Faber-Richardson Quantitative System Works: A Modified Approach.

Includes: BWX, DBC, EFA, RWX, VNQ, VWO
by: Lowell Herr

The following six-year study is a slight modification of the Mebane Faber-Eric Richardson quantitative model outlined in their book, The Ivy Portfolio. Different ETFs were selected in The Feynman Study and a 195-Day Exponential Moving Average (EMA) was used as explained in this blog post (Level 1).

Eighteen (18) ETFs were selected to be part of the portfolio. They were not chosen for any reason other than they provided a well-diversified array of asset classes and they had sufficient history to be viable for this analysis.

The eighteen ETFs include six U.S. Equities (IVE, IJJ, IJS, IVW, IJK, and IJT), Developed International Equities (NYSEARCA:EFA), Emerging Markets (NYSEARCA:VWO), five Bonds and Treasury ETFs (TLT, LQD, TIP, AGG, and SHY), Commodities (NYSEARCA:DBC), Metals (NYSEARCA:GLD), U.S. REITs (NYSEARCA:VNQ), International REITs (NYSEARCA:RWX), and International Bonds (NYSEARCA:BWX).

The study runs from late June 2007 through late June 2013 so as to capture a major bear market as well as a highly successful bull market.

Benchmark: VTSMX was selected as the benchmark as it sets a higher bar than the VFINX (S&P 500 equivalent).

Four model portfolios were tested in this study and they are described below.

  • Passive Portfolio
  • Dynamic Portfolio
  • Passive Plus ITARR
  • Dynamic Plus ITARR

Passive Portfolio: The Passive Portfolio is a strategy whereby an "optimally" weighted portfolio, selected from the Feynman Asset List of 18 ETFs, was constructed as a Buy and Hold portfolio. In this analysis the number of shares were held constant throughout the analysis period, and no adjustments were made to the share allocations. There was no further optimization - no new assets were added to the portfolio once the initial optimization was determined.

The portfolios with/without ITARR differ slightly in that the portfolio used in Passive Portfolio of the study maintained a fixed quantity of shares throughout the Study Period - the portfolio was "passive" in the sense that there was no change in share quantities. The Portfolio used in the ITARR analysis uses a fixed allocation (%) of shares throughout the Study Period - these are the asset allocations established at the beginning of the period and there is no further optimization i.e. the included assets and allocation percentages remain unchanged - the portfolio is "passive" in the sense that there is no change in allocation percentages. The necessity for the slight difference results from the fact that the share quantities cannot be kept constant since there will always be either a shortfall or an excess of cash available as assets are added back into the portfolio as their price moves back above the 195-Day EMA. The differences do not significantly affect the validity of the comparisons.

Passive Plus ITARR: The Passive Portfolio plus ITARR requires the money manager to apply a Faber-Richardson style quantitative model. In this analysis a modified model (ITARR) was applied to the "Passive" Feynman Portfolio. ETFs were removed from the portfolio when their price fell below their 195-Day EMA and were returned to the portfolio when the price moved from below to above the 195-Day EMA. Adjustments were made quarterly. ETFs whose price has fallen below the 195-Day EMA are removed from the portfolio and the value of these assets was held in cash.

The following graph shows the performance of the VTSMX benchmark, Passive Portfolio and Passive Portfolio Plus ITARR. There is very little difference between the two strategies, but a close look at the graph shows a lower volatility for the Passive Portfolio Plus ITARR. Perhaps a faster EMA such as a 150-Day EMA would capture a fast rebound in a quick moving bull market.

Dynamic Portfolio: The Dynamic Portfolio differs from the Passive Portfolio in that each evaluation period (once a quarter) a portfolio of assets were selected from the Feynman Asset List (18 possible ETFs) as an optimized portfolio (lying on the Efficient Frontier) based on Modern Portfolio Theory (MPT). The portfolio was re-optimized and re-balanced quarterly resulting in a portfolio of changing assets with changing allocations. This was designated the "Dynamic" Feynman Portfolio.

Dynamic Plus ITARR: The fourth portfolio is the "Dynamic" with the ITARR overlay. In this part of the analysis the 195-Day EMA filter is applied to the "Dynamic" Feynman Portfolio. ETFs whose price moves from above to below the 195-Day EMA on the quarterly adjustment/evaluation date are removed from the portfolio. The portfolio is re-optimized on subsequent adjustment/evaluation dates and the assets are returned/included in the portfolio if their price moves from below to above or lies above the 195-Day EMA. The portfolio allocations are re-balanced. Assets selected for inclusion in the portfolio, but whose price has fallen below the 195-Day EMA are removed from the portfolio and the value of these assets is held in cash.

In the following graph we see the performance of the VTSMX benchmark and the four portfolios that were part of The Feynman Study. The top performing portfolio was the "Dynamic Plus ITARR." Applying the modification of the Faber-Richardson quantitative system, in this case the ITA Risk Reduction model, added alpha to the portfolio.

The Faber-Richardson model reviews the assets ever month whereas this study updated the portfolios every quarter. My personal preference is to review each portfolio every 33 days so as to avoid the wash sale, short-term trading and to shift the analysis to different periods within the month.

Additional details to this study are available at this site.

Disclosure: I am long VBR, VNQ, RWX, TLT, TIP, BND. 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.

Additional disclosure: This research was conducted by "HedgeHunter," an author on the ITA Wealth Management blog. Credit is due for his detailed analysis.