As an experiment I set out to test the SHY cutoff model with a group of Dividend Aristocrat stocks. The SHY model is explained in detail in this Seeking Alpha article. In the software I used for this experiment I had spots for nine stocks plus SHY. To fill those nine openings I pulled down a list of Dividend Aristocrat securities and selected the first nine that showed yields of 2% or higher. Those nine stocks are the following and there was no additional identifying metric other than yield.
- PG - The Procter & Gamble Company
- GPC - Genuine Parts Company
- MMM - 3M Company
- JNJ - Johnson & Johnson
- CB - The Chubb Corporation
- SWK - Stanley Black and Decker, Inc.
- FRT - Federal Realty Investment Trust
- TGT - Target Corporation
- GWW - W.W. Grainger, Inc. (On another list I see where GWW now has a yield below 2%)
Disclaimer: While I am familiar with the names of the above companies, I've only owned PG and JNJ in the past and hold none of these at present.
Analysis: A starting date of 7/31/2003 was selected as historical data for SHY is required and SHY came into being on July 30, 2002. One year of historical data is required for the analysis so that pushed the starting date up to the summer of 2003. The Dividend Aristocrat Portfolio was reviewed every 90 days. This review period rotates the rebalancing process throughout the month so end of month mutual fund adjustments rarely impact this portfolio.
The rules for portfolio construction (SHY cutoff model) are quite simple.
- Stocks ranked higher than SHY in the momentum rankings (example table shown below) are included in the portfolio according to the Strategic Asset Allocation (SAA) plan. In this example, 12% was assigned to PG and 11% to each of the other eight (8) stocks.
- Allocations assigned to stocks ranking lower than SHY in the moment rankings are invested in SHY.
Here is an example of a screen-shot showing the stock ranking system.
Performance Graph: In the following graph the light green line shows the performance of the nine Dividend Aristocrats (DA) if one bought according to the SAA percentages and did nothing after 7/31/2003. $100,000 turned into $368,715. Buy and Hold worked very well with this set of securities over this eleven year period.
The dark blue line is the performance of the Dividend Aristocrats with the SHY cutoff overlay. In this case, $100,000 grew to $277,328 or significantly lower than the Buy and Hold model.
The bottom curve over most of the graph is the performance of our benchmark, the VTSMX index fund. VTSMX increased from $100,000 to $266,031 or the worst performer of the three, but still a respectable return.
Additional Data: The Buy & Hold strategy had a volatility of 13.9% and a Sharpe Ratio of 0.19 while the SHY overlay model had a modest 7.2% volatility rating and a higher 0.26 Sharpe Ratio. Worst of the three was the VTSMX benchmark as its volatility was 15.6% and a Sharpe Ratio of 0.12.
While the SHY overlay took much of the shock out of the Great Recession, it was not able to keep up with the Dividend Aristocrats even though it was leading through the early part of 2010. Any time a stock underperformed SHY it was sold out of the portfolio and the cash was used to purchase shares of SHY. It was those periods when a stock was out of the market that the Buy and Hold portfolio surged ahead. Normally I review portfolios every 33 days and this may have made a difference, but likely not sufficient to make up the $90,000 difference between the Buy & Hold model vs. the SHY overlay model.
Disclosure: The author is long SHY.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.