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Summary The simple ETF portfolio with monthly reallocation performed better than the equal weight portfolio in 2015. The low and mid risk portfolios had good positive returns, while the high risk portfolio had a very small loss. Even the high risk portfolio performed better than the equal weight portfolio. The simple ETF portfolio was introduced in an article published in August 2015. Since then the markets suffered a mini crash and a correction associated with high volatility and very negative market sentiment. Investors all over the world moved large amount of money out of the stock market and into other “perceived safer” asset classes such as bonds. It is appropriate, therefore, to ask ourselves how an adaptive strategy is dealing with this kind of market environment. In this article we analyze the performance of the simple ETF portfolio, emphasizing its results during the latest period of high market turbulence. For completeness, we will review the historical performance of the portfolio since January 2003, but will discuss in more detail its performance during the first nine months of 2015. The portfolio is made up of the following four ETFs: SPDR S&P MidCap 400 ETF (NYSEARCA: MDY ) PowerShares QQQ Trust ETF (NASDAQ: QQQ ) iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) Basic information about the funds was extracted from Yahoo Finance and marketwatch.com and it is shown in table 1. Table 1. Symbol Inception Date Net Assets Yield% Category MDY 5/04/1995 14.23B 1.41% Mid-Cap Blend QQQ 3/03/1999 36.93B 0.96% Large Growth SHY 7/22/2002 13.11B 0.48% Short Term Treasury Bond TLT 7/22/2002 6.41B 2.62% Long Term Treasury Bond The data for the study were downloaded from Yahoo Finance on the Historical Prices menu for MDY, QQQ, SHY and TLT. We use the daily price data adjusted for dividend payments. For the adaptive allocation strategy, the portfolio is managed as dictated by the mean-variance optimization algorithm developed on the Modern Portfolio Theory ( Markowitz ). The allocation is rebalanced monthly at market closing of the first trading day of the month. The optimization algorithm seeks to maximize the return under a constraint on the portfolio risk determined as the standard deviation of daily returns. The portfolios are optimized for three levels of risk: LOW, MID and HIGH. The corresponding annual volatility targets are 5%, 10% and 15% respectively. In Table 2 we show the performance of the strategy applied monthly from January 2003 to September 2015. Table 2. Performance of MVO algorithm applied monthly versus an equal weight portfolio. TotRet% CAGR% VOL% maxDD% Sharpe Sortino 2015 return LOW risk 167.65 8.03 5.60 -5.59 1.43 1.99 3.16% MID risk 399.09 13.45 10.61 -10.34 1.27 1.68 3.60% HIGH risk 697.85 17.70 16.40 -17.18 1.08 1.52 -0.33% Equal weight 204.71 9.14 9.58 -24.50 0.95 1.29 -1.33% Please notice that the realized volatilities are well correlated with the target values. In fact, the realized volatilities are just slightly greater that the target values. Also, as expected, the realized annual returns are also well correlated to the volatility targets. All the values in the CAGR% column are a little greater than the realized volatilities in the VOL% column. The 2015 returns column shows that all MVO strategies performed better than the equal weight portfolio. The LOW and MID risk portfolios achieved a positive return of over 3% while the equal weight portfolio lost 1.33%. The HIGH risk portfolio lost a minute 0.33%. The equity curves for all portfolios are shown in Figure 1. (click to enlarge) Figure 1. Equity curves of the portfolios with MVO monthly optimization and equal weight allocation. Source: All charts in this article are based on calculations using the adjusted daily closing share prices of securities. We see in figure 1 that the equity of the LOW risk portfolio had a constant, very stable, rate of increase over the entire time of the simulation. It was almost unaffected by any market event. By contrast, the equity of the equal weight strategy with rebalancing shows the highest variability and the highest loss during the 2008-09 crises. The equal weight strategy worked quite well during long bullish periods of the market such as during 2003-07 and 2009-14. The MID and HIGH risk strategies worked extremely well during the 2009-14 period with a very brief periods of mild correction in 2011. All strategies show a flattening of their equity curves during 2015. In Figures 2, 3 and 4 we show the time allocation for all MVO strategies from January 2014 to September 2015. We decided to display the allocations over a shorter most recent time interval in order to get graphs that are easy to read. (click to enlarge) Figure 2. In figure 2 we see that the LOW risk strategy allocated, on average, over 60% of the money to the bond funds. About 30% to 40% was allocated alternately to QQQ or MDY. (click to enlarge) Figure 3. In figure 3 we see that in 2014 the money was allocated alternately between TLT and QQQ. The first half of 2015 the allocation went to MDY and TLT. In July and August of 2015 the money was allocated to QQQ and SHY, switching all to TLT and SHY in September and October. (click to enlarge) Figure 4. In figure 4 we see that the HIGH risk strategy allocates the money to a single asset at any time. Since January 2014 it simply alternated between QQQ and TLT. This strategy worked very well most of the time, but in the first nine months of 2015 it suffered a very small loss. In table 4 we show the current allocations for all the strategies. Table 3. Current allocations for October 2015. MDY QQQ SHY TLT LOW risk 0% 0% 69% 31% MID risk 0% 0% 35% 65% HIGH risk 0% 0% 0% 100% As seen in table 3 all portfolios are invested only in bond funds, regardless of risk level. The low risk portfolio in mostly invested in the short term, while the high risk is 100% in long term treasuries. Conclusion The simple ETF portfolio with monthly reallocation performed better than the equal weight portfolio in 2015.The low and mid risk portfolios had good positive returns, while the high risk portfolio had a very small loss. Additional disclosure: The article was written for educational purposes and should not be considered as specific investment advice. Scalper1 News
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