All of my previous investing strategies have focused on tactical asset allocation to reduce risk in a portfolio while maintaining moderate growth. My objectives for a low risk, moderate growth tactical strategy have been: 1) 10% Compounded Annual Growth Rate [CAGR], 2) -5% Maximum Drawdown [MaxDD], and 3) all positive years of return. In my research, I have found a combination of five Vanguard mutual funds that can be bought and held (rebalanced annually) that nearly meet my objectives. A passive strategy holding these funds eliminates the need (and cost and risk) of updating every month in a tactical asset allocation strategy. This article will describe the components of this buy & hold strategy and present backtest results from 1988 to the present. As an overview, portfolio growth of this buy & hold strategy is presented below.
The five Vanguard funds are:
1. Vanguard GNMA Fund (MUTF:VFIIX),
2. Vanguard High Yield Tax-Exempt Fund (MUTF:VWAHX),
3. Vanguard Health Care Fund (MUTF:VGHCX),
4. Vanguard Long-Term Treasury Fund (MUTF:VUSTX), and
5. Vanguard Short-Term Treasury Fund (MUTF:VFISX).
Five different classes of funds are represented in the basket of funds: 1) a GNMA bond fund, 2) a high yield municipal bond fund, 3) a healthcare equity fund, 4) a long-term treasury bond fund, and 5) a short-term treasury bond fund. The correlations between these funds can be seen below (taken from Portfolio Visualizer [PV]). It can be seen that the funds do not correlate well with each other, as desired.
Backtesting was performed from 1988 - present using PV. In order to backtest to 1988, Fidelity Limited Term Government Fund (MUTF:FFXSX) was substituted for VFISX. The backtest results are shown below. For comparison, results of an absolute momentum strategy and the Vanguard Total Bond Index Fund (MUTF:VBMFX) are also presented. The absolute momentum strategy buys and holds all five funds unless any fund has a one-month total return that is less than a money market return. If that occurs, then the money from that fund is diverted into a money market fund until the one-month return is greater than the money market return.
It can be seen that the buy & hold strategy has the highest total return with relatively low drawdown. The CAGR is 9.0% and the MaxDD is -6.0%. The worst year is -0.9% in 1994, and the only other year with negative return is 1999 (-0.4%). All other years have positive returns. The risk adjusted return numbers are: Sharpe Ratio = 1.2, Sortino Ratio = 2.2, and MAR (CAGR/MaxDD) = 1.5. The monthly win rate is ~73%. The buy & hold strategy has the highest annual return (over the other two investment vehicles) in 16 of the 28 years presented.
Usually, an absolute momentum strategy such as the one presented here will help reduce drawdown at the expense of annual growth. And, indeed, we see that kind of result here. The absolute momentum tactical strategy has a CAGR of 7.4% and a MaxDD of -3.0%. So there is a tradeoff, higher CAGR for the buy & hold passive strategy (9.0% vs. 7.4%), or lower MaxDD for the absolute momentum active strategy (-3.0% vs. -6.0%). In this case, I would prefer the higher growth buy & hold strategy because of its simplicity and -6.0% MaxDD is still quite low.
Disclosure: I am/we are long VFIIX, VWAHX, VGHCX, VUSTX, VFISX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.