ETF Replay Portfolio For July

by: Scott's Investments

I previously detailed here how an investor can use to screen for best performing ETFs based on momentum and volatility. I select only the top ETFs out of a static basket of 25 ETFs and re-balance the portfolio monthly.

The buy/sell strategy for the portfolio is simple: purchase the top ETFs based on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking) and the average of the 3 month return, 20 day return, and 20 day volatility. I refer to these two different sets as "6/3/3″ and "3/20/20″. The top 2 ETFs in the 6/3/3 ranking and top 2 in the 3/20/20 ranking are purchased each month. When there are duplicates in the top 2, I look to the third ranked ETF in the 3/20/20 and, if necessary, the third ranked ETF in the 6/3/3. The strategy always holds 4 ETFs.

I track this strategy as a public portfolio on Scott's Investments. As of the close on June 29th, the hypothetical portfolio was up 10.32% since inception on January 1st 2011. Returns include dividends but exclude commissions and taxes and all trades are hypothetical so real results will differ. For some backtests on these strategies please see a recent post here.

For June 29th, the strategy sold its positions in iShares Barclays 7-10 Yr Treasury (NYSEARCA:IEF) and iShares Barclays TIPS (NYSEARCA:TIP). The proceeds were used to purchase PCY (PowerShares Emerging Mkts Bond) and Vanguard MSCI U.S. REIT (NYSEARCA:VNQ). The portfolio also continues to hold iShares iBoxx Invest Grade Bond (NYSEARCA:LQD) and U.S. Utilities Sector SPDR (NYSEARCA:XLU).

Minor fluctuations in rankings may not always justify selling positions each month. For example, if one ETF drops from the second highest rated to the third or fourth highest rated, it may not warrant selling the position. An investor could only sell a position when it drops out of the top 4 or 5 at the end of the month. This type of modification could be used when someone is looking to limit turnover; however, I think it is important to have whatever rule you prefer to use in place prior to making the investment decision in order to avoid discretionary or emotional decision making.

Below are the top 6 ranked ETFs for this month, using both the 6/3/3 and 3/20/20 strategy:

PCY PowerShares Emerging Mkts Bond (7-9yr)
LQD iShares iBoxx Invest Grade Bond (7-8yr)
PFF iShares S&P US Preferred Stock Index
TIP iShares Barclays TIPS (4-8yr)
TLT iShares Barclays Long-Term Trsry (15-17yr)
PCY PowerShares Emerging Mkts Bond (7-9yr)
XLU U.S. Utilities Sector SPDR
PFF iShares S&P US Preferred Stock Index
HYG iShares iBoxx High-Yield Corp Bond (4-5yr)
DBA PowerShares DB Agricultural Commodities
Click to enlarge

Below is a performance graph of the portfolio (green) versus SPY (SPDR S&P 500 ETF) in purple from the portfolio's inception until June 29th, 2012. Total returns are similar, but a significant drawdown was avoided in 2011:

Disclosure: No positions