This article describes the third in a series of tactical asset allocation (TAA) strategies for long-term investors. I believe TAA strategies using ETFs (Exchange Traded Funds) are the best way to grow retirement savings with minimum risk. These strategies can be used in 401K or IRA retirement plans that utilize platforms such as Schwab, Fidelity, Scottrade, etc. Please refer back to my first two articles on TAAs that describe a moderate AllAssetsExcept Bonds Strategy (for mid-age investors) and an aggressive CSD-Bond Strategy (for young investors).
In this article, I will present a conservative TAA strategy with lower drawdown and volatility at the expense of lower growth rates. More conservative investors will find this strategy appealing. I call this strategy the AssetBlend Strategy in which 60% of the funds use the AllAssetsExceptBonds Strategy discussed in my first article, and 40% of the funds are invested in a Bond-Only Strategy. Since I have previously discussed the methods and ETF universe of the AllAssetsExceptBonds Strategy (in my first article on TAAs), I will only discuss the bond portion of the AssetBlend Strategy. Then I will give backtested results of the AssetBlend Strategy that combines the AllAssetsExceptBonds Strategy and the Bonds-Only Strategy.
The ETF universe is composed of the following ETFs in the bond-only portion of AssetBlend Strategy: 1) Vanguard Long-term Government + Credit ETF (NYSEARCA:BLV), 2) Barcap Global Ex-U.S. Bond ETF (NYSEARCA:BWX), 3) ishares JPM Emerging Markets Bond (NYSEARCA:EMB), 4) ishares iBoxx High-Yield Corporate Bond ETF (NYSEARCA:HYG), 5) Advisor Shares Peritus High-Yield Bond ETF (NYSEARCA:HYLD), 6) Barclays Low Duration Treasury ETF (NYSEARCA:SHY) and 7) ishares Barclays Long-Term Treasury ETF (NYSEARCA:TLT). The Bond-Only Strategy ranks the relative strength of the ETFs in three different categories: 1) 4-month total growth (dividends included), 2) 20-day total growth (dividends included), and 3) 20-day volatility. To determine a final ranking of the ETFs, a weighting is applied to the rank of the ETFs in each individual category. The weightings are 35%, 35%, and 30% respectively. The best ETF is chosen at the start of each period. The cash filter is turned on, meaning the top ETF has to have greater relative strength than SHY, or SHY is selected. Semimonthly updating is used (two times per month).
The backtested results of the Bond-Only Strategy are shown below. The ETFreplay software was utilized. Backtesting only went back to the start of 2008 since most of the ETFs started in 2007. This backtesting timeframe is not ideal, but it is the best we have. Backtesting could be calculated back to 2003, but then only two ETFs would be available in the 2003-2006 timeframe. The benchmark ETF was TLT. TLT was chosen as a benchmark rather than an aggregate bond ETF like ishares Core Total U.S. Bond (NYSEARCA:AGG) because TLT has much higher overall growth than AGG (albeit with higher volatility).
The Bond-Only Strategy had a compounded annual growth rate, CAGR, of 16.6% and a maximum drawdown of 8.7%. This compares to a CAGR of 5.1% and maximum drawdown of 26.6% for TLT. The Bond-Only Strategy had positive growth every year with a minimum growth of 8.4% in 2013 and a maximum growth of 30.9% in 2008. $100,000 invested in the Bond-Only Strategy at the start of 2008 would have increased to $251,200 at the end of 2013. A similar amount invested in TLT (buy and hold) would have only increased to $134,500. The overall volatility of the TAA strategy was 11.1% compared to 16.7% for TLT.
(click to enlarge)When the Bond-Only Strategy is combined with the AllAssetsExceptBonds Strategy, giving the AssetBlend Strategy, a very good conservative TAA strategy results. The backtested results are shown below for a 60/40 split (60% in the AllAssetsExceptBonds Strategy and 40% in the Bond-Only Strategy). The backtesting covers the years from 2003-2013. Please realize that not all of the ETFs are available in the earlier years of backtesting, so the results in those years may be tainted somewhat. The benchmark in this case is Vanguard's 60-40 Balanced ETF (MUTF:VBINX), arguably the best strategic (static) asset allocation ETF available. Up to three ETFs are owned in each period of the strategy. Once again, semimonthly updating is employed.
The AssetBlend Strategy has a CAGR of 17.6% with a maximum drawdown of only 9.7%. This compares with VBINX that had a CAGR of 7.8% with a maximum drawdown of 36.0%. The overall volatility of the TAA strategy is 10.1% compared to 11.8% for VBINX. Every year produced positive growth for the AssetBlend Strategy, ranging from 9.9% in 2004 to 30.4% in 2009. The AssetBlend Strategy beat VBINX every single year.
Three ETFs were selected every period. Based on the backtesting, there was on average of 46 complete trades (buy & sell) each year. Thus, the cost of this strategy is approximately $828 per year on the Schwab platform. This amounts to an expense of 1.6% if $50,000 is invested. If perfect rebalancing is desired for each semimonthly investment period (to perfectly match the ETFreplay calculations), then 72 complete buy/sell trades are required per year, resulting in an expense of $1296 per year. This amounts to a 2.6% expense if $50,000 is invested. As the account value grows, the expense percent goes down accordingly. For example, if the account value grows to $100,000, then the expense is just 1.3%.
If enough people are interested, I will post the semimonthly selections of the conservative AssetBlend Strategy on my Seeking Alpha Instablog, along with postings of the moderate AllAssetsExceptBonds Strategy and the aggressive CSD-Bond Strategy. I will post the selections after the close of business on the last day in the period. If you use any of these strategies, you should sell/buy the ETFs near the end of the first business day of the new period. If possible, the ETF trading needs to be done in the 3:00 - 3:30PM timeframe on that day for best agreement with the strategy.
Please let me know if you are interested in such postings if you haven't already.
Additional disclosure: I am using this strategy on part of my retirement savings.