The Delta Factor and the Basic Portfolio

by: Lowell Herr

When setting up a basic portfolio, investors want to include at least the "Big Six" asset classes from the U.S. equities market. Then add some bonds, developed international markets, emerging markets, and REITs. For larger portfolios, commodities, international REITs, and international bonds are common additions. Remember, this is a basic or core portfolio.

This blog entry will show how the Delta Factor can play a role in improving portfolio performance. Right now we place risk or uncertainty in the background, but not completely forgotten. To gain confidence in the merits of the Delta Factor we need to see what a basic portfolio looked like near the last market high and low. Let's first see what the different classes were telling us back on October 1, 2007 when the stock market was near its recent high. Before getting into the details, here is a QPP analysis of the basic portfolio.

Note that the portfolio does not look too shabby. The Return/Uncertainty ratio could be higher, but overall, it looks acceptable considering I did nothing special with the asset allocation plan.

Note that I consider this critical information.

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Note that I needed to use iShares ETFs such as IJJ, IJK, EFA and EEM as the Vanguard ETFs were not in existence as far back as October 1, 2004. Regardless, just look at the outlook for these ETFs based on the Delta calculation. All but TIP and TLT are negative. The signal is obvious. Stay on the sidelines and keep your investing powder dry. Granted, this is easier to see at a high point rather than looking at the situation on the market high "shoulders" when the market is peaking or just beginning to decline.

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Now we move on to the end of the first quarter of 2009 when the market was near its recent low. Don't pay attention to TIP, TLT, and AGG as those are bond and income type ETFs. Look at the equity ETFs and there is a lot of green showing. It was time to back up the truck and load up with equity ETFs. Remember, this was back on March 30th of 2009. Now we need to look where we are today.

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The data table below looks grim from my perspective. Using current data, the asset ETFs are close to flat with too many negatives. Do readers understand why I am market negative right now? This is the time to be patient and build cash. If you have asset classes that are under water, set limit orders 3% to 10% below the current price and wait. Now is not the time to be rushing in and taking major positions. I have been buying very small shares here and there, but nothing too serious.