Building A 20-ETF Portfolio Using Optimization And Momentum

Includes: RWX, VEU, VNQ, VWO
by: Lowell Herr

Basic financial principles require that long-term investment portfolios exhibit diversification, include potential inflation and deflationary holdings, but still have an equity orientation. The following 20-ETF portfolio meets these requirements although the portfolio is unlikely to hold inflation and deflation securities at the same time.

The following 20-ETF portfolio includes thirteen equity ETFs and seven bond and treasury ETFs. The portfolio is global with exposure to both developed international markets (NYSEARCA:VEU) and emerging markets (NYSEARCA:VWO). Domestic (NYSEARCA:VNQ) and international real estate (NYSEARCA:RWX) are included. Bonds, treasuries, commodities, precious metals, and sovereign debt are part of the Strategic Asset Allocation plan.

One of the twenty security positions is reserved for the top performing sector ETF, determined by an advanced screening process.

In the following analysis, five years of historical data is included for the optimization and momentum calculations. The U.S. market is projected to grow at 7% annually over the next few years and the index used in this calculation is Vanguard's Total Market Index Fund, VTSMX.

Efficient Frontier: The following graph shows the efficient frontier for this 20-ETF portfolio. The diamond dot indicates the Return/Volatility coordinates of the current portfolio and the small red dot represents the optimized portfolio. The specific shares for each ETF held in this $200,000 portfolio are identified below.

ETF Rankings: The following table includes the rankings for the 20 Exchange Traded Funds. A 50% weight is assigned to performance over the last three months, 30% is allocated to the six month performance and the final 20% is tied to the volatility of the security. A 10-Day standard deviation calculation is used to determine volatility.

Vanguard's Healthcare ETF holds the top spot and is included in the portfolio since one equity spot is reserved for the top performing sector ETF. VHT is one of the few ETFs that is not commission free for clients of TD Ameritrade.

Buy-Hold-Sell Filter: The following table is the operation manual for the money manager. Both the optimization guidelines and momentum information is provided in one table. While Buy-Hold-Sell signals are generated, the money manager is required to use judgment. For example, the optimizer indicates one should sell 49 shares of VHT while the momentum indicator is signaling a buy. These two ideas are in conflict and need to be resolved by the money manager.

At any given time the optimizer will not assign shares to all 20 securities. Nevertheless, they are included should the optimizer recommend shares be included. Right now the recommendation is to overload the portfolio with equities vs. bonds.

Disclosure: I am long VTI, VOE, VBR, VEU, VWO, VNQ, RWX, TLT, TIP, VUG, VOT, JNK, VHT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.