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  • Balanced Strategy: Value Funds 19 comments
    Mar 9, 2014 5:23 PM | about stocks: IVE, IJJ, IJS, RPV, RFV, RZV, TLT, EDV

    This strategy of quarterly rebalancing the portfolio on the basis of risk parity and relative strength has satisfactory performance in general but here we focus on its application to the baskets containing large, mid and small-cap, mostly value, funds (specific funds used for the study are shown at the end of this post) from a few different families.

    First we summarize the various performance metrics for the strategy applied to the funds. Also shown, for the purpose of comparison, are the corresponding metrics for DFSVX and PRWCX. The latter are by no means the appropriate benchmarks, but are used here mainly because they are well known equity and allocation funds whose performance has been quite attractive during their lifetimes. (As a personal aside, none of these funds is available cost-free to me in my personal accounts, and hence this study.)

    Family/Fund

    CAGR (%)

    Sharpe Ratio (Sortino)

    Max. Drawdown (%)

    Min. Annual Return (%)

    2003-2013

        

    iShares ETFs

    13.8

    1.0 (1.8)

    16.9

    7.2

    Fidelity

    15.6

    1.2 (2.1)

    15.0

    4.6

    Vanguard

    14.0

    1.1 (1.9)

    15.2

    2.6

    T. Row Price

    14.1

    1.1 (2.0)

    15.2

    7.7

    J. P. Morgan

    14.1

    1.1 (2.0)

    15.6

    6.9

    DFSVX

    13.7

    0.6 (1.1)

    61.2

    -36.8

    PRWCX

    10.4

    0.8 (1.2)

    36.6

    -27.2

    2005-2013

        

    American Century

    12.2

    1.0 (1.7)

    14.6

    7.0

    DFSVX

    8.4

    0.4 (0.7)

    61.2

    -36.8

    PRWCX

    8.3

    0.6 (0.9)

    36.6

    -27.2

    2007-2013

        

    Guggenheim ETFs

    14.4

    0.9 (1.5)

    19.8

    1.8

    DFSVX

    6.8

    0.4 (0.6)

    61.2

    -36.8

    PRWCX

    7.7

    0.6 (0.8)

    36.6

    -27.2

    Clearly, inasmuch as the improved relative performance is pervasive across the various fund families considered here, the strategy seems to provide a robust alternative to the buy and hold portfolio of DFSVX or PRWCX. It should be noted, however, that the one and five year returns (for the period ending in 2013) of DFSVX are considerably superior as shown in the following table.

    Family/Fund

    1 Year CAGR (%)

    3 Year CAGR (%)

    5 Year CAGR (%)

    10 Year CAGR (%)

    iShares ETFs

    24.4

    21.0

    16.9

    13.0

    Guggenheim ETFs

    30.9

    22.9

    18.4

     

    Fidelity

    26.4

    22.1

    20.2

    14.0

    Vanguard

    27.6

    22.0

    18.5

    13.0

    Am. Century

    18.9

    17.2

    14.6

     

    T. Row Price

    23.8

    19.2

    17.0

    13.2

    J. P. Morgan

    24.1

    20.8

    17.5

    13.5

    DFSVX

    42.4

    17.0

    22.9

    10.0

    PRWCX

    22.4

    13.2

    17.1

    9.0

    The Method

    The general approach is quite straightforward.

    Select a basket of equity funds, and add to it some fixed income funds (here we have used TLT and EDV for the latter). Use one of the following strategies to rebalance every quarter.

    Aggressive Strategy:

    • On the first trading day of every quarter, select a subset of assets in the basket on the basis of the total returns during the immediately preceding quarter. The number of selected assets should not exceed the number of equity funds in the basket.
    • The weights of the assets in the selected basket are determined on the basis of risk parity allocation that uses the daily returns for the prior quarter.

    With the restriction on the number of selected assets, there would be quarters wherein one is invested only in equity funds, and hence this strategy is characterized as aggressive. However, depending on the market conditions, the hope is that the fixed income assets will be included in the selected basket during the downturns.

    Conservative Strategy:

    On the first trading day of every quarter, select a subset of assets in the basket on the basis of the total returns during the immediately preceding quarter. The number of selected assets must be more than the number of equity funds in the basket.

    The weights of the assets in the selected basket are determined on the basis of risk parity allocation that uses the daily returns for the prior quarter.

    With the restriction on the number of selected assets, a part of the portfolio would always be invested in one or more fixed income assets, and hence this strategy is characterized as conservative. Clearly this strategy is expected to underperform the market, perhaps substantially, during the boom times.

    Moderate Strategy

    Depending upon one's risk tolerance, a fraction of the portfolio is invested in the aggressive strategy, and the rest in the conservative strategy.

    The following equity funds (representing large, mid, and small cap value funds, but in some case not necessarily value funds) were used in this study:

    iShares ETFs: IVE, IJJ, IJS

    Guggenheim ETFs: RPV, RFV, RZV

    Fidelity: FLPSX, FDVLX, FSCRX

    Vanguard: VWNDX, VASVX, VSMAX

    American Century: TWEIX, ACMVX, ASVIX

    T. Rowe Price: TRVLX, PRSVX, TRMCX

    J.P. Morgan: HLQVX, JAMCX, PSOAX

    Further (a) three assets were selected for the aggressive strategy, (b) four were selected for the conservative strategy, and (c) 70% of the portfolio was invested in the aggressive strategy, and 30% in the conservative strategy.

    A typical asset allocation diagram for the Fidelity funds is shown below.

    (click to enlarge)

    The equity curves for the best and worst performing family and the two funds are shown below.

    (click to enlarge)

    Disclosure: I am long IJS.

    Additional disclosure: This is not meant to be investment advice but just a summary of some results that might be of interest.

    Themes: Adaptive Allocation Stocks: IVE, IJJ, IJS, RPV, RFV, RZV, TLT, EDV
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Comments (19)
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  • OwnPuts
    , contributor
    Comments (14) | Send Message
     
    How do the results compare if you rebalance monthly?
    Great article. Thanks for your work.
    14 Mar, 10:12 AM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » Thanks. I am trying to look at less frequent rebalancing for obvious reasons. The monthly ones work just as well, but were designed mainly to switch between two different type of assets - value or growth, emerging markets or domestic, etc. with fixed income and real estate added for the times when none of them is expected to do well.
    14 Mar, 03:15 PM Reply Like
  • OwnPuts
    , contributor
    Comments (14) | Send Message
     
    It is true that less frequent rebalancing will reduce your expenses, but it comes at the cost of potentially missing market moves that could lead to a larger drawdown. My guess is that the larger drawdown could greatly outweigh any savings when the market reverses quickly.

     

    16 Mar, 04:09 PM Reply Like
  • extremebanker
    , contributor
    Comments (1699) | Send Message
     
    Varan:

     

    I simply review a number of stock ETF accounts based on relative strength and moving average and select enough to provide a 60% allocation. Same thing for fixed income except a smaller allocation. Funds I hold at this time are: RSP,RPV,VBR,VHT, NPI,VCLT,JNK.
    16 Mar, 05:18 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » That will work too. So many ways to do it. I just want to explore more well defined almost mechanical methods. Perhaps due to the fact that I started in this business by being a member of a team that developed an HFT system in 1999, and we spent much of the year watching the automatic buys and sells on the screen and marveling at the results that magnified the mania of time.

     

    Thanks.
    16 Mar, 05:37 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » @ExtremeBroker

     

    By the way if I add TLT to your basket, use 3 selections for Agressive (70%) and 5 for Conservative (30%) I get the following results:

     

    2007 5.05%
    2008 -6.28%
    2009 32.43%
    2010 10.91%
    2011 19.81%
    2012 13.30%
    2013 25.25%
    2014 3.37%

     

    CAGR 13.81%
    16 Mar, 06:09 PM Reply Like
  • spielerman
    , contributor
    Comments (204) | Send Message
     
    Hi Varan, I have a Fidelity account and can invest in those mutual funds. Just exactly how do I implement this strategy? I see the following funds in your article, Fidelity: FLPSX, FDVLX, FSCRX, but not sure how to select which funds and the proportion to invest in each fund. Can you show me how I would do it, if I started today?

     

    Thanks,
    17 Mar, 11:50 AM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » In order to follow the performance of this method, I will be posting the allocations for the various portfolios discussed here at beginning of every quarter. There may be some software for doing the allocations on the basis of risk parity that I have used here.
    17 Mar, 12:38 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » 4/1/2014

     

    1. We will also follow the Vanguard ETF basket VTV, VOE, VBR with TLT and EDV.

     

    Q1/2014 performance (The percentages following the tickers are the weights allocated to the fund.)

     

    ishares: IVE 33.1% IJS 26.9% IJJ 10.9% TLT 10.9%
    Q1 2014 Return 4.1%

     

    Fidelity: FDVLX 27.9% FSCRXX 24.6% FLPSX 37.6% TLT 9.9%
    Q1 Return 3.46%

     

    Guggenheim: RPV 31.6% RFV 30.2% RZV 26.5% TLT 11.7%
    Q1 Return 3.88%

     

    Vanguard Mutual Funds VAASVX 32.4% VWNDX 30.2% VSMAX 26.4% TLT 11% Return 4.17%

     

    Vanguard ETFs VTV 32% VOE 29.7% VBR 27.7% TLT 10.6% Return 4.74%

     

    All these returns have been better than the returns of the major indexes.

     

    Q2 Weights starting the close of Market on 2014/4/1:

     

    ishares: IJS 6.8% IJJ 37.4% TLT 33.2% EDV 22.6%

     

    Fidelity: FDVLX 39.1% FLPSX 8.8% TLT 30.9% EDV 21.2%

     

    Guggenheim: RPV 41.1% RFV 5.9% TLT 31.7% EDV 21.3%

     

    Vanguard Mutual Funds VWNDX 39.6% VSMAX 5.6% TLT 32.4% EDV 22.4%

     

    Vanguard ETFs VOE 39.6% VBR 6.4% TLT 32.0% EDV 22.0%

     

    Without pretending that this method has a crystal ball, it is worth noting that over 50% allocated to TLT/EDV suggests that the portfolios are well positioned for a downturn in case the doomsayers are correct.
    1 Apr, 02:08 AM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » Final results for Q1 2014 (Positions closed at market close on 4/1/2014).

     

    iShares 4.6%
    Fidelity 4%
    Guggenheim 4.4%
    Vanguard Mutual Funds 4.9%
    Vanguard ETFs 5.2%

     

    IJJ has been the best during the period of holding (1/2/2014 - 4/1/2014) having returned 5.7%.
    2 Apr, 12:03 PM Reply Like
  • extremebanker
    , contributor
    Comments (1699) | Send Message
     
    Varan: I need some help understanding risk parity. I think I get the concept but I don't understand your execution. Instead of combining equities and bonds I have developed a growth portfolio and income portfolio. How much of each you want depends on your risk tolerance. I did this because I found it easier to benchmark each separately. What would be your benchmark with your portfolio?
    1 Apr, 09:13 AM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » For these portfolios, the benchmark would be the 60/40 SPY/TLT which has returned 4.1% YTD.

     

    Thanks.
    1 Apr, 09:59 AM Reply Like
  • sergio_303
    , contributor
    Comment (1) | Send Message
     
    Great article, I find your posts very inspiring towards finding good sistematic investment approachs :)

     

    You may already know this, but in case you don't, it has a lot of nice ideas I look forward to investigate further:

     

    http://bit.ly/1jEhtIG
    8 May, 09:42 AM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » Thanks.
    8 May, 09:46 AM Reply Like
  • umgf004
    , contributor
    Comment (1) | Send Message
     
    Hi varan,

     

    Thanks for your articles. What software do you use for backtesting and plotting?

     

    Greg
    10 May, 08:13 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » Thanks.

     

    I have my own library that I have written in a Matlab type scripting language, Mathnium, that I developed some ago.
    10 May, 10:37 PM Reply Like
  • Lowell Herr
    , contributor
    Comments (897) | Send Message
     
    Varan,

     

    I'm gearing up to experiment with the VTI/TLT ratio to see if it works with out-of-sample data.

     

    http://bit.ly/1uHQyOl

     

    The portfolio I'm using for this test is the Aristotle. Right now TLT is outperforming VTI so I am selling off U.S. Equity shares so I can pick up more TLT. I plan to update this portfolio every 33 days and I have a spreadsheet already built to see if this management style gains or loses ground with respect to two benchmarks. Should be interesting.

     

    Lowell
    19 Jun, 09:18 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » This is the current VTI/TLT post.

     

    http://seekingalpha.co...

     

    Thanks.
    19 Jun, 09:30 PM Reply Like
  • varan
    , contributor
    Comments (3543) | Send Message
     
    Author’s reply » Q2 Results

     

    iShares Q2 5.45% Q1-Q2 10.36%
    Guggenheim Q2 5.71% Q1-Q2 10.41%
    Vanguard ETFs Q2 5.28% Q1-Q2 10.8%
    Fidelity Q2 5.28% Q1-Q2 9.55%

     

    Equally weighted IVE, IJJ, IJS Q1-Q2 7.1%

     

    Q3 allocations

     

    iShares IJJ 41.8% TLT 28.9% EDV 19.4% IVE 9.9%
    Guggenheim RPV 44.1% EDV 19.5% TLT 28.7% RFV 7.7%
    Vanguard VOE 43% EDV 20% TLT 29.7% VBR 7.3%
    Fidelity FDVLX 42.8% EDV 18.9% TLT 28.2% FLPSX 10.1%
    8 Jul, 01:57 PM Reply Like
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