- Last month equities outperformed bonds.
- The Belgian Dentist Asset Allocation performance is as expected.
- There are no changes to the current asset allocation
This article gives you more details about the Belgian Dentist's value investing approach to asset allocation. Today we update you on the results for January. The algorithm performs as expected.
In the month of January equities continued their rise (+1.90%). Bonds also ended in green (+0.43%) and the meager return for cash (+0.04%) was no surprise given the current low interest rates.
The Belgian Dentist Asset Allocation performance is as expected. If equity markets rise, we will underperform them, but in that case we expect to deliver positive, absolute returns. And this is the case, as you can see in Table 1.
Table 1: Returns YTD
Our current expected return estimates can be found in Table 2.
For cash and (government) bonds the prospective return is simply the current yield and for equities we use the model from the website Philosophical Economics based on the average investor portfolio allocation to equities.
Table 2: Expected returns
How do we determine the asset allocation between cash, bonds and stocks? We use the idea proposed by John Hussman to equal the total portfolio (modified) duration and the investment horizon. The calculation of duration for cash and bonds is straightforward and for equities this can be approximated by using the inverse of the dividend yield.
So our algorithm maximizes the expected return with the constraint that the total duration cannot exceed the investment horizon.
Table 3: Current asset allocation
Here you can find more detail about this month's asset allocation.
Longer term results: value investing outperforms!
Table 4: Long-term nominal returns
The Dynamic BD portfolio e.g. has a volatility equal to that of a 100% bond portfolio. The latter has a long-term (geometric) return of 6.51%, which the former outperforms by more than 3%!
What are the reasons for the success of the BD-algorithm?
1) It's simple.
Only three building blocks are used: cash, bonds and equities. It's asset allocation in its purest form.
2) It's mechanical.
The portfolio is monthly rebalanced to a (moving) target allocation. The fact that it is rules-based limits the negative impact of behavioral biases.
3) Risk management aiming for absolute returns
The algorithm automatically reduces exposure when markets become more expensive. This value-investing-feature limits the downside risk and results in small drawdowns.
As a consequence, the portfolio underperforms equity markets in good equity years and outperforms in bad equity years. You can see this clearly in Table 5.
Table 5: average BD-returns in good and bad equity-years
How will the Belgian Dentist perform in 2017? We don't know. It depends on what the equity markets will do. If they tank, the Belgian Dentist will outperform. If they continue to rise, we will underperform them, but in that case we expect to deliver positive, absolute returns. In both cases, we are happy! The month of January is certainly a case in point.
This article provides opinions and information, but does not contain a recommendation or personal investment advice to any specific person for any particular purpose. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor.
Back-tested performance is hypothetical and does not represent actual performance, should not be interpreted as an indication of such performance and is not a guarantee of future results.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.