Tag Archives: investing

Goal-Oriented Investing

By Seth J. Masters How should investors assess the asset-allocation decisions they or their advisors make? In our view, the key benchmark is the investor’s own goals. The display below assesses the success of three plausible asset allocations for meeting the risk and return goals of three different hypothetical investors. Investor A wanted annualized returns greater than 5%, with no peak-to-trough drawdown deeper than 20%. Investor B targeted annualized returns greater than 7%, with no drawdown deeper than 30%. Investor C cared only about achieving a return greater than 7%, with no drawdown constraint at all. The display shows the share of all rolling 10-year periods from January 1976 to June 2015 in which each investor would have achieved his goals through each of three different mixes of global stocks and municipal bonds. The conservative (30% stock/70% bond) allocation would have most often achieved Investor A’s conservative goals, with his lower return objective and tighter drawdown limit. The moderate and growth-oriented portfolios, by contrast, would have repeatedly exceeded his drawdown constraint. The moderate (60/40) portfolio would have most often met Investor B’s goals. And the growth-oriented (80/20) portfolio would have had the greatest success rate in meeting Investor C’s goals. When risk isn’t an issue, stocks are the asset of choice. This display underscores the importance of matching a portfolio’s asset allocation to the investor’s return and risk objectives. Investors who don’t select an asset allocation that fits their objectives are likely to be disappointed. Of course, this illustration covers only simple return and drawdown goals. In most real-world situations, investors also need to take into account their expected cash flows, their tax situation, prevailing market conditions, and a host of other factors. And real-world investors can choose between more than two asset classes. But no matter how complex the objectives an investor seeks, or how diverse his or her asset allocation, we think one simple standard should apply: The asset allocation has to be designed around the investor’s objectives. If not, the investor is unlikely to be satisfied with the plan and unlikely to stick with it. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Seth Masters, Chief Investment Officer – Bernstein

Risk Rotation Portfolio: A Strategy For Retirement Accounts

Summary What is the Risk Rotation portfolio? How to construct and manage a Risk Rotation portfolio inside a 401K type of account. How does a Risk Rotation portfolio perform compared to the broad market? What is the Risk Rotation Portfolio? The Risk Rotation (or Asset Rotation) portfolio is not something new. One can find many variations for such a portfolio on the Internet. In the SA community, you can find several articles and contributions on similar and other Asset Allocation strategies by Frank Grossmann , Varan , Joseph Porter and others. In brief, the core principle in a Risk (or Asset) Rotation portfolio is to periodically move (or rotate) assets out of an asset with a higher downside risk to an asset that has lower downside risk and higher upward momentum. Such a portfolio aims to provide much lower volatility and drawdowns while capturing similar (or better) returns as the broader market. Though such a portfolio can be constructed inside any brokerage account, I personally find them more appropriate for retirement accounts. Risk Rotation portfolio for retirement accounts Investing successfully has never been easy. Even for the most disciplined investors, the market’s volatility sometimes takes its toll. The past few months have been an emotional rollercoaster for many folks, especially for those closer to retirement. If your horizon is very long term, this is simply market noise and best be ignored. However, for anyone who is already retired or close to retirement, any sharp correction has the potential to derail their near and medium-term planning. The big question is how do you protect yourself from a market downturn or an outright crisis like the one we had in 2008? Furthermore, most retirement accounts like 401K accounts do not provide the flexibility to buy individual stocks or even ETFs (Exchange Traded Funds). A vast majority of them provide just a handful of funds to invest. So, you cannot select your own dividend paying stocks and follow a DGI strategy. In my opinion, one good option is to construct a Risk Rotation portfolio. In my own experience, and also based on back testing, such a portfolio will provide market-beating returns in most situations while providing a high degree of risk protection. A disclaimer: I am also a believer in DGI strategy, and personally invest the majority of my investible funds in individual stocks that pay and grow their dividends. However, for accounts where I cannot invest in individual stocks, I follow the Risk Rotation strategy for about 50% of such assets. If you are interested in my other portfolio strategies, I publish a ” Passive DGI Portfolio ” and another portfolio that is Income-centric named ” The 8% Income Portfolio ” on SA. How to construct a Risk Rotation portfolio: I believe in keeping things simple so they can be easily followed long term. As an example in this article, I will use two securities (a pair of two securities). This pair can be easily implemented inside a 401k type account with moderate risk. There can be more aggressive pairs or strategies that promise higher returns (with higher risk obviously), but they cannot be easily implemented inside a retirement account. Moderate Risk strategy: SPY and TLT pair SPDR S&P 500 ETF (NYSEARCA: SPY ) is an ETF that corresponds to the price and yield performance of the S&P 500 Index. Almost all of the 401K or retirement accounts would offer something that is equivalent of S&P500 index. SPY is taken as an example to illustrate, but any similar fund or ETF can be used in place of SPY. iShares 20+ Year Treasury Bond (NYSEARCA: TLT ) is a 20+ year Treasury fund and oftentimes provides the inverse co-relation with stocks. One can find something similar to TLT inside a retirement account. If nothing similar is available, it could be replaced by cash or cash-like money-market funds. However, the back-testing results by using cash are not as impressive as with TLT. One reason is that TLT provides some yield and at times meaningful appreciation, but cash provides neither (though money market funds do provide some minimal yield). On the first of every month, compare the performance of each of the two funds with a 3-month (or 65 trading days) look-back period. – Invest 70% of the allocated amount in the fund that has better performance over the last 3 months – Invest 30% of the allocated amount in the fund that has worse performance over the last 3 months – If the look-back period performance has been the same or nearly same, invest 50% in each of the two securities. – Repeat every month, on a fixed date of the month. It can be 1st of the month or any other date. Low Risk strategy: SPY, TLT and Cash For more conservative investors, a strategy that involves adding cash to the basket (SPY and TLT) will work a little better. This will also work better during times when both stocks and Treasuries are headed down. This strategy will provide much lower drawdowns, however, at the cost of some performance or overall returns. – On the first of every month, compare the performance returns of each of the three funds with a 3-month (or 65 trading days) look-back period. Performance of cash being taken as 0%. – Invest 60% of the allocated amount in the fund that has better performance over the last 3 months – Invest 30% of the allocated amount in the fund that has second worse performance over the last 3 months – Invest 10% of the allocated amount in the fund that has worst performance of three funds over the last 3 months – Repeat every month, on a fixed date of the month. It can be 1st of the month or any other date. Performance comparison: RRP Strategies vs. S&P 500: (click to enlarge) Image1: Performance/Returns – RRP Strategies vs. S&P 500 The table above shows the performance/returns of the Risk Rotation portfolio (RRP) starting with the year 2006. Row 12: Shows how the portfolio would have performed versus S&P 500 if we had invested $100,000 on January 1, 2006 and remained invested until 10/30/2015. Row 11: Shows how the portfolio would have performed versus S&P 500 if we had invested $100,000 as of January 1, 2007 and remained invested until 10/30/2015. And so on… Notice, except for two starting years (2012 and 2013), the RRP either matches or handily beats S&P 500 with much lower drawdown. The main benefit that stands out is that it moves the portfolio away from the risk in a crisis situation that we witnessed in 2008. I did not go back to the year 2001-2002, but I expect similar behavior. (click to enlarge) Image2: Growth of $100,000 starting on 1/1/2006 – RRP strategy vs. S&P 500. (click to enlarge) Image3: Monthly drawdowns since year 2006 – RRP strategy vs. S&P 500. (click to enlarge) Image4: Maximum drawdown since year 2006 – RRP strategy vs. S&P 500. Risks from this strategy: Let’s consider some potential risks: The first risk comes from the fact that we are seeing the performance comparison based on back-testing results. As the adage goes, past performance is no guarantee of future results. TLT or any other equivalent fund would invest in a treasury based bond fund. In a rising interest rate environment, TLT may have inferior performance compared to past. However, this risk should be mitigated by the fact that we are checking the performance of the two securities every month and switching if necessary. Lack of Diversification: For the stocks component, we are investing in SPY (equivalent of S&P 500), so there is not much exposure to any of the international markets or other asset types like gold or commodities. However, this is partially mitigated by the fact that the companies inside S&P 500 earn a lot of their revenue from outside of the US. Another risk comes from the fact that oftentimes, the performance of this portfolio will be different than the broader market. If it happens to be negative compared to the broader market for a couple of years, the investor may lose conviction and the discipline and may abandon the plan mid-course. This probably is the biggest risk. Concluding Remarks: As they say, hindsight is 20:20. It is hard to predict with any certainty that such a strategy will work as well as it has worked in the past. That’s why it is important to not keep all of your eggs in one basket and depend too much on any one strategy. In my opinion, for the long haul, this strategy should at least match S&P 500 performance with much lower drawdowns, and hence should allow much better sleep at night. I am starting out a sample portfolio with $100,000 initial capital allocated as of November 3, 2015 and will provide regular updates. I plan to publish the performance comparison of the two securities (SPY and TLT) with the previous 3 months’ look-back period on or after the first trading day of every month. This will indicate if a switch of assets is required for the strategy. Here is the relative performance of SPY and TLT as of November 2nd with 3-month look-back period: Price (adj. close) on 11/02/2015 Price (adj. close) on 7/31/2015 Performance/Return Over last 3 months TLT 121.95 121.75 0.16% SPY 210.33 209.36 0.46% Source: Yahoo Finance Since the performance is nearly the same for both, the strategy will invest 50% of $100,000 in each of the two securities. Full Disclaimer: The information presented in this article is for information purpose only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Every effort has been made to present the data/information accurately; however, the author does not claim for 100% accuracy. The portfolio or other investments presented here are for illustration purpose only. The author is not a financial advisor, please do your own due diligence.

DEM: Emerging Market Equities With A 4.98% Yield Are Worthy Of A Closer Look

Summary The individual company allocations won’t be familiar, but the sector allocations and country allocations can be analyzed well. The expense ratio is simply too high for my taste. The sector allocation looks fairly aggressive, but I do like the idea of getting telecommunications exposure through an emerging market ETF rather than emphasizing it in domestic equity. Allocations to Brazil and South Africa are offering investors the opportunity to incorporate exposure to South America and Africa into their portfolio. The WisdomTree Emerging Markets Equity Income ETF (NYSEARCA: DEM ) offers great yields and appealing allocations to underrepresented countries and continents. The expense ratio is a pain, but the yield looks fairly nice. Expenses The expense ratio is .63%. This is certainly too high for my taste, and that is unfortunate, because there are some really nice things about this ETF. Dividend Yield The yield is currently running at 4.98%. For an income investor, this sounds like a beautiful way to get some of the emerging market exposure. Holdings I put grabbed the following chart to demonstrate the weight of the fund’s top 10 holdings: (click to enlarge) When looking at the emerging market company allocations, I don’t expect to be very familiar with the companies. Rather than focus heavily on the individual companies, I prefer to look into the sector breakdown and country allocations for the ETFs. Sectors (click to enlarge) The sector allocation here is fairly interesting. It feels like when I’m researching WisdomTree ETFs, I’ve simply come to expect high allocations to the financial sector. I’m not thrilled seeing it, but the positions are establishing a very significant amount of income for investors in this sector, and the weak income on equity investments in foreign markets can be a disincentive for retirees to grab enough foreign equity to optimize their portfolio for risk-adjusted returns. The thing I do like seeing here is the heavy allocation to the energy sector and telecommunications services. I’ve been bearish on domestic telecommunications because the market has become so competitive relative to previous years, but it is still developing in many countries. I like the idea of getting telecommunications exposure and emerging markets exposure at the same time, so that allocation is great. Investors should take note that this fund is fairly low on consumer staples and utilities, which tend to be more resilient to market weakness, so there is the potential of some fairly substantial price movements. If an investor is going to run with this kind of aggressive high yield portfolio, they should be ready to rebalance and raise allocations if the shares are falling as part of a bear market. Country The country allocations are another major area of importance for establishing proper diversification. (click to enlarge) I have to admit, this is a fairly interesting allocation. I’d be a bit concerned that the top countries receive such a heavy allocation, which would make me favor combining this ETF with another one or two to round out the international exposure. In those ETFs, I’d be looking for lower weights on the top three countries here to enhance the diversification. The nice thing is that I’m seeing substantial allocations to South Africa and Brazil, which provides this ETF with exposure to continents that are often marginalized or excluded from international ETFs. South America and Africa are the most common continents for being mysteriously left off of international funds, so I find this allocation fairly attractive for diversification. Conclusion The yield on this ETF is great, but the expense ratio is not. Since the companies represent emerging markets, they will generally be unknown to domestic investors, but the sector allocation and country allocation give us some perspective on how the ETF should be performing. The sector allocations feel fairly aggressive, and investors using this fund may want to control for that by being prepared to rebalance if the share prices take a hard hit. The country allocations are the high point of the portfolio. The countries represented in this portfolio, and the continents they are on, are often excluded or marginalized in other international funds. For this high yield, if the expense ratio was dropped down and the sector allocation was modified to be slightly more defensive, this fund would be very interesting. I should point out that the total returns on the fund left a great deal to be desired over the funds history, but the last 8 years have shown dramatically superior domestic performance than international performance, so investors should take the weak past performance with at least a few grains of salt.