A 12 ETF Portfolio For 2012

by: Lowell Herr

Investors looking for a low volatile portfolio with a global outreach will find the following collection of investments of interest. Four years of historical data were used in this analysis and the S&P 500 is assumed to grow at a rate of 7% over the next year. Seven percent may be high, considering the condition of some global markets and how they may impact U.S. equities.

When constructing a portfolio, several goals are established. 1) The projected return is to be one percentage point above that assumed for the S&P 500. At 7.9%, the following portfolio falls a little short of the goal. 2) The projected standard deviation should be less than 15%. The portfolio, with 40% allocated to treasuries, comes in well below the 15% goal. 3) The Return/Risk ratio goal is to exceed 0.60. In this portfolio the ratio is 0.67. 4) The desired mark for the Diversification Metric is to top 40%. At 48% we have a cushion.

Had one eliminated the 5% allocated to VTI and shifted that percentage to TLT, one can bring down the standard deviation of a low 10.5% and lift the Return/Ratio to 0.73. That move relies to heavily on the accuracy of the projections associated with the TLT treasury. The current 40% allocated to treasuries is about as far as I wanted to venture.

I did include one dividend-oriented stock, Annaly Capital (NYSE:NLY). Competing Seeking Alpha articles on NLY can be found here and here. Investors can replace NLY with their own favorite dividend aristocrat.

To modify portfolio volatility even further, apply the ITA Risk Reduction model, a slight adaptation of the Faber-Richardson model explained in their book Ivy Portfolio. The Risk Reduction model is undergoing a test on my ITA Wealth Management blog.

Click to enlarge.

The following screen shot shows what I call the Delta Factor projections. Overall, the market is fairly valued if this group of ETFs and one stock are any indicator. It will come as no surprise that beaten down ETFs such as VEU, VWO, and RWX show up as a potential Buy. The Delta Factor is built on the assumption that decimated ETFs will eventually return to the mean.

The Delta Factor can be used as an advanced probability indicator for individual ETFs. It tends to be an early indicator, and the best buying opportunities show up when both the Delta and Delta Factor columns display "green" signals. None of the tickers in this portfolio are showing such positive signals.

The following correlation matrix shows which ETFs are instrumental in pulling down portfolio volatility and lifting the Diversification Metric percentage. Note how highly correlated both the developed international markets (NYSEARCA:VEU) and emerging markets (NYSEARCA:VWO) are with the domestic markets (NYSEARCA:VTI).

While this is a sample or model portfolio, it is under serious consideration for implementation in 2012.

Disclosure: I am long VTI, VEU, VWO, RWX, VNQ, IGE, NLY, IEF, TLT, DBC, SLV.