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The events of recent days reveal the connected nature of the world in which we live. Twenty years ago, Japan was part of the mysterious far east and now we share their disaster minute by minute and are moved by their courage amid tragedy.

We also observe how startling events of nature, along with man-made events in North Africa and the Middle East have put a significant damper on the financial markets and a dagger of fear can pierce our hopes for a sustained rally and the recovery of our hopes for a secure retirement. Just as the Japanese preparedness has been tested to breaking point, incidents and unexpected changes in direction test the preparedness of our financial planning and investing strategy. It is one thing to have a backup in case it rains but who really would have thought that a triple disaster would strike.

In that light, we are looking to build an investment portfolio that will provide downside protection and upside growth to deal with the slings and arrows of outrageous fortune. We have seen that diversifying from three to six asset classes doubled your investments in a decade based on historical simulations of a simple six asset class benchmark. Subsequent to that, we have been adding more funds to each of the asset classes to determine if, and by how much, adding additional funds will provide additional returns.

We have already reviewed what adding more funds to fixed income, US Equities and REIT has made. In this article we add commodities and then review all the work we have done to date and draw some conclusions before we add the last two classes.

In the original benchmark, we had (NYSE: DBC) as the commodity ETF. The main reason for this is that it is one of the oldest commodity ETF's that will provide the best history. If we review the alternatives with an eye to the future as well as the past, we should look at how they have performed recently.

Description Symbol 1 Yr 3 Yr 5 Yr Avg. Volume(K) 1 Yr Sharpe
GreenHaven Continuous Commodity GCC 36.84% -0.63% NA 193 247.99%
ELEMENTS Rogers Intl Commodity RJI 28.08% -8.14% NA 596 137.27%
iPath DJ-UBS Commodity Index Tracker DJP 23.05% -9.31% NA 461 135.02%
PowerShares DB Commodity Index DBC 24.64% -8.02% 6.6% 2,249 127.44%
iShares S&P GSCI Commodity-Index GSG 16.76% -15.92% NA 639 77.14%

We note that DBC is the only choice with five years of history. We also note that GreenHaven has the best 1 and 3 year returns and so would be a natural pick. I am have decided to stay with DBC so that we have the historical perspective when we run simulation.

When we look at this, we would expect that the addition of GCC will be of benefit to the strategic asset allocation as it provides a better choice in the three and one year timeframe. The benefit to the tactical asset allocation will be more in the one year timeframe as the strategy would likely have preferred fixed income or cash in the three year timeframe.

SAA (Moderate) Performance Comparison of Plans
Plan Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETF Benchmark(Moderate) 10% 113% 4% 17% 6% 32%
Six Core Asset ETF Benchmark With PTTRX(Moderate) 11% 111% 5% 23% 7% 37%
Six Core Asset ETF Benchmark With PTTRX-3USETFs(Moderate) 10% 109% 6% 26% 7% 38%
Six Core Asset ETF Benchmark With PTTRX-3USETfs-2REIT(Moderate) 10% 113% 5% 23% 7% 35%
Six Core Asset ETF Benchmark With PTTRX-3US-2REIT-2COMM(Moderate) 11% 86% 5% 21% 7% 30%

We can see that the results are not monotonic. You can see that there is a "drift" towards higher historical returns with more funds but you can't bank on it. Remember that the strategy rotates funds in based on their price performance and this is not always correct. It often is, but not always. The more funds you have, the more decisions the strategy is making. When you have a large number of funds, the strategy will be right more often than not, but when you only have a few, the times when it isn't right are more noticeable.

The key point is that having the ability to rotate funds can help when circumstances favor a particular sub-class, you just can't guarantee that you will make the right choice all the time. However, you will have more choices when you want to be defensive and find a safer harbor for your funds.

TAA (Moderate) Performance Comparison of Plans

Plan Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETF Benchmark(Moderate) 8% 86% 9% 65% 12% 88%
Six Core Asset ETF Benchmark With PTTRX(Moderate) 8% 90% 10% 78% 13% 97%
Six Core Asset ETF Benchmark With PTTRX-3USETFs(Moderate) 7% 84% 10% 75% 13% 96%
Six Core Asset ETF Benchmark With PTTRX-3USETfs-2REIT(Moderate) 7% 80% 10% 74% 13% 96%
Six Core Asset ETF Benchmark With PTTRX-3US-2REIT-2COMM(Moderate) 8% 58% 9% 69% 12% 86%

The behavior here is slightly different. We have previously noted that 2010 was a poor year for tactical asset allocation strategies as no strong trend was established and with more funds, there was more opportunity to swap in and out of funds looking for a trend that never materialized. It is easy to see that with hindsight but, at the time, nobody knew. At this point, it appears that Commodities are on a strong run and that maybe set for some time. On the other hand, there has been a crossing between REIT and US equities for the second asset class to be selected.

Given that we have looked at the commodities ETFs and we know that GCC has had better 1 year performance and we know that Commodities are currently being deployed, we also know that the final portfolio is unique in having access to that ETF and so there will be an incremental boost to the short term returns.

Takeaways

  • There is no magic or free lunch in retirement investing
  • You want to be as diversified in as many asset classes as you can
  • You want to have alternative funds in each asset class in case one of them is performing poorly
  • Additional funds in the asset class does not always result in higher returns
  • Whichever way you look at it, there are upsides and downsides
  • With SAA, you get the maximum benefit in good times but you can see significant downsides in bear markets
  • With TAA you are protected from big downside risk but you will likely miss the start of the upturn and/or and surprises with asset classes performing unexpectedly well
  • Over the longer term, when there are benefits for more funds in each asset class
  • If you want to limit downside, TAA has clear benefits
Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.
Source: Japan and Libya: Lessons About Commodity Placement Within Tactical Asset Allocation Strategies