Seeking Alpha

varan's  Instablog

Send Message
Individual investor.
  • Naive Graham: Passive Investing According To The Master 20 comments
    Jun 15, 2014 10:29 AM

    In a 1963 lecture on the subject of Securities in an Insecure World, Benjamin Graham, the father of value investing and the guru of Warren Buffett, asserted that diversification between stocks and bonds was the true source of excess returns compared to the market. Specifically, he advised that the relative allocation to stocks and bonds should be between 25% and 75% one way or the other depending on the current state of the markets with respect to the value of the stocks. ( . See also, page 89 of the 2006 Edition of Graham's book, The Intelligent Investor)

    The Naïve Graham strategy, which is the simplest one that can be derived from Graham's idea - one that the he probably would not approve, though it difficult to say so definitively as the investment vehicles such as ETFs did not exist at that time - leads to results that are noteworthy. Prior to describing the details of the strategy, we summarize the results for a number of cases. For the purposes of comparison with much simpler buy and hold alternatives, also shown are the results for a small cap value fund, DFSVX, and a balanced fund PRWCX, both of which have historically yielded superior performance compared to their respective peers.


    CAGR (%)

    Sharpe Ratio (Sortino)

    Max. Drawdown (%)

    Min. Annual Return (%)

    2003-2013 Two Fund Baskets

    VTI TLT (Market)


    1.1 (2.0)



    IJJ TLT (Mid Cap Value)


    1.0 (1.9)



    IJS TLT (Small Cap Value)


    1.0 (1.9)





    0.6 (1.1)





    0.8 (1.2)



    2007-2013 Six Fund Baskets (component assets shown at the end of the post)

    Guggenheim Value


    0.9 (1.4)



    Guggenheim Growth


    1.3 (2.4)



    Vanguard Value


    1.1 (1.95)



    Vanguard Growth


    1.2 (2.0)













    Inasmuch as the risk-based performance metrics are substantially better than those of the alternatives considered here, the strategy has much to recommend itself.

    The strategy entails rebalancing a basket of stock and bond ETFs at the beginning of every quarter on the basis of their relative returns during the immediately preceding quarter. The weights of the various ETFS are determined such that the total weights of each of the two classes of ETFs (stocks and bonds) are between 25% and 75% as advised by Graham.

    The Method for Two Fund Baskets

    This method applies to a basket of two funds, one a stock fund, and the other a bond fund.

    1. On the first trading day of every quarter, rank the two funds on the basis of their total return during the prior quarter.
    2. Allocate 75% of the portfolio to the top ranked ETF and 25% to the other.

    The Method for Six Fund Baskets

    This method applies to a basket of six funds, half of them being stock funds, and the rest bond funds.

    1. On the first trading day of every quarter, rank the six funds on the basis of their total return during the prior quarter.
    2. Allocate the following percentages of the portfolio to the various funds according to their ranks:


    Weight (%)













    The precise values of the weights are not very important: the only requirement is that the total for the top three ranked funds be 75% and it be 25% for the bottom three funds (even the totals of 75% and 25% weights may be replaced by slightly different weights for stocks and bonds). If the rank-based weights are in decreasing order, the allocation is determined purely by relative strength: the funds with higher returns in a quarter are assumed to likely perform better than the other lower ranked funds in the next quarter.

    The following equity ETFs were used in the various baskets:

    1. Guggenheim Value: RPV RFV RZV
    2. Guggenheim Growth: RPG RFG RZG
    3. Vanguard Value: VTV VOE VBR
    4. Vanguard Growth: VUG VOT VBK

    The ETF TLT and the mutual funds FLBIX and VUSTX, all based on long term treasuries, were used for the bond portion of the six fund baskets. In actual implementation, once the weights at the beginning of a quarter are determined, FLBIX and VUSTX may be replaced by TLT. (Alternatively one may just use three copies of TLT in the computations, but for the sake of simplicity we have used three distinct funds here.)

    The main advantage of this strategy is that the allocation is determined without any complex computations, in sharp contrast to the other methods such as risk parity or the maximum diversified portfolio algorithm, and yet the returns are quite satisfactory. For the baskets considered here, the volatility of the returns and the maximum drawdown are also much lower than those of the stock funds alone. Just as the asset allocation methods that minimize volatility end up yielding portfolios which have superior returns over periods that span multiple market cycles, it appears that the portfolios whose allocation is based on returns alone may have low volatility.

    As an example, the equity growth curve and the allocation diagram for the Guggenheim Growth basket are shown in the following figures.

    Disclosure: The author is long IJS.

    Additional disclosure: This is not investment advice.

Back To varan's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (20)
Track new comments
  • Algyros
    , contributor
    Comments (81) | Send Message
    Thank you for posting this strategy. It's a wonderful eddy of sanity in a somewhat turbulent river.


    Do you have any reason to believe that the returns, as well as the drawdowns, wouldn't increase if one were to implement a Naive Graham strategy with leveraged ETFs?
    16 Jun, 06:07 PM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » They definitely will increase. A first cut for (simulated) SSO and UBT suggests that the CAGR for the period 1991-2014 is around 20%, but the maximum drawdown is high as well in the low 30% range.


    16 Jun, 11:00 PM Reply Like
  • bobswee
    , contributor
    Comments (11) | Send Message
    Any idea why Guggenheim Growth outperformed Vanguard by so much? I can trade Vanguard for free, but the difference in returns, if sustainable, more than offsets the fees to trade Guggenheim instead. Also, have you tried this simple strategy with a larger basket of stocks that included other asset classes besides U.S. stocks? Thanks.
    16 Jun, 07:55 PM Reply Like
  • bobswee
    , contributor
    Comments (11) | Send Message
    It's interesting to note that the three month test would have the Guggenheim growth portfolio totally out of stocks right now.
    16 Jun, 09:28 PM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » @bobswee
    1. I have not tried other asset classes.


    2. Actually one interesting feature of this approach is that you are always invested in every asset. For the period starting on 4/1/2014, for the Guggenheim Growth basket, it went 75% into treasuries, 12% in RPG, 8% in RFG and 5 % in RZG. It was a (happy) fluke that the returns of all of these equity ETFs have been lower than the returns of the treasury funds during this period, though perhaps I am entitled to take credit for this precise call (see 4/01/2014 update for another similar strategy ) :)


    3. There is no way to tell if the performance difference between the Vanguard and Guggenheim will persist in the future.


    Thanks for your interest.
    16 Jun, 10:56 PM Reply Like
  • 91656
    , contributor
    Comments (2) | Send Message
    Hi Varan,


    In reference to your other strategy, could I use the 5 VG ETF's with an additional bond ETF or just go with the original 5?


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


    Would adding a short term bond such as VGSH be of use for those times nothing is going up, it would be your 35% allocation?


    Great post, Thanks
    19 Jun, 10:04 PM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » In principle, yes. However, due to the more recent date of inception of VGSH the back tests could be done only starting in 2011, and the CAGR comes to 20%. Seems to be OK.


    The basket of VTV VOE VBR TLT VUSTX and SHY gives a CAGR of 13.1% during 2007-2014, with no year of loss, and drawdown of 12%. This appears to be quite a defensive basket.
    20 Jun, 11:13 AM Reply Like
  • bobswee
    , contributor
    Comments (11) | Send Message
    I'm wondering if a shorter time period, say every month looking back 3 months, etc. would produce a more accurate momentum change in a sector, or would that just result in more trades but not better results. Thanks.
    28 Jun, 06:37 PM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » Slightly worse for monthly updates with 3 month look back for VTI/TLT, Gugenheim Value, and Gugenheim Growth. Probably not worth the effort.


    The little change from quarterly to monthly updates provides further evidence for the robustness of the strategy.
    28 Jun, 07:09 PM Reply Like
  • leonf675
    , contributor
    Comments (7) | Send Message
    Just to clarity... Wouldn't this strategy have us buy more of the asset class that got even more expensive and less of the class that didn't appreciate as much in the prior period? How is this a good deal if look at it from a real-world perspective?


    If markets are assumed to be trending for an extended period, it makes sense. Have you back tested this strategy for a period when the markets were oscillating?
    4 Jul, 07:47 PM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » You are right that it will work only if the momentum persists for at least one quarter.


    The longest period I have studied is 1991-2014 with the basket FDVLX, FLPSX and two copies of VUSTX and the rank based weights [50% 25% 15% 10%].


    CAGR 13%
    Max Drawdown 16.9%
    Sharpe 1.1
    Sortino 2.0
    No. of years of losses 2 (2008 -4.1% 1999 -1%)


    Compared to the performance of various allocation/balanced funds, this is pretty good.


    4 Jul, 08:07 PM Reply Like
  • leonf675
    , contributor
    Comments (7) | Send Message
    Thanks, right. - not bad.


    The only problem I have with your trend-following model is associating it with Benjamin Graham. Yes, he was a proponent of switching the allocation between bonds and stocks depending on the market conditions, but I don't think he advocated for continuing to investment more money into the asset class that went up in price.


    I re-read his lecture at and can't find any evidence to support such claim. If I missed something, please reply with a quote or page number.
    7 Jul, 12:02 AM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » That's why I call it 'Naive' Graham.


    It takes his advice on reallocation when the market conditions dictate such an action, and on nothing else. As I said of the method, it is 'one that the he probably would not approve'. Clearly I have taken some liberties here.


    7 Jul, 12:10 AM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » Q2 2014 update




    VTI/TLT Q2 4.8% Q1-Q2 9.5%
    IJJ/TLT Q2 5.1% Q1-Q2 11.2%
    IJS/TLT Q2 4.2% Q1-Q2 9.1%
    iShares Value Q2 4.5% Q1-Q2 9.4%
    iShares Growth Q2 4.3% Q1-Q2 8.4%
    Guggenheim Value Q2 4.6% Q1-Q2 9.6%
    Guggenheim Growth Q2 4.4% Q1-Q2 8.6%
    Vanguard Value Q2 4.6% Q1-Q2 10.2%
    Vanguard Growth Q2 4.3% Q1-Q2 8.7%
    Leveraged Q2 9.3% Q1-Q2 17.0%




    VTI/TLT TLT 75% VTI 25%
    IJJ/TLT IJJ 75% TLT 25%
    IJS/TLT TLT 75% IJS 25%
    iShares Value TLT 52% IJJ 35% IVE 8% IJS 5%
    iShares Growth TLT 52% IVW 35% IJK 8% IJT 5%
    Guggenheim Value TLT 52% RPV 35% RFV 8% RZV 5%
    Guggenheim Growth TLT 52% RPG 35% RZG 8% RFG 5%
    Vanguard Value TLT 52% VOE 35% VBR 8% VTV 5%
    Vanguard Growth TLT 52% VUG 35% VOT 8% VBK 5%
    Leveraged UBT 52% SSO 35% MVV 8% DDM 5%
    8 Jul, 03:07 PM Reply Like
  • bobswee
    , contributor
    Comments (11) | Send Message
    Are these allocations that were used during the 2nd quarter or the new allocations for the 3rd?
    9 Jul, 09:16 AM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » New Allocations for the third.
    9 Jul, 09:30 AM Reply Like
  • bobswee
    , contributor
    Comments (11) | Send Message
    Re: the leveraged account, I show that UBT under performed the other three etf's for the second quarter. What am I missing?
    9 Jul, 10:28 AM Reply Like
  • varan
    , contributor
    Comments (3519) | Send Message
    Author’s reply » According to Yahoo Finance adjusted close prices for 3/31/2014 thru 6/30/2014 (which is the data source that I use), I get this:


    UBT 58.56 64.12 9.49% 2014/03/31 2014/06/30
    MVV 66.45 71.96 8.29% 2014/03/31 2014/06/30
    SSO 105.23 115.78 10.03% 2014/03/31 2014/06/30
    DDM 113.63 119.40 5.08% 2014/03/31 2014/06/30
    9 Jul, 11:23 AM Reply Like
  • ikkyu
    , contributor
    Comments (192) | Send Message
    Wow. I tend to miss you posts. But I am going to follow much more closely.


    This is simple, elegant, and extremely well reasoned stuff.


    Many thanks for your sharing. Keep up the good work.


    Cheers from Osaka,


    25 Jul, 08:18 AM Reply Like
  • ikkyu
    , contributor
    Comments (192) | Send Message
    BTW, I would do this with futures....


    25 Jul, 08:21 AM Reply Like
Full index of posts »
Latest Followers


More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.