Momentum Applied To Swensen Six Portfolio

|
Includes: TIP, VNQ, VTI, VWO
by: Lowell Herr

Summary

How to build a portfolio around the Swensen Six ETFs.

Applying the Tranche Momentum Model to portfolio management.

What ETFs are currently recommended and in what proportion.

Position Sizing as a model for controlling portfolio risk.

As background to understanding the Swensen Six portfolio as outlined in the book, Unconventional Success, check out this article before reading further. The Swensen Six portfolio is built around six ETFs that provide global diversification. David Swensen recommends the following asset allocation for these six securities.

  • U.S. Equities (NYSEARCA:VTI) - 30%
  • Developed International Equities VEA) - 15% (In a later paper this is revised to 10% with the remaining 5% allocated to Emerging Markets.
  • Emerging Markets (NYSEARCA:VWO) - 5% (More recent recommendation is to elevate this to 10%)
  • U.S Real Estate (NYSEARCA:VNQ) - 20%
  • U.S. 20+ Year Treasury Bond - 15%
  • U.S. Treasury Inflation Protection (NYSEARCA:TIP) - 15%

Investors working with different brokerage houses will be able to find mirror ETFs or mutual funds that are available as commission free securities. I use the ones above as they are commission free with TDAmeritrade.

The Swensen Six as originally constructed form the backbone of a passively managed portfolio. All one needs to do is rebalance the portfolio once a year.

Another approach is the Tranche Momentum Model explained below and the primary argument for this approach is one of risk control. Passively managed portfolios following a Strategic Asset Allocation Model, as does the basic Swensen Six model, are subject to declines in bear markets such as we experienced in 2008 and early 2009. The following model is designed to minimize major draw-downs.

Using the Swensen Six ETFs as the core holdings, how does one apply the Tranche Momentum Model. The first step is complete as the securities are pre-selected. We then enter the six ETF tickers into the Kipling spreadsheet for momentum analysis.

Swensen Six Tranche Momentum Recommendations: The following six ETFs are ranked based on absolute momentum (how well each is performing with respect to SHY) and relative momentum (how the ETFs rank with respect to each other.) This analysis uses two look-back periods. 1) A 50% weight is allocated to the 60 trading day look-back. 2) A 30% weight is assigned to the 100 trading day look-back. 3) The remaining 20% focuses on the volatility of the security where low volatility is rewarded. These look-back periods are used based on back-testing results.

Attention is drawn to VNQ as it is currently under-performing SHY. If already in the portfolio, VNQ would be sold. If not in the portfolio, it would not be added. This is where the Tranche Momentum Model parts ways with the Strategic Asset Allocation Model. Portfolio risk is reduced by staying away from low performing asset classes.

Column 8 shows the number of shares recommended for each security including SHY.

Manual Risk Adjustments: Given the above recommendations there is another worksheet within the Kipling spreadsheet that provides additional help in monitoring portfolio risk. This is known as Position Sizing. With guidance from the first screen shot, we assign a particular number of shares for the five ETFs recommended for investing. Remember that VNQ will not play a role in this portfolio since it is currently under-performing SHY. That will change in the future.

In column 13 of the following worksheet, a specific number of shares are specified for each security. Based on the number of shares identified for purchase, the New Portfolio Risk is 2.8% or well below the 5% I use as a benchmark reference. Based on current prices, this leaves $844 in cash.

Once the portfolio has been populated, it goes into "neglect mode" for 33 days or until the next review arrives.

Disclosure: I am/we are long VEA,VTI,VWO.

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.