Theoretically, two assets are all that's needed to demonstrate the concepts behind portfolio construction. In reality, three assets seems like too few to pass a laugh-test. To me, a dozen seems like too many. Five funds seems about right.
For a few months now, we've been posting the results of the Konno and Yamazaki Mean-Absolute Deviation Portfolio with positive feedback. This handy mathematical tool has been used to quickly scan hundred of stocks and determine portfolio allocations. I'm sure this, or something like it, is plugging away on those pesky hedge-fund co-located servers. The results can be written on the back of business card, sent to someone's hand-held device, or broadcast on twitter. Here, we take a small universe of Exchange Traded Funds, compute a basic set of statistics, and determine which funds and allocations provide a target return of 10% AND minimize the mean absolute deviation. We assume the investor is at or near retirement.
Given a universe of the following assets:
- Fixed-Income/Bond Assets: TIP, SHY, IEF, TLT, AGG
- Commodities: IAU, SLV, GSG, BDC, USO
- Global Equities/Emerging Markets: FXI, EFA, EEM, IEV, IOO
- US Equities: OEF, IVV, ISI, IYY, JKD, JKG, JKJ
- Leveraged Assets (i.e. Double Longs): DDM, SSO, QLD, MVV
- Inversely Correlated Assets (i.e. Shorts): DOG, SH, PSQ, MYY
- Inversely Correlated and Leveraged Assets (i.e. Double Shorts): DXD, SDS, QID, MZZ
- US Equity Sectors: XLF, IYM, XLE, VNQ, XLI, XLY, SMH
The resulting 10% MAD portfolio allocation for the previous 252 trading days was:
|Exchange Traded Fund Name Symbol||Return||Std Dev||Weight|
|iShares Barclays 1-3 Year Treasury Bond Fund SHY||1.72%||1.21%||60.00%|
|iShares Silver Trust SLV||126.27%||30.06%||9.09%|
|iShares S&P 500 Index Fund IVV||11.86%||17.63%||8.32%|
|iShares Morningstar Mid Core Index Fund JKG||22.49%||21.20%||12.60%|
|ProShares UltraShort S&P500 SDS||-21.43%||35.61%||10.00%|
and yielded a 10% return, with a standard deviation of 3%. Compare that to the performance and standard deviation for the S&P500, which was 10% and 18%, respectively, and those allocations don't sound all that crazy.
Had we allocated our capital into the assets listed above 252 days ago, our performance would have looked something like this (click to enlarge images):
Here are the take home messages for today:
The bond asset remains iShares Barclays 1-3 Year Treasury Bond ETF (SHY). The estimated annualized performance has increased slightly from 1.57% last week to 1.72% this week and the estimated volatility, annualized, has increased from 1.20% last week to 1.21% this week. The weight for this single bond asset has remained at the maximum allowed allocation of 60% for a few weeks and doesn't seem out of control for retired or near retired folks. The other bond assets we're tracking (TIP, IEF, TLT, AGG) have also been relatively stable as well, with the longer term bonds providing higher returns but also come with higher volatility.
The commodities asset remains iShares Silver Trust ETF (SLV). The allocation has increased a little from last week's 8.68% last week to 9.09% this week and the estimated annualized return is continuing to show triple digit returns. The other commodity ETFs we're tracking (IAU, GSG, DBC, and USO) have all been showing strong performance, with a slight decline this past week, but none have entered into the 10% portfolio for several periods and they don't appear to do so anytime in the near future.
The US equity assets continue to be iShares S&P 500 (IVV) and iShares Morningstar Mid Core Index ETF (JKG). The estimated annualized returns for most of the US equities has taken a hit for the past week with JKG and IVV being no exception. These two are still maintaining their allocations as being the best combinations, but a serious dip in the returns over the past week sends me a red flag.
The short/leveraged hedge position remains ProShares UltraShort S&P500 (SDS) and has stayed at the maximum allocation of 10% for a couple of weeks. The estimated annualized return has increased slightly from last week's -27% to -21% this week with the standard deviation remaining about the same at 36%. As the performance of the short/short leveraged assets have been showing signs of life (i.e. positive returns over the short term), this might be a good time to consider including these negatively correlated assets in your portfolio in order to have some protection against downward movements and create a smoother ride.
Disclosure: I am long SLV.