In a previous article, we introduced a trend following based tactical asset allocation portfolio that has the longest history using index mutual funds. The portfolio consists of the following 6 major asset classes, all of which are represented by index mutual funds (except for gold (GLD)):
- U.S. stocks: Vanguard 500 Index (VFINX), inception:3/27/1987 (ETF: SPY or VOO)
- European stocks: Vanguard European (VEURX), inception: 11/1/1990 (Corresponding ETF: VGK)
- Pacific stocks: Vanguard Pacific (VPACX), inception: 11/1/1990 (ETF: VPL)
- U.S. REITs: Vanguard REITs (VGSIX), inception: 6/28/1996 (ETF: VNQ)
- Gold: GLD, inception:1/4/1971. Before ETF GLD's inception on 11/18/2004, we use London spot gold price (monthly closing).
- U.S. Bonds: Vanguard Total Bond Index (VBMFX), inception: 6/4/1990 (ETF: AGG or BND)
- CASH: calculated using 3 month T-Bill interest.
When risk asset markets (i.e. stocks and commodities) are rising, 100% of the portfolio can be in risk assets. On the other hand, when risk markets are falling, up to 100% of the portfolio can be in fixed income such as bonds and cash. Therefore, the portfolio should be considered as a stock portfolio or one that can have 100% risk level. It should be compared with a stock index fund such as S&P 500 (SPY or Vanguard 500 Index fund VFINX).
The reason behind choosing European stock and pacific stock funds instead of broad base developed market stocks (such as EFA) or emerging market stock funds (such as EEM or VWO) is purely for the purpose of longer history: the broad base funds representing developed market stocks and emerging market stocks have a much shorter history. See the original article for more details.
As we just finished 2012, it is a good time to review how this tactical asset allocation portfolio has been doing in various secular market cycles since its inception date of 6/28/1991. The following charts show the year by year returns and 5 year rolling returns of the portfolio, compared with those of Vanguard 500 (VFINX or SPY):
S&P 500 fund represents a buy and hold (strategic asset allocation) approach in a portfolio, while the trend following portfolio represents a tactical allocation strategy.
- Both the Tactical (Trend Following) and the Strategic can have advantages in different secular cycles.
- In the raging bull market since 1995, the Strategic buy and hold out performed the Tactical.
- Notice that the Tactical, though under performed S&P 500, still managed to have very meaningful returns - 13.97% annual return from 12/31/1991 to 12/31/1999 (users can click on More Performance Analytics and then Calculate Performance for A Period on the portfolio page of P Relative Strength Trend Following Six Assets and input the start and end date to calculate the above figure).
- It is natural to see that the Tactical out performed in the rolling 5 year periods after a bear market began, such as from 2000 and from 2008.
- However, from 2003 to 2007, after the internet bubble induced bear market was over, the Tactical out performed S&P 500 every year. This is a bull market period.
- In the most recent 'bull' market since 2009, the Tactical has under performed every year.
- Tactical Allocation can still deliver respectful returns in a raging bull market such as the period of 1995 to 1999.
- Tactical Allocation can still beat the Strategic, even in a bull market such as the period of 2003 to 2007.
- Strategic Allocation can outshine the Tactical in a 'weak' or 'uncertain' bull market such as the ones from 2009 to present and from 1991 to 1995.
- Strategic Allocation can outshine the Tactical in a raging bull market.
From the above, one can see that both buy-and-hold (strategic asset allocation) and tactical asset allocation strategies have pros and cons. They complement with each other in various market cycles. Investors should adopt a core-satellite portfolio approach that uses both strategies to form a more stable overall portfolio.