12 ETF Portfolio: Another Look

by: Lowell Herr

A Basic Portfolio

When it comes to design, simplicity is an admirable feature and the 12-ETF Portfolio embodies this characteristic. In addition, the projected numbers are quite respectable as readers can see from the following QPP analysis. When designing or constructing a portfolio specific goals are set, although it is more difficult to attain those goals when the market is priced as richly as it is today. Those benchmarks are as follows: 1) The projected return should exceed the percentage projected for the S&P 500 by one percentage point. 2) The projected standard deviation will come in under 15%. 3) From the first two projections the Return/Risk ratio will exceed 0.60. 4) The Diversification Metric (DM) will exceed 40%. 5) The Portfolio Autocorrelation (PA), the least important metric, will not exceed 20%. How does the 12-ETF Portfolio meet these goals?

With a 7.5% projected return, this goal falls short by 50 basis points. Portfolio risk is a low 12.3%. At least it is low in this environment. The Return/Risk ratio is slightly greater than 0.60 and the last two values, DM and PA, exceed their requirements.

Correlation Matrix: The equity, commodity, and real estate ETFs are highly correlated (yellow background). We pick up diversification with international bonds, gold, and treasury holdings. One needs to be careful as to the importance paid to TLT as it had a great run with respect to the equity holdings over the time frame analyzed. There is a low probability this will be repeated over the next two years. Using historical data to look into the future needs to be tempered with much caution. Remember, these are "Monte Carlo" types of projections.

"Delta Factor" Projections: While the prospects for investing at this time based on the following projections looks dim, it is important to examine the time frame for this analysis. Since a few of the ETFs have limited history, I was required to limit the analysis to 34 months. That is not far short of the 36 month default setting for the QPP program, but I still prefer to use 60 months so as to incorporate the entire recession of 2008.

Given the time constraints for this analysis, the "Delta Factor" projections do not look favorable going forward. VEA and VWO were good buys a few weeks ago, but the recent run makes even these asset classes suspect. The last time I've seen this much red was near a market high. A 10% to 15% correction would improve a number of these probability projections. Caution is in order.

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