Is Following the Fed Smart?

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 |  Includes: AGG, BND, IEF, IEI, LQD, TIP, VB, VBK, VTI
by: MyPlanIQ

Douglas S. Roberts is Founder and Chief Investment Strategist for the Channel Capital Research Institute. Doug developed the Follow the Fed Strategy which is simply based on the fed monetary policy—Following the Fed. It follows the Fed's stance and allocates its assets in three equal parts:

  • Large/small stocks
  • Gold/Treasury bonds
  • Intermediate government notes

Research shows that large caps behave better when money is tight while small caps outperform large caps when money is easy. A similar relationship is also found in gold and Treasury bonds. Gold does better than Treasury bonds when the Fed’s easy, and vice versa. Switching between large and small stocks, gold and Treasury bonds is driven by the Fed’s monetary policy.

To lower the risk still further, simple intermediate government notes are added to the portfolio. Thus this strategy allocates assets equally among large/small stocks, gold/Treasury bonds and intermediate government notes.

If money is tight, the portfolio is composed of:

  • 1/3 in large stocks
  • 1/3 in Treasury bonds
  • 1/3 in intermediate government notes

If money is easy, the portfolio is made up of:

  • 1/3 in small stocks
  • 1/3 in gold
  • 1/3 in intermediate government notes

The strategy adjusts portfolios every month according to the money status.

The fund selection for testing the strategy is listed below with the ETF alternatives:

Large cap VFINX ETF: SPY, VTI
Small cap NAESX ETF: VBR, VBK, VB
Gold GLD ETF
Long term treasury VUSTX ETF: IEF, LQD, TIP, AGG
Intermediate term treasury VFITX ETF: IEI, BND

Things to note about the portfolio:

  • With 66% and 33% in fixed income, this would be considered moderate risk
  • It is difficult to map the asset classes as there are really three that are tactically managed. We will compare this with a four and five asset SIB

We will make a comparison of the performance of this portfolio with Simpler Is Better (SIB) portfolios we discussed in a previous article.

The first set of results compares strategic asset allocation performance. What we note is:

  • Following the Fed is a simple and effective strategy but suffers from events that the Fed doesn’t predict or to which it fails to respond appropriately
  • The 2008/2009 downturn shows the benefits of a tactical asset allocation
  • The extra asset class in the 5 asset SIB enables it to outperform everything else

click to enlarge

Comparison of Follow the Fed and SIBs tactically managedClick to enlarge

Details of Follow the Fed and SIBs
Annualized Returns 1 Year 3 Year 5 Year Inception
Roberts-Follow-the-Fed 14.64 8.37 10.25 10.36
Four Asset SIB 15.67 6.65 9.04 8.73
Five Asset SIB 12.62 8.13 11.35 11.46
Click to enlarge

Takeaways:

  • Following the Fed is a simple tactical asset allocation strategy
  • Following the Fed is easy to understand and delivers solid results even in choppy market conditions – it recovered well after the major downturn in 08/09
  • Conventional tactical asset allocation with the right number of asset classes (at least five) still provides the best performance
  • ETFs give you a good degree of choice, a good vehicle for any portfolio and with increasing track record, it’s possible to demonstrate good historical performance

Disclosure: No positions