New Model Portfolio Structure

As the investment outlook becomes increasingly uncertain, it is worth testing the limits of portfolio construction to see how much of this risk could be automatically handled at the allocation stage.

Can a portfolio be created that would automatically readjust its asset allocation between stocks, bonds and commodities when it was necessary? Could the portfolio also incorporate risk management as well as exceptional entry points to different major equity sectors? How would it have done over the last 10 volatile years? How much should it make in the future? Can I adapt it to my own needs and preferences?

Investors may be surprised to find how far down this road they can already go. I recently took on this challenge and have created a portfolio which attempts to answer these questions.

I have endlessly tweaked and tested multiple systems over a 10 year period. This means that these systems have traded through the 2006/7 housing bubble, the 2008 collapse and the recovery since, right up to the current date. I was very surprised by what I found. There are multiple systems that provide extraordinary risk adjusted returns even through the highly volatile last decade. They can also fit together in very complimentary ways.

The search for better systems never ends, however, I have made sufficient progress to date to make up a composite portfolio that shows what can be achieved. The result is a highly adaptive portfolio which produces exceptional return for risk characteristics, and answers many of the initial questions.

Here is a low risk version which has remarkable stability.

Fixed Allocation                                                      Ave return*/yield pa        sharpe ratio

25% Fixed Income:

10% less than 3yr maturity bonds                            5%

15% Bond system SHY/TLT/TIP                              7.5%                                        1.5

10% Equity Rotation Systems:

5% XLY/XLU/XLV/XLI/ XLF                                       7%                                            2.9

5% XLE/VNQ/EEM/XLP/XLK                                  20%                                           3.0

20% Individual Equities:

1% allocation per stock 25% trailing stop             10% (discretionary estimate)

10%  Gold                                                                       5% (discretionary estimate)

Adaptive Allocation

15% Bond/Equity Systems:

5% TLT/SPY   time stop                                            16%                                           2.4

10% TLT/SPY  trend/low vol                                   8.3%                                          2.6

15% Bond/Equity/Gold Systems:

5% TLT/SPY/GLD time & trailing stop                16%                                            2.9

10% TLT/SPY/GLD low risk                                     8.7%                                         2.3

5% Commodity system:

5% GLD/DBB/DBA/DBE/DJP                                 7.1%                                          4.0

*Returns based on 10 years back tested results including commissions. Past performance is no guarantee of future returns.

The weighted yield on the portfolio comes to 9.125%. In practice it would probably be a little higher as the systems are not fully invested at all times and surplus cash could be reinvested in the bond system on each next signal, and raised from the bond system when a new signal occurs.

Please recognize that I have taken a conservative investment approach in my allocation and investors should understand that this would be a low risk portfolio, with very consistent returns, even through 2008. It would not be difficult to add a little risk and get a much higher prospective return.

It is also worth highlighting how much the overall allocation would systematically shift with the signals. The fixed allocation would stay the same but the overall allocation would be constantly changing as shown in the table below.

—————————Fixed Allocation              Adaptive Allocation

Bonds                                        25%                                   + 30%

Equities                                     30%                                   + 30%

Gold/Commodities                 10%                                   + 20%

Naturally this model could be adjusted in many different ways according to suitability and preference. This approach provides investors with an excellent formula to analyze and engage much more deeply into portfolio construction, analysis and measurement. It is also a very timely formula in the current situation as this is a portfolio that will automatically adapt both to market opportunities as well as key adjustments to allocation as conditions change. It also has a very high degree of risk management embedded in the systems.

 

 

 

 

 

 

 

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