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  • Naive Graham: Passive Investing According To The Master

    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. (http://business.financialpost.com/2013/04/26/benjamin-graham-revisited/ . 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.

    Funds

    CAGR (%)

    Sharpe Ratio (Sortino)

    Max. Drawdown (%)

    Min. Annual Return (%)

    2003-2013 Two Fund Baskets

    VTI TLT (Market)

    12.7

    1.1 (2.0)

    14.3

    3.0

    IJJ TLT (Mid Cap Value)

    12.8

    1.0 (1.9)

    14.3

    4.6

    IJS TLT (Small Cap Value)

    13.1

    1.0 (1.9)

    15.4

    2.9

    DFSVX

    13.7

    0.6 (1.1)

    61.2

    -36.8

    PRWCX

    10.4

    0.8 (1.2)

    36.6

    -27.2

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

    Guggenheim Value

    12.9

    0.9 (1.4)

    24.6

    -7.15

    Guggenheim Growth

    17.1

    1.3 (2.4)

    15.8

    -0.9

    Vanguard Value

    13.35

    1.1 (1.95)

    13.6

    4.8

    Vanguard Growth

    14.8

    1.2 (2.0)

    20.1

    -6.6

    DFSVX

    6.8

    0.4(0.6)

    61.2

    -36.8

    PRWCX

    7.7

    0..6(0.8)

    36.6

    -27.2

    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:

    Rank

    Weight (%)

    1

    35

    2

    25

    3

    15

    4

    12

    5

    8

    6

    5

    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.

    Jun 15 10:29 AM | Link | 47 Comments
  • Distribution Phase Of The 60/40 MDY/VUSTX Portfolio.

    This post summarizes a calculation for 60/40 MDY/VUSTX portfolio starting on Jan. 1, 2000. The portfolio is re-balanced at the beginning of every year after withdrawal which is made at the beginning of the year according to the following schedule: 4% on the first day of the first year, with the dollar amount increasing by 4% every year thereafter.

    The first table lists the adjusted close data obtained from Yahoo Finance, and the returns of the components as well as of the portfolio.

    Year

    MDY on 12/31

    VUSTX on 12/31

    Return MDY (%)

    Return VUSTX (%)

    Return 60/40 (%)

    1999

    69.35

    4.15

       

    2000

    81.52

    4.97

    17.55

    19.76

    18.43

    2001

    80.83

    5.19

    -0.85

    4.43

    1.26

    2002

    69.09

    6.06

    -14.52

    16.76

    -2.01

    2003

    93.46

    6.22

    35.27

    2.64

    22.22

    2004

    108.32

    6.67

    15.90

    7.23

    12.43

    2005

    121.89

    7.11

    12.53

    6.60

    10.16

    2006

    134.06

    7.24

    9.98

    1.83

    6.72

    2007

    143.74

    7.91

    7.22

    9.25

    8.03

    2008

    91.37

    9.7

    -36.43

    22.63

    -12.81

    2009

    125.69

    8.53

    37.56

    -12.06

    17.71

    2010

    158.72

    9.27

    26.28

    8.68

    19.24

    2011

    155.35

    11.98

    -2.12

    29.23

    10.42

    2012

    183.03

    12.4

    17.82

    3.51

    12.09

    2013

    243.54

    10.78

    33.06

    -13.06

    14.61

    In this table we summarize the growth of the portfolio with the withdrawals made as described above.

    Year

    Withdrawal

    Portfolio Value After Withdrawal

    Return (%)

    Portfolio Value at End of the Year

    1999

       

    100

    2000

    4.00

    96.00

    18.43

    113.70

    2001

    4.16

    109.54

    1.26

    110.92

    2002

    4.33

    106.59

    -2.01

    104.45

    2003

    4.50

    99.95

    22.22

    122.16

    2004

    4.68

    117.48

    12.43

    132.09

    2005

    4.87

    127.22

    10.16

    140.14

    2006

    5.06

    135.08

    6.72

    144.16

    2007

    5.26

    138.90

    8.03

    150.05

    2008

    5.47

    144.58

    -12.81

    126.06

    2009

    5.69

    120.37

    17.71

    141.69

    2010

    5.92

    135.77

    19.24

    161.89

    2011

    6.16

    155.73

    10.42

    171.95

    2012

    6.40

    165.55

    12.09

    185.57

    2013

    6.66

    178.91

    14.61

    205.05

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    May 28 1:38 PM | Link | 26 Comments
  • Balanced Strategy: Value Funds

    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.

    Mar 09 5:23 PM | Link | 20 Comments
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