Simple 5 ETF / 10% Retirement Portfolio Drops IVV for OEF in U.S. Equity Hedge

Includes: IVV, JKG, OEF, SDS, SHY, SLV
by: Jeff D. Hamann

Here are the results of a backward looking portfolio of five funds using the Konno and Yamazaki Mean-Absolute Deviation Portfolio for this week. Using a basic set of statistics, we determine which funds should have been included, and determine the allocations that would have generated a 10% return AND minimize the mean absolute deviation (MAD). We restrict the number of assets to 5 so that the results can be written on the back of business card, sent to someone's hand-held device, or broadcast on twitter (which we do regularly). We assume the investor is at or near retirement and include common constraints like “don't include more than 10% commodities.”

Given a universe of the following Exchange Traded Funds (ETFs):

The resulting 10% MAD portfolio allocation for the previous 252 trading days was:

Exchange Traded Fund Name Symbol Return Std Dev Weight
Barclays 1-3 Year Treasury Bond Fund (NYSEARCA:SHY) 1.84% 1.21% 60.00%
iShares Silver Trust (NYSEARCA:SLV) 167.46% 30.22% 7.84%
iShares S&P 100 Index Fund (NYSEARCA:OEF) 11.50% 16.98% 12.30%
iShares Morningstar Mid Core Index Fund (NYSEARCA:JKG) 23.58% 21.15% 9.87%
ProShares UltraShort S&P500 (NYSEARCA:SDS) -23.77% 35.56% 10.00%

...which yielded a 10% return and a standard deviation of 2.64%.

Had we allocated our investable capital into the assets listed above 252 days ago, our performance would have looked something like this (click to enlarge images):

Here are the take home messages for today:

  1. The bond asset remains iShares Barclays 1-3 Year Treasury Bond ETF (SHY). The estimated annualized performance has increased slightly from 1.74% last week to 1.84% this week and the estimated volatility, annualized, has decreased from 1.22% last week to 1.21% this week. The weight for this single bond asset has remained at the maximum allowed allocation of 60% for a few months now and doesn't seem out of control for retired, near retired, or conservative return seekers. The other bond assets we're tracking (TIP, IEF, TLT, AGG) have also been relatively stable (i.e. low volatility) and have returns that are steadily increasing as well, despite all the news of S&P's downgrading of US debt and several impending sovereign-debt crises.

  2. The commodities asset remains iShares Silver Trust ETF (SLV). The allocation has not changed from last week's 8% as the estimated annualized return continues to increase it's triple digit returns. It has remained near it's maximum allocation of 10% to commodities for several months now. The other commodity ETFs we're tracking (IAU, GSG, DBC, and USO) have all been showing strengthening performance too, but none have entered into the 10% portfolio for several periods and they don't appear to do so anytime in the near future.

  3. The US equity assets has switched out of iShares S&P 500 (NYSEARCA:IVV) in favor of iShares S&P 100 Index Fund (OEF) and kept iShares Morningstar Mid Core Index ETF (JKG). The weight of JKG has declined slightly from last week's 10.33% to 9.87% this week; Not really time to get out as it's been stable since January. The weight of OEF, which is pretty much the same as the ousted IVV, as are the return and volatility. As we enter the “be out of the market” season, this could signal a trend to the larger caps, and we may see the return of a global/emerging equity. Regardless, the US equity allocation remains about 22%, which doesn't sound irrational for a conservative retirement portfolio.

  4. The short/leveraged hedge position remains ProShares UltraShort S&P500 (SDS) and has stayed at the maximum allocation of 10% for a few months. The estimated annualized return has decreased from last week's -21% to -24% this week. While it might look strange being 22% long US equities and 10% short US equities in the portfolio, this looks like a signature equity hedge that's slightly “bullish” to mid-core US equities. Regardless, this might be a good time to consider looking further into strategies to protect yourself against downward movements and create a smoother ride for your portfolio if you haven't already done so.

Comparing these results to the S&P500, which for the previous 252 trading days, has returned about 12% with a standard deviation of 18%, respectively, and I think this portfolio has performed well given our desire obtain a 10% return AND minimize volatility. Like always, these results simply provide a reality-check against poorly allocated portfolios, and are not intended to predict asset prices or market movements in the future.

Disclosure: I am long AGG, IAU, XLE, SLV, VXX, TIP.

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