Low Risk Portfolios For 2019

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Includes: BERIX, FBALX, IAU, JABAX, MERFX, PSL, VMVFX, VTINX, VTWNX, VWELX, VWIAX, VWINX, XMLV
by: Charles Bolin
Summary

The Investment Model continues to show growth at a decelerating rate.

One hundred low cost, lower volatility Mutual Funds and ETFs are selected from 47 Lipper Categories using Mutual Fund Observer, Morningstar, and Portfolio Visualizer.

Five Model Portfolios are created for Vanguard, Fidelity, "Other" Mutual Funds and Exchange Traded Funds to maximize return at 3.5% volatility.

"We will want to follow the trade situation closely, as well as global growth data. If we see significant deterioration in either area, an overweighting of relatively liquid instruments within each asset class or even reduced exposure to risk assets may be warranted." - Stock Losses Snowball Across The Globe In A December Sell-Off, Kristina Hooper, Invesco

"The economy remains strong, indicating that the current stock market correction will be nothing more than a correction. The weakness in consumer and financial indicators may be the beginning of very early pre-recessionary conditions. Coincident indicators have caught up to leading indicators, suggesting that the rate of economic growth is unlikely to exceed that of the past two quarters." - Mid-October 'Real Time' Update: The Economy May Be Moving Into A Very Early Pre-Recessionary Stage, David Rice, Econ P.I.

"Since stock markets around the world are currently in a downtrend and relative strength levels for risky assets are quite low, the system [The Data Driven Investor] is currently invested two-thirds in cash and one-third in REITs. The quantitative indicators are saying that it's time to protect your portfolio by allocating your capital to low-risk investments."- Are You Worried About The Stock Market? How To Protect Your Portfolio, Andres Cardenal

Introduction

I am a do-it-yourself investor and a firm believer in investing according to the business cycle. I wrote "Portfolio Strategies For Employer Sponsored Plans" for Seeking Alpha in October describing investment strategies for plans with limited options. This month I met with a Fidelity Financial Adviser and moved all of my pre-tax funds from the Employer Sponsored Plan into a Traditional IRA to expand access to other funds. I used the methods described in this article to develop a proposed portfolio, and have a followup meeting to finalize the transition.

As I have written during the past year in, "Portfolios Of Funds That Do Well In A Bear Market" and "Building Bear Market And Full Cycle Portfolios", I have concentrated on reducing risk in portfolios. The past three months has been a good stress test to see how funds will perform in a Bear Market. In this article, I selected one hundred funds in 47 different Lipper categories that have done well during the past year or have the potential to do well if interest rates rise at a slower rate.

The funds were selected based on Ulcer Index, Maximum Draw Down, Martin Ratio, and Risk and Rank Ratings from Mutual Fund Observer. Morningstar was used to further reduce the funds based on performance during the recent downturn. Portfolio Visualizer was used to create portfolios with approximately 10 funds for each of Vanguard, Fidelity, other mutual funds, and exchange traded funds to maximize return at 3.5% volatility (standard deviation) which compares to 5.0% for my baseline, Vanguard Wellesley Income Fund (VWIAX).

Below is a summary of the Model Portfolios for the past 12 months. For the Combined Fund Portfolio, I chose one fund per Lipper category to avoid over-concentration of investments. Based on this information, my ideal defensive portfolio in this environment will have a standard deviation lower than the Wellesley Fund, have about 35% stocks which are mostly large caps overweighted in health care, real estate, and utilities, and a very low allocation to high yield bonds.

Investment Model

The Investment Model is built upon 30 main indexes including leading and coincident indicators, monetary policy, interest rates, housing, income, orders, profits, valuations, inflation, and financial risk, among others. It was built to provide a six month outlook of the direction of the stock market. It currently shows that the investment environment has been deteriorating since late 2017 and the decline has accelerated during the past quarter. The risk of a recession starting in the near term is relatively low, in my opinion, and I expect the markets to recover, but remain volatile in 2019.

The slowdown has become more pronounced and the number of negative indicators is starting to increase.

Source: Created by the Author

The Federal Reserve Bank of Atlanta GDPNow raised its forecast to 3.0% real growth from 2.4% last week.

Indicator Highlights

Below is the Monetary Policy Indicator in the Investment Model. It is a composite of money supply, federal funds rate, 1 Year Treasury rate minus the federal funds rate, and monetary base. It reflects higher interest rates and the unwinding of Quantitative Easing.

While there are many positives in the economy, Construction is showing weakness.

Orders are starting to show weakness.

Housing is not doing well.

The Global Economy is slowing down.

Rising interest rates slow the economy and the yield curve has inverted for two and five year rates.

Financial Risk (Conditions, Stress, Uncertainty, and Volatility) is increasing.

Retail and Institutional Investors have been building cash reserves modestly. In the short term, Retail Investors are increasing Money Funds, while Institutional Investors are decreasing them.

Funds By Lipper Category

Below are the Lipper Categories and the funds selected. I selected funds from Vanguard, Fidelity, other mutual funds, and Exchanged Traded Funds, if they met the volatility and risk criteria. Average Risk (1 is lowest risk and 5 is highest) is the Mutual Fund Observer risk rank average of funds shown for each Lipper Category. Average Rank (5 is best rank and 1 is lowest) is the Mutual Fund Observer performance rank of funds shown for each Lipper Category. The majority of the funds in my proposed Fidelity Portfolio are in the list below with the exception of the Fidelity Advisor Multi-Asset Income Fund (FAYZX).

Lipper Category Vanguard Fidelity Other ETF Avg Risk Avg Rank
Alternative Credit Focus FPNIX 1 5
International Income VTABX FCDSX FFIYX BNDX 1 5
Loan Participation FFRIX LFRFX SRLN 1 5
U.S. Mortgage BATAX 1 5
Core Bond VBMFX FLXCX DODIX BND 1 4
Inflation Protected Bond VAIPX FSIPX ABNOX 1 4
Multi-Sector Income FSIAX IOFIX MINC 1 4
Municipal Int. Debt VWITX FLTMX BMNIX 1 4
U.S. Gov. General FGOVX SNGVX AGZ 1 4
Ultra-Short Obligations VUBFX TRBUX MINT 1 4
General Bond FWHBX PTIAX IUSB 1 3
Global Income FGBFX PRSNX HOLD 1 3
Short Inv. Grade Debt FYBTX BBBMX FLRN 1 3
Short-Int. Inv. Grd Debt VFSTX FTHRX FTSM 1 3
U.S. Government Short VSGBX VGSH 1 3
U.S. Treasury Short VFISX FSBAX BTTTX SHY 1 3
Municipal Short Debt VWSTX FMCFX ORSYX MEAR 1 2
Absolute Return PYARX 1 1
Consumer Goods PSL 2 5
Alternative Event Driven MERFX MNA 2 4
Alternative Multi-Strategy DIVY 2 4
Mixed-Asset Target 2015 VTXVX FLIFX 2 4
Mxd-Asset Tar. Alloc Con VWINX FTANX BERIX AOK 2 4
Mxd-Asset Target Today VTINX FFFAX 2 4
High Yield VWEHX SPHIX FDHIX PGHY 2 3
Retirement Income VPGDX FIRMX NBARX 2 3
Global Multi-Cap Core ACWV 3 5
Mxd-Asset Alloc Growth VWELX FBALX PRWCX 3 5
Multi-Cap Core VTCLX FSUVX USMV 3 5
Utility FSUTX BULIX FXU 3 5
Alt. Long/Short Equity BRBPX PBP 3 4
Precious Metals Comm. IAU 3 4
Global Small-/Mid-Cap VMVFX 3 4
Large-Cap Value VIVAX FSDIX YAFFX 3 4
Mixed-Asset Target 2020 VTWNX FPIFX MFLJX 3 4
Mxd-Asset Tar. Alloc Mod VSCGX FASMX JABAX 3 4
U.S. Treasury General VFITX FBLTX 3 4
Equity Income VDADX PRBLX QDEF 4 5
Large-Cap Core VFTSX FLCEX GQETX FDLO 4 5
S&P 500 Index VFINX FXAIX SWPPX IVV 4 5
Global Equity Income FGILX LDIFX 4 4
Global Real Estate FFERX

MGLIX

REET 4 4
Mid-Cap Core VMCIX FMCSX XMLV 4 4
Multi-Cap Value VUVLX FLVEX FVD 4 4
Real Estate VGSIX FRIFX JIREX MORT 4 4
Health/Biotechnology VGHCX FHCIX SWHFX 5 4
Specialty/Miscellaneous DEF 5 4

Source: Mutual Fund Observer

Exchange Traded Funds

The link in Portfolio Visualizer is provided and interested readers can change parameters to suit their own tastes. The following is the Efficient Frontier (Return vs Volatility) for the Exchange Traded Funds for the past year. Standardization is a measure of deviation from the mean. In "The Great Owl Portfolio", I show the relationship of Standard Deviation to Bear Market Deviation and Martin Ratio.

Source: Portfolio Visualizer

The Exchange Traded Funds selected to maximize return at 3.5% volatility are shown below. The return for the 3.5% Volatility Portfolio was 5.6% while the maximum draw down was 1.6. This compares to -0.5% return for the Vanguard Wellesley Income Fund (VWINX) with a maximum draw down of 3.5%.

Source: Portfolio Visualizer

In addition to the Portfolio with the Maximum Return at 3.5% volatility is the Vanguard Wellesley Income Fund (VWIAX). The Provided Portfolio is the equal weighted universe of selected exchange trade funds.

Source: Portfolio Visualizer

Vanguard Mutual Funds

The link in Portfolio Visualizer is provided. The following is the Efficient Frontier (Return vs Volatility) for the Vanguard Mutual Funds for the past year.

Source: Portfolio Visualizer

The Vanguard Mutual Funds selected to maximize return at 3.5% volatility are shown below.

Source: Portfolio Visualizer

Source: Portfolio Visualizer

Fidelity Mutual Funds

The link in Portfolio Visualizer is provided. The following is the Efficient Frontier (Return vs Volatility) for the Fidelity Mutual Funds for the past year.

Source: Portfolio Visualizer

The Fidelity Mutual Funds selected to maximize return at 3.5% volatility are shown below.

Source: Portfolio Visualizer

Source: Portfolio Visualizer

Other Mutual Funds

The link in Portfolio Visualizer is provided. The following is the Efficient Frontier (Return vs Volatility) for the Mutual Funds other than Vanguard and Fidelity for the past year.

Source: Portfolio Visualizer

The Mutual Funds other than Vanguard and Fidelity selected to maximize return at 3.5% volatility are shown below.

Source: Portfolio Visualizer

Source: Portfolio Visualizer

Combined Funds

All of the 100 mutual funds and exchange traded funds are used to create the combined portfolio. The link in Portfolio Visualizer is provided.

Source: Portfolio Visualizer

From the combined list of 100 mutual and exchange traded funds, the funds selected to maximize return at 3.5% volatility are shown below.

Source: Portfolio Visualizer

By comparison, the same 100 funds were used to maximize the Sharpe Ratio.

Source: Portfolio Visualizer

Source: Portfolio Visualizer

Comparison Of Portfolios

The Portfolios for the Vanguard Funds, Exchange Traded Funds, Combined Funds are compared, along with the Vanguard Wellesley Income Fund which I use as a conservative baseline fund. As can be seen below the Portfolio from the Combined Funds has a higher return with lower draw down than the others including the Vanguard Wellesley Income Fund. The link in Portfolio Visualizer is provided.

Source: Portfolio Visualizer

Source: Portfolio Visualizer

Conclusion

Future performance is guaranteed to be different than the past. The optimum portfolio is a journey and not a destination. Moving funds from an Employer Sponsored Plan to a Traditional IRA sped up the process, but other areas of my portfolio still need attention.

Below is my choice for a conservative, defensive portfolio as I near retirement. It is about 35% stock with about 75% in large cap stock and is overweight in defensive sectors. I will create a CD ladder instead of some of the bond funds when I meet with my Financial Adviser. The portfolio below would have returned 4.5% YTD with a maximum draw down of -1.7%.

I write one or two articles per month which involve investing according to the business cycle, managing risk and/or portfolio optimization. I write based on the topics that interest me, as someone approaching retirement.

Disclosure: I am/we are long FRIX, VTABX, VAIPX, VUBFX, VSGBX, BERIX, VTINX, MERFX, VWINX, FSUTX, FXU, VWELX, XMLV, VTWNX, VMVFX, YAFFX, VGHCX, PSL, JABAX. 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.

Additional disclosure: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional.