June 18, 2012: Reasonable Returns Don't Need To Come With Excessive Risk
06/19/2012 0 comments
Re-balance Cycle Reminder
Based on our monthly re-balance calendar, the next re-balance time will be on Monday, July 2, 2012. You can also find the re-balance calendar of 2012 on 'My Portfolios' page.
As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.
Also please note that we now list the next re-balance date on every portfolio page.
Reasonable Returns For Retirees And Conservative Investors
Investing in the past 10+ years has proven to be chaotic and for many, difficult. A conventional wisdom is that to achieve higher returns, one has to take higher risk. This statement is true in general. The question is that to achieve reasonable returns, how much risk one has to take.
This question is very important for most retirees and conservative investors who rely on investment returns to fund their retirement needs. In the following, we would like to take a look at a conservative investment strategy.
Portfolio P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly is listed on Advanced Users page. It is accessible to expert or pro users. The strategy behind this portfolio is to use a momentum scoring strategy that is very similar to MyPlanIQ's Tactical Asset Allocation(TAA): it uses total returns of past 1, 3,6 and 12 months to determine a fund's momentum score. What is unique for this strategy is that every month or quarter, it selects a fund with the highest score from a pool of total return bond funds whose managers have been recognized by Morningstar as fixed income manager of the year. The candidate funds are:
- PIMCO Total Return Bond Fund, managed by Bill Gross: PTTRX or PTTDX
- TCW Total Return Bond I, managed by TCW: TGLMX or TGMNX
- Western Asset Core Bond, managed by Western Asset: WATFX or WABRX
- Metropolitan West Total Return Bond, managed by Metropolitan West: MWTRX
- Loomis Sayles Bond, managed by Dan Fuss at Loomis Sayles: LSBDX or LSBRX
- Dodge & Cox Income, managed by Dodge & Cox: DODIX
- FPA New Income, managed by FPA's Robert Rodriguez: FPNIX
The portfolio is rebalanced monthly (or quarterly in P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Quarterly). The following shows the two portfolios' performance:
Portfolio Performance Comparison (as of 6/15/2012)
| Portfolio/Fund Name | 1 Week Return* | YTD Return** | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe | Since 2001 |
|---|---|---|---|---|---|---|---|---|---|
| P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly | 0% | 3% | 4% | 92% | 12% | 274% | 10% | 188% | 10.8% |
| P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year Quarterly | 1% | 1% | -3% | -57% | 10% | 221% | 8% | 156% | 9.8% |
Critics may point out that in the testing period since 2001, bonds have gone through a huge bull market. It will be much tougher to attain similar returns going forward. In fact, PIMCO's Bill Gross stated this many times in the past.
However, even though going forward, investing in fixed income will be tougher, we are not going to readily concede that it will spell the doom for these managers. Since these funds are total return bond funds, fund managers have many ways to invest in fixed income. These include high yield bonds, foreign bonds and inflation protected bonds (TIPS). For example, Loomis' Dan Fuss has dabbled in high yield bonds for years to enhance returns. In fact, his fund's over exposure in high yield bonds in 2008 caused severe damage to the fund's return in that year. Similarly, PIMCO's Gross has been very adept in investing in international bonds, as well as in TIPS.
Though fixed income investment environment will become tougher in the years to come, we are still very optimistic in using such fund rotation strategy among these great total return bond funds. We believe fixed income offers enough room for a good bond manager to take advantage of in the future.
The above portfolios have been live since 2008. They went to public in 2009.
In the next newseletter, we will discuss another strategy that works on conservative mutual funds. It again delivers very reasonable returns with acceptable risk to conservative investors.
Portfolio Reviews
We compare strategic and tactical portfolios for two popular ETF plans:
Portfolio Performance Comparison (as of 6/15/2012)
| Portfolio/Fund Name | 1 Week Return* | YTD Return** | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|---|---|
| VBINX | 2% | 6% | 7% | 41% | 13% | 104% | 3% | 16% |
| Six Core Asset ETFs Tactical Asset Allocation Moderate | 0% | 3% | -0% | -3% | 9% | 75% | 8% | 59% |
| Six Core Asset ETFs Strategic Asset Allocation Moderate | 1% | 3% | 1% | 4% | 11% | 88% | 3% | 16% |
| MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate | 0% | 3% | 2% | 24% | 10% | 84% | 9% | 68% |
| MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation Moderate | 1% | 4% | 1% | 8% | 11% | 99% | 3% | 14% |
*: NOT annualized
Some users have expressed concerns on the under performance of TAA portfolios, compared with SAA or even the simple vanilla index fund Vanguard Balanced Index Fund (VBINX). In fact, TAA portfolios have lagged behind since the stock market bottom in March 2009. In general, 2011 and 2012 thus far have been difficult for many funds or portfolios that adopt tactical strategies.
We have long argued that as investing is about future outcome (thus uncertainties), all investment strategies are subject to a period of under performance. The key to differentiate a good strategy from a bad one, in addition to (back tested) good performance in the past, is whether the strategy possesses simple intuitions that conform with nature (see June 27th, 2011: Simple Intuitions Are Keys to a Successful Investment Strategy). We pointed out in August 1st 2011: Intuitions Behind MyPlanIQ Tactical Asset Allocatio the following:
Intuitively, momentum exists everywhere in nature. Furthermore, even in fundamental based stock investing, momentum is used: in fact, growth style stocks are from companies that exhibit strong earnings momentum. Fundamental momentum drives price momentum until the price gets out of hand (thus the bubble) or until the fundamental loses its momentum. Fundamental momentum is reflected by price momentum.
The second key intuition behind TAA is that momentum is much easier to observe and thus exploited for major asset classes. A major asset class represents a large economic or financial segment such as U.S. stocks, international developed country stocks, emerging market stocks, commercial real estates, commodities, or debts (bonds). The fundamentals of these asset classes drive their prices. Since these asset classes represent a large economic or financial segment, their fundamental change will not happen overnight and is much easier to be spotted and followed.
Current financial markets represent one of those extraordinary periods in history: government and central banks intervention to defer painful solutions to structural economic problems have altered markets regularly: when a crisis hit, quantitative easing or bailout or stimulus was applied to forcefully drive up risk asset prices for a short period of time until the next crisis hit. Such a market condition creates whip sawing markets for many assets. This affects the TAA performance in a meaningful way.
However, we would like to point out also that our TAA, with its simple and intuitive principle, has done better than most mutual funds and ETFs that employ tactical strategies. For that, it again validates somewhat the strategy.
We further recommend the following previous newsletters to our readers:
- July 25th 2011: Why Tactical Asset Allocation
- July 4th 2011: What Make Strategic Asset Allocation Work?
Market Overview
US stocks and REITs again show signs of decoupling from the rest of the world: the latest trend scores show that both US REITs and US stocks are now above the total bond market index. See 360° Market Overview for more details.
For now, the best is to follow what the markets tell us.
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