Multi-Asset Investment Strategy Recommendation: Keep Overweighting Risky Assets

by: Henry Ma, CFA
Happy New Year, everyone. I would like to thank those readers who took time to make comments and suggestions since I published the model a month ago. In this article, I will discuss the performance of the strategy in December and update the model recommendations for January.
Model Performance in December 2010
In last month’s publication, I recommended over-weighting risky assets. It turned out to be a winning strategy. All the risky assets earned positive returns. On the other hand, bond yields continued rising after Fed announced QE2, resulting in a negative return for bonds. The Multi-Asset Timing Strategy (MATS) outperformed the 60/40 equity/bond benchmark by 2%. Table 1 shows the details of the strategy performance. Table 1: Performance of MATS vs. 60/40 Equity/Bond Benchmark
(December 2010)
Portfolio Allocation Performance
Dec-10 Dec-10
MATS Portfolio 5.8%
Benchmark 3.7%
Excess Return 2.0%
Domestic Equity
SPY 20% 6.7%
Foreign Equity
EFA 15% 8.3%
Emerging Market Equity
EEM 15% 7.2%
High Yield Bond
HYG 10% 2.8%
Emerging Market Bond
EMB 10% 0.4%
DJP 10% 11.0%
GLD 10% 2.4%
IYR 10% 4.6%
AGG 0% -0.7%
Cash T-Bill 0% 0.01%
Click to enlarge
Recommendations for January 2011
The ISM Manufacturing Index was reported at 57.0, in line with expectation on the first trading day of 2011. The spread between 10-year Treasury rate and 3-month T-Bill has widened to 3.25% and yield curve has steepened after the sell-off of Treasuries last month. The prices of the risky assets are above their 200-day moving averages and my proprietary indicators. They are still in upward trends. I believe the economy is in the second phase of expansion. The first phase of recovery was mainly driven by the government stimulus and easy monetary policy. The second phase will rely more on private investments and consumptions. The valuations of major stock market indexes are in the low to middle teens, which are not expensive from historical standards. As a result, I continue recommending over-weighting risky assets.
With regard to commodity allocation, I have split the 10% allocation in DJP into 5% in DJP and 5% in USCI. Based on a reader’s recommendation, USCI has some benefit of reducing the negative effects of commodity contango. According to its prospectus, USCI holds commodities with the least contango and the highest momentum. In that sense, USCI is not a passive commodity index, but a rule-based commodity strategy. The research by the two Yale professors, Gorton and Rouwenhorst,* has showed that backwardated and momentum commodities tend to outperform over time.
My recommendations for January 2011 are summarized as follows:
· Risky assets (100%)
o S&P 500 Index (NYSEARCA:SPY): 20%
o MSCI Emerging Market Index (NYSEARCA:EEM): 15%
o IBOXX High Yield Bond Index (NYSEARCA:HYG): 10%
o J.P Morgan Emerging Market Bond Index (NYSEARCA:EMB): 10%
o Dow Jones UBS Commodity Index (NYSEARCA:DJP): 5%
o United States Commodity Index (NYSEARCA:USCI): 5%
o Gold Index (NYSEARCA:GLD): 10%
o Dow Jones US REIT (NYSEARCA:IYR): 10%
· Bonds (0%)
o Barclays US Aggregate Bond Index (NYSEARCA:AGG): 0%
o US 3-month Treasury Bill: 0%.
* Reference: Gary B. Gorton and K. Geert Rouwenhorst, Facts and Fantasies about Commodity Futures, Financial Analysts Journal, 2006 (Mar/Apr).
Disclosure: I am long EFA, EEM, SPY, IYR.