Six months ago I was discussing the logic behind a risk reduction model over on ITA Wealth Management with this particular blog entry. The portfolio under discussion is made up of the seven ETFs listed below plus PCY. PCY is not included in the following analysis as it does not have the required minimum data. All ETFs, with exception of DBC, pay dividends and the yield for this group of ETFs ranges from 2.75% to 3.0% per year. Obviously this is tied to the percentage held in each ETF. While the yield is respectable, the portfolio is built with a dividend-growth balance rather than a strict concentration on dividend oriented ETFs.
The model under discussion is a modification of the Faber-Richardson model that is explained in detail in their Ivy Portfolio book.
The portfolio has a global exposure with the inclusion of VEU, VWO, and RWX. All the ETFs, including PCY, are commission free for TD Ameritrade clients. The inclusion of IWN provides a bias toward the value side of the investing spectrum. Bonds are an integral part of the risk reduction portfolios, but I did not include them in the following analysis as they require a separate benchmark to come up with their "Delta Factor" projections. The benchmark for the equity ETFs is Vanguard's Total Market Index Fund, VTSMX.
The first screen shot shows what the future projections (Delta Factor) looked like back on October 1, 2011. The analysis uses four years of data so we are examining information from 10/1/2007 through 10/1/2011. Even though the market was not in the jaws of the 2008 bear, we see that a positive projection was evident in early October of 2011.
ETFs with the greatest probability of doing well over the next six to twelve months were VEU, VWO, and RWX. While each of these ETFs had a nice six-months run, so did VTI and the other ETFs showing Hold in the analysis. The "Delta Factor" provided additional support for the risk reduction model as outlined in this blog post.
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What is the "Delta Factor" projecting today? The "Buy" signals are gone even though the future projections are nearly identical. When the market closes on 4/5/2012, we expect the price of each ETF will be above its respective 195-Day EMA, so the risk reduction model matches up well with the "Delta Factor" projections.
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While dividends are an essential ingredient of the portfolio, preserving the corpus of the assets is equally important. When calculating the dividend yield for a portfolio I use this source and I enter the smaller of the current yield or five-year average. This provides a conservative value for portfolio yield. Portfolios are set up with an array of ETF assets so the yield will provide a payout of between 2% and 3% annually.
Disclaimer: The mathematical calculation behind the "Delta Factor" relies on future projections - an extrapolation of data. Caution is always in order when data is extrapolated so an additional level of awareness is required when another calculation is overlade on a future projection. With this caution in mind, I've found that the greater the peak or the deeper the market valley, the greater the accuracy in probability projections of the "Delta Factor."