Tactical Asset Allocation Using David Swensen's Lazy Portfolio ETFs

by: MyPlanIQ

David Swensen, the Yale Endowment Manager, proposed this one size fits all model portfolio for individual investors. The major difference between this portfolio and other conventional portfolios is that it emphasizes international equities (including emerging market equities) as well as real estate investment. Compared with various diversified portfolios, an interesting asset class missing is the commodities, which has been considered to be an excellent anti-inflation diversifier. This is complemented with its emphasis on the inflation-protected treasury bonds. We assume annual rebalance although Swensen actually pointed out that Yale’s institutional portfolio is rebalanced daily, which, by his estimate, gave about 1-2% of excessive returns vs. annual rebalancing.

Compared with the Simpler Is Better (SIB) portfolios discussed in an article, one can see that Swensen's six assets exclude the commodities while putting emphasis on using fixed income for the purpose of inflation protection and hedging.

Note: it has been confusing whether Swensen advocated using long-term Treasury bonds or just average duration Treasury bonds. In his book "Unconventional Success: A Fundamental Approach to Personal Investment," he wrote "The purity of noncallable, long-term, default-free Treasury bonds provides the most powerful diversification to investor portfolios". Based on this sentence, it has been interpreted that he meant to use the long-term Treasury bond. However, recently, a reader posted a reply from David Swensen on this question in morningstar.com, which indicates the average duration of Treasury bonds.

The portfolio consists of the following:

  • 30% in Vanguard Total Stock Market Index (VTSMX)
  • 20% in Vanguard REIT Index (VGSIX)
  • 20% in Vanguard Total International Stock (VGTSX) or (15% in VGTSX and 5% in VEIEX)
  • 15% in Vanguard Inflation Protected Securities (VIPSX)
  • 15% in Vanguard Long Term Treasury Index (VUSTX)

The above model portfolio should be compared with the moderate model portfolios discussed below.

We use the funds suggested in Swensen's lazy portfolio to construct an investment plan called the David Swensen Six ETF Asset Individual Investor Plan.

The following ETFs in the plan cover 5 major assets: US Equity, Foreign Equity, Emerging Market Equity, REITs, Fixed Income.

Asset Class Ticker Name
LARGE BLEND VTI Vanguard Total Stock Market ETF
Foreign Large Blend VEU Vanguard FTSE All-World ex-US ETF
Inflation-Protected Bond TIP iShares Barclays TIPS Bond
LONG GOVERNMENT TLT iShares Barclays 20+ Year Treas Bond

Two asset allocation strategies: Strategic Asset Allocation (SAA) (an equal weight allocation among risk assets) and Tactical Asset Allocation (TAA) (a trend following strategy across the asset classes) are used to contruct the following portfolios.

The following shows the performance of the two moderate risk model portfolios.

(Click to expand)

Performance table (as of Nov 25, 2011)

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
David Swensen Six ETF Asset Individual Investor Plan Tactical Asset Allocation Moderate 10% 88% 10% 80% 9% 61%
David Swensen Six ETF Asset Individual Investor Plan Strategic Asset Allocation Moderate 0% 2% 15% 82% 4% 19%
Five Core Asset ETF Benchmark Tactical Asset Allocation Moderate 2% 15% 9% 71% 7% 49%
Five Core Asset ETF Benchmark Strategic Asset Allocation Moderate -5% -30% 14% 68% 2% 4%

Both Strategic and Tactical portfolios are doing well. This is mostly due to the long-term Treasury bonds (NYSEARCA:TLT) and inflation-protected bonds (NYSEARCA:TIP) as candidate funds that have been held during the recent market downturn. Furthermore, the Tactical Asset Allocation portfolio was able to reduce risk asset (stocks) exposure before the market weakness in September.

The takeaway is that Swensen's candidate ETFs (or index funds) have a good mix that allow an asset allocation strategy to gain exposure in various market cycles, as demonstrated in the recent history.

Disclosure: I am long TLT, VNQ.

Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical

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