Momentum-Optimization Portfolio Construction

Includes: BRK.B, VIG, VII, VTV, VWO
by: Lowell Herr

Constructing a portfolio through the use of a Momentum-Optimization Model (MOM) is infinitely easier than it was just a few years ago. For one, we have many commission free ETFs to use so that trading costs do not consume all returns. Computing power is the big difference, as readers will see in a few moments. If you Bing or Google search "ETF Momentum Investing" you will find many references to academic articles, discussions, and opinions as to the merits of momentum investing. Readers know we are testing a Momentum-Optimization Model with several portfolios and the very early evidence is that portfolio returns are increasing at a faster rate than the ITA Index Internal Rate of Return (IRR), our customized benchmark. However, it is still early in this test. The ITA Index is a unique benchmark established for each portfolio.

The following MOM information is not one of the eleven portfolios tracked here at ITA. Instead, it is a sample portfolio made up primarily of commission free ETFs from TDAmeritrade. There are two exceptions. BRK.B is an individual stock and SDS is an ultra-short ETF that is available for use in special circumstances. Rare is the time shares will be held in SDS.

Efficient Frontier: The shares invested in each ETF were such that the portfolio Return/Risk ratio lands nearly on top of the optimized portfolio (small red dot).

ETF Rankings: Take time to examine the ETFs used to come up with this portfolio. Most are familiar to long-term ITA readers, but it is still good to review ETFs that are used to construct a portfolio. I did not include any sector ETFs, something I do with most of the ITA portfolios. What I do is run a ranking of 10 or 11 sectors of the market and then extract three sector ETFs to be potential securities when putting together a portfolio.

Note that VTV has taken over the top spot with Berkshire Hathaway (NYSE:BRK.B) coming in second. Of particular importance is the high ranking of VTI. This total U.S. Equities ETF is performing so well that it makes it impossible for portfolios diversified across the globe to keep up. Since VTI and VTSMX are mirror index funds, our portfolios are lagging the broad U.S. market. This is not an excuse, but just a fact of this concentrated market.

Buy-Hold-Sell Recommendations: Due to my initial setup, few buy or sell decisions are necessary. VWO is an example where the optimizer is calling for an additional 4 shares, but the momentum indicator is negative. The fact that the price of VWO is below its 195-Day EMA may tilt me toward selling off some shares were this an operating portfolio.

The situation will not be as clear for some of the upcoming portfolio reviews, so pay attention to Buy, Hold, and Sell decisions. I will be examining the Euclid tomorrow and the Schrodinger on Friday.