U.S. Stock Market
SHY Barclays Low Duration Treasury (2-yr)
HYG iShares iBoxx High-Yield Corp Bond (4-5yr)
VNQ Vanguard MSCI U.S. REIT
EFA iShares MSCI EAFE

For June the strategy is moving to 75% cash. This will be the first time in 2013 that the absolute momentum filter has come into play and the first time since 2009 the strategy has less than 2 non-cash ETFs.  Since SHY is the second highest rated ETF, anything ranked below it will not be held.  The balance of the portfolio will continue to hold VTI since it is the highest rated ETF.

VNQ was sold for a gain of 2.4% and purchase date of 2/28/13, HYG for a loss of 1.52% and purchase date of 3/28/13, and RWX for a gain of .93% and purchase date of 10/31/12 (individual returns exclude any dividends).

The absolute momentum filter comes as somewhat of a surprise this month, although volatility increased in several asset classes in May. Time will tell if this conservative rotation helps reduce drawdowns or is a false signal.

 

Dual ETF Momentum – May Update

In February I announced a new “Dual ETF Momentum” spreadsheet. The idea was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.

The spreadsheet is available on Scott’s Investment’s here. The objective of the spreadsheet is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative 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 bill ETF (a “cash” filter). 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 the cash ETF. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

I have added an “average” return signal for each ETF 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.

Below are the four portfolios along with current signals. As you can see, the 12-month and 3-6-12 signals are the same with the exception of the Real-Estate risk portfolio. REM has  higher 12-month returns than VNQ; however, VNQ has higher 3/6/12 returns than REM.

Return data courtesy of Finviz
Equity ETF Average of 3/6/12 Returns Signal based on 1 year returns Signal based on average returns
US Equities VTI 16.72 Invested Invested
International Equities VEU 13.06
Cash SHY 0.17
Credit Risk ETF Average of 3/6/12 Returns Signal based on 1 year returns Signal based on average returns
High Yield Bond HYG 7.67 Invested Invested
Interm Credit Bond CIU 2.28
Cash SHY 0.17
Real-Estate Risk ETF Average of 3/6/12 Returns Signal based on 1 year returns Signal based on average returns
Equity REIT VNQ 17.17 Invested
Mortgage REIT REM 14.43 Invested
Cash SHY 0.17
Economic Stress ETF Average of 3/6/12 Returns Signal based on 1 year returns Signal based on average returns
Gold GLD -13.42
Long-term Treasuries TLT 0.46 Invested Invested
Cash SHY 0.17

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. Also, the dual momentum strategy has historically had relatively low turnover.

If you enjoy these free tools, please consider making a donation on the home page of Scott’s Investments using the Paypal link in the upper-right corner!

Permanent Portfolio Spreadsheet

I created a Permanent Portfolio Spreadsheet which tracks various investment metrics for four ETFs, the Vanguard Total Stock Market (VTI), iShares Barclays 20+ Year Treasury Bond (TLT), SPDR Gold Trust (GLD), and iShares Barclays 1-3 Year Treasry Bond Fund (SHY).  They were selected to reflect a Harry Browne-esque Permanent Portfolio. The spreadsheet is accessible at the top of the home page.

There are numerous indicators on the sheet, including long-term moving averages  (both 10 month and 200 day), momentum, and absolute momentum (i.e. TLT, VTI, and GLD returns versus SHY). I will probably add to it as time progresses, I don’t yet have a final vision for it but if you have any input let me know.

I realize having anything other than an equal weight flies in the face of Browne’s original Permanent Portfolio strategy of an equal weight allocation. However, I have written several articles on the Permanent Portfolio with some simple twists that have, in some cases, improved historical performance.  Some of those articles are listed below.  And if you need another reason: It is fun creating spreadsheets….

Creating a Permanent ETF Portfolio
Building a Permanent ETF Portfolio, Part 2
Tactical Applications of the Permanent Portfolio
Testing a Harry Browne Permanent ETF Portfolio

Dual ETF Momentum Update

In February I announced a new “Dual ETF Momentum” spreadsheet. The idea was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.

The spreadsheet is available on Scott’s Investment’s here. The objective of the spreadsheet is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative 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 bill ETF (a “cash” filter). 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 the cash ETF. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

I have added an “average” return signal for each ETF 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.

Below are the five portfolios along with current signals. As you can see, the signals are the same with the exception of the Economic Stress portfolio. TLT has slightly higher 12-month returns than SHY. However, TLT and GLD both have lower 3/6/12 returns than SHY:

Equity Representative ETF 1 Year % Total Returns Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
US Equities VTI 17.93 14.07 Invested Invested
International Equities VEU 11.89 11.57
Cash SHY 0.36 0.14
Credit Risk Representative ETF 1 Year % Total Returns Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
High Yield Bond HYG 11.22 6.27 Invested Invested
Interm Credit Bond CIU 4.49 1.78
Cash SHY 0.36 0.14
Real-Estate Risk Representative ETF 1 Year % Total Returns Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Equity REIT VNQ 18.25 11.29
Mortgage REIT REM 25.16 15.46 Invested Invested
Cash SHY 0.36 0.14
Economic Stress Representative ETF 1 Year % Total Returns Average of Quarterly/Half/Full Year % Returns Signal based on 1 year returns Signal based on average returns
Gold GLD -6.5 -6.8
Long-term Treasuries TLT 0.64 -5.23 Invested
Cash SHY 0.36 0.14 Invested
Return data courtesy of Finviz

As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs. 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. Also, the dual momentum strategy has historically had relatively low turnover.

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Three Permanent Portfolios for the Long-Run

Last week different tactical approaches (momentum, moving average) to the Permanent Portfolio were detailed here. Harry Browne proposed a “Permanent Portfolio” allocation in his 1998 Fail-Safe Investing: Lifelong Financial Security in 30 Minutes.  The portfolio is an equal-weight portfolio of stocks, long-term bonds, cash, and gold. One approach to replicate the Permanent Portfolio is to hold a stock, long-term bond, cash, and gold position.

Another alternative is to hold a mutual fund or ETF that replicates the entire Permanent Portfolio strategy.  Two “one-stop” options presently exist,  the Permanent Portfolio Mutual Fund (PRPFX) and the Global X Permanent ETF (PERM).

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PRPFX invests 20% of its assets in Gold, 5% of its assets in Silver, 10% of its assets in Swiss franc assets, 15% of its assets in Stocks of U.S. and foreign real estate and natural resource companies, 15% of its assets in Aggressive growth stocks, and 35% of its assets in Dollar assets. This allocation is similar to the one proposed by Browne, but does differ in its allocation weightings and its exposure to real estate, silver, natural resource companies, and the Swiss franc.

In February Global X Funds launched the Permanent ETF (PERM). This ETF seeks to replicate, net of expenses, the Solactive Permanent Index. The index tracks the performance of four asset class categories that are designed to perform differently across different economic environments. They include stocks, U.S. Treasury bonds (long-term), U.S. Treasury bills and bonds (short-term), and gold and silver.

Since its inception in February, PERM has failed to gather significant assets, with total assets currently listed at less than $15 million. It also has thin volume, with average daily volume less than 15,000 shares and its current expense ratio is .49%. The thin volume makes trading more difficult than more widely held ETFs and could lead to larger bid-ask spreads.

In March I compared the early performance of PERM to an equal-weight portfolio of four ETFs: SPY (SPDR S&P 500 ETF), TLT (iShares Barclays 20+ Year Treasury), SHY (iShares Barclays 1-3 Year Treasury Bond Fund), and GLD (SPDR Gold Trust). Below is an update to the two portfolio’s relative performance. Portfolio A is 100% invested in PERM while Portfolio B uses the four ETF allocation. Returns include dividends (PERM has yet to pay a dividend), data courtesy of ETF Replay:

Since its inception PERM has under-performed a 4 ETF strategy.  The 4 ETF strategy has no exposure to silver, while PERM maintains exposure to silver. As you can below, silver (using the ETF SLV as a proxy) has underperformed gold since February 7th (PERM’s inception date). Date courtesy of Yahoo Finance:

Thus, part of the short-term underperformance of PERM could be related to its silver exposure. The performance difference between gold and silver will fluctuate in the long-term, and at times PERM’s silver exposure could aid its performance.

The expense ratio of PERM is also worth considering when evaluating performance. The expense ratio of .49% compares to the SPY expense ratio of .09%, TLT expense ratio of .15%, GLD expense ratio of .40%, and SHY expense ratio of 15%. In an equal weight portfolio these expense ratios average  .20%. However, additional commissions could be generated when each ETF is bought or sold, while a single Permanent allocation to PERM only creates one transaction.

PRPFX is another viable alternative for investors looking for a Permanent Portfolio strategy. However, as detailed above this mutual fund’s allocation strays further than the Harry Browne allocation. Its performance since February in relation to PERM:

PRPFX has an expense ratio of .84%, higher than its ETF counterpart. However, it may offer an alternative allocation preferred by some investors.

The three Permanent Portfolios detailed here all share similar strategies.  However, as we can see, even small (or in the case of PRPFX, moderate) differences in allocations and expense ratios can lead to differences in performance over a relatively short time period. For the long-term investor, identifying these differences and then allocating accordingly will  impact returns in the long run.

 

Tactical Applications of the Permanent Portfolio

Harry Browne proposed a “Permanent Portfolio” allocation in his 1998 Fail-Safe Investing: Lifelong Financial Security in 30 Minutes.  Browne proposed an equal-weight portfolio of stocks, long-term bonds, cash, and gold. One of the major appeals of the portfolio is its simplicity and the low correlation between the assets. Today an investor could create this portfolio using as little as four ETFs: SPY (SPDR S&P 500 ETF), TLT (iShares Barclays 20+ Year Treasury), SHY (iShares Barclays 1-3 Year Treasury Bond Fund), and GLD (SPDR Gold Trust). Holding four low-cost ETFs and re-balancing periodically can help minimize trading costs and potential tax implications while also providing diversity.

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In February 2012 I back-tested the Permanent ETF Portfolio (SPY, TLT, SHY, and GLD) and some minor variations of the portfolio, with the results available here. The conclusion reached then was “the portfolio has had relatively low drawdown and volatility with recent returns outpacing equity markets. The 10 month moving average system lowered the volatility of the portfolio…but had slightly lower overall returns than simply buying and holding the portfolio.” The moving average system also results in higher trading costs and potential tax implications.

Today we will re-examine the same strategies detailed in February as well as additional tactical applications of the Permanent Portfolio. The time-frame for all tests is January 3rd 2005 to August 23rd, 2012. All tests were conducted using ETF Replay.

First, buying the ETF version of the Permanent Portfolio on January 3rd, 2005 with no re-balance has resulted in the following returns:

If we bought the portfolio and re-balanced annually, total returns decreased slightly versus the “no re-balance” portfolio but volatility decreased, resulting in a higher sharpe ratio and lower max drawdown:

The 10 month simple moving average system has been popularized in recent years by Mebane Faber in The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. For the tests below 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 a substitute for cash). When it closed the month above its 10 month moving average, the ETF was purchased at the stated allocation.

The performance for the 10 month moving average system within the 4 ETF permanent portfolio is below. GLD did not have adequate trading history at the start of 2005 to generate a 10 month moving average, so the results are slightly skewed until GLD generated a signal in mid 2006.

The moving average system has resulted in lower total returns but lower volatility, resulting in a slightly higher sharpe ratio than the first two strategies. However, this comes at potentially higher trading costs and tax implications. There were 37 trades since 2005 using the 10 month moving average, which equates to roughly 5 trades per year. When compared to an annual re-balance strategy that potentially requires 4 year end trades, the moving average system still has relatively low turnover for an active strategy.

A potential momentum strategy for the Permanent Portfolio is to purchase the top 1 or 2 ETFs of the 4 based on relative strength.  For the tests below the ETF with the top 6 month relative strength is purchased and held for a month. The returns when purchasing the top 1 ETF each month are below:

The returns for the top 1 ETF strategy has resulted in substantially higher volatility and comparable returns to a buy-and-hold strategy. In addition, the strategy had 61 trades since 2005.

However, the historical results for purchasing the top 2 ETFs are much more promising:

A relative strength system that purchased the top 2 ETFs has resulted in substantially higher returns versus the top 1 system. The strategy resulted in 50 trades or an average of  6-7 trades per year.

Additional strategies an investor could use would be to allocate a percentage of funds to each strategy. For example, if we allocate 50% of a portfolio to the 10 month moving average system and 50% to the 6 month top 2 relative strength system, the results are below:

As you can see, returns and the sharpe ratio were better than buy-and-hold but again it comes at higher turnover.

Below is a table comparing the various strategies tested above:

System Total Return % Volatility % CAGR % Sharpe Max Drawdown %
Buy and Hold 107.70 9.30 10.00 0.76 -16.71
Buy and Hold, Annual Rebalance 102.00 7.70 9.60 0.85 -14.03
10 Month SMA 89.70 6.70 8.70 0.87 -7.1
6 Month Relative Strength Top 1 111.20 19.00 10.30 0.46 -24.3
6 Month Relative Strength Top 2 213.90 12.40 16.10 1.04 -14.2
Combined Systems (10 month SMA + top 2) 145 9.3 12.4 1.01 -10.7

Simple tactical approaches like the ones detailed above offer viable alternatives to investors nervous about buying-and-holding the portfolio over the long run. For example, someone may be nervous about the direction of long-term rates and the potential for losses in TLT in the coming years.  A simple moving average system and relative strength system could help reduce exposure to asset classes when they display weakness.

These systems come at potentially higher trading costs and tax implications. Also, a systematic approach can be difficult for some investors to follow –  we may allow the outside “noise” to interfere with the signals of our investment system.  In doing so, we can actually hurt our long-term returns when compared to the original system or a buy-and-hold approach.

Key takeaways are threefold, 1) Buying and holding the Permanent Portfolio the past 8 years has resulted in strong risk-adjusted returns 2) Tactical approaches have offered slightly higher risk-adjusted returns and in some cases total returns, but with higher trading costs, 3) There is no guarantee any of the systems detailed above will perform well in the future. For example, a rise in long-term interest rates coupled with an equity market malaise or a collapse in the price of gold combined with either of the two could impact the strategy’s ability to outperform in the future.

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Permanent Portfolio Smack-Down

In February Global X launched a Permanent Portfolio ETF, symbol PERM.  The fund’s fact sheet states it “seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Solactive Permanent Index.”

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The Solactive Permanent Index “tracks the performance of four asset class categories that are designed to perform differently across different economic environments, as defined by the index provider. On each rebalance, the Underlying Index allocates 25% each to four asset class categories: Stocks, U.S. Treasury Bonds (Long-Term), U.S. Treasury Bonds (Short-Term), and Gold and Silver.”

This allocation closely correlates to Harry Browne’s proposed allocation in his 1998 Fail-Safe Investing: Lifelong Financial Security in 30 Minutes.  Browne proposed an equal-weight portfolio of stocks, long-term bonds, cash, and gold. Today an investor could create this portfolio using as little as four ETFs: SPY (SPDR S&P 500 ETF), TLT (iShares Barclays 20+ Year Treasury), SHY (iShares Barclays 1-3 Year Treasury Bond Fund), and GLD (SPDR Gold Trust).  I recently posted some historical results on this allocation here.

How closely has PERM correlated to the 4-ETF Browne Permanent Portfolio referenced above?  PERM has a very short trading history, so these results are very preliminary.  However, this type of comparison could be useful to periodically monitor for investors weighing an all-in-one Permanent Portolio solution (PERM) versus a self-managed, multi-ETF Permanent Portfolio.

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As expected, an equal weight portfolio of SPY/TLT/SHY/GLD (Portfolio A) has been highly correlated with PERM (Portfolio B) since February 8th, 2012. The results using ETF Replay are below.  It is important to note that PERM has not yet paid a dividend, while SPY, SHY, and TLT have all paid dividends since February 8th. These dividends are reflected in the returns for Portfolio A, which helps explain the small out-performance to date.  I will revisit the comparative results once PERM has paid a dividend, which will give us a more accurate total return comparison for both portfolios:

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Testing the Harry Browne Permanent Portfolio with Emerging Markets

In response to my Harry Browne Permanent ETF Portfolio article from last week, David Jackson of Seeking Alpha wondered if the portfolio had been tested with Emerging Markets ETFs as opposed to US equities. His theory is the Emerging Markets have added beta over US stocks and may perform better in the future due to higher expected GDP growth.

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I created a second Harry Browne Permanent ETF Portfolio in ETF Replay and then used their platform to test the results.  The portfolio consists of a 25% equal allocation to EEM (MSCI Emerging Markets Index Fund), TLT (iShares Barclays 20+ Year Treasury), SHY (iShares Barclays 1-3 Year Treasury Bond Fund), and GLD (SPDR Gold Trust).   This allocation is identical to the portfolio in my “original” Harry Browne portfolio with one exception: EEM has been substituted for SPY (SPDR S&P 500 ETF).

If an investor bought the Emerging Markets Permanent Portfolio on January 3rd, 2005 and held until February 17th, 2012, the total return was 128.4% (12.3% CAGR) and 12.7% volatility (all returns discussed exclude commissions, taxes, and slippage). The original Harry Browne Portfolio (SPY/SHY/TLT/GLD) would have returned 105.6% (10.7% CAGR) at 9.3% volatility:

The max drawdown on the Emerging Market Permanent portfolio was 26.15% versus 16.17% for the original version.  The increased volatility and drawdown of the Emerging Market version is not surprising since emerging market equities have traditionally had higher volatility than large cap US equities.

In my original article I also tested the 10 month moving average system popularized in recent years by Mebane Faber in The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. 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 a substitute for cash). When it closed the month above its 10 month moving average, the ETF was purchased at the stated allocation.

To properly test the moving average system I had to begin the test at the beginning of 2006 since GLD did not have adequate trading history to generate a 10 month moving average in 2005.  In order to properly compare strategies (moving average vs. buy and hold) we first need to show the results for buying and holding the portfolios over the same time period of 2006-present (portfolio A is the Emerging Markets version, Portfolio B is the original):

We see that the Emerging Markets version had a total return of 90.5% (11.1% CAGR). .63 sharpe ration, and 12% volatility. The original version had a total return of 81.1% (10.2% CAGR), .73 sharpe ratio, and 9.2% volatility.

For the first 10 month moving average test we will revisit the original Harry Browne ETF Portfolio (SPY/SHY/TLT/GLD). When we test the 10 month moving average system we see is that the moving average system decreased volatility and returns while increasing the sharpe ratio:

Below are the annual performance statistics which include no down years (2012 is down year to date):

When we apply the 10 month moving average system to the Emerging Markets version(EEM/SHY/TLT/GLD), we see the same impact, a decrease in returns and volatility and an increase in the portfolios sharpe ratio:

The annual statistics include no losing years (2012 is down year to date):

The table below summarizes the returns of each strategy for comparison purposes:

 

Time Period 2006-present
Portfolio Strategy Total Return CAGR Volatility Sharpe Max draw down
“Original” Permanent Portfolio (SPY/SHY/TLT/GLD) Buy & Hold 81.10% 10.20% 9.20% 0.73 -15.85%
“Emerging Mkt” Permanent Portfolio (EEM/SHY/TLT/GLD) Buy & Hold 90.50% 11.10% 12.00% 0.63 -23.12%
“Original” Permanent Portfolio 10 month SMA 69.30% 9.00% 7.10% 0.79 -7.10%
“Emerging Mkt” Permanent Portfolio 10 month SMA 83.30% 10.40% 9.10% 0.75 -11.80%
SPY Buy & Hold 23.90% 3.60% 24.40% 0.12 -55.20%
SPY 10 month SMA 60.30% 8.00% 13.20% 0.38 -18.70%

There are some important caveats in these tests. The time period covered is relatively short by historical standards so it is difficult to draw significant conclusions.  The period tested includes 2008, a particularly volatile period for equities and fixed income securities. Commissions, taxes, and slippage (the price you would actually get filled at when placing a real order versus the historical data used for the tests) will impact results.