Re-balance Cycle Reminder

Based on our monthly re-balance calendar, the next re-balance time will be on MondaySeptember 10, 2012. You can also find the re-balance calendar of 2012 on ‘Dashboard‘ page once you log in.

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.

New Features 

Many users have responded favorably on our new look in the Dashboard and the new Get Started Now flow. However, there have been some glitches and confusion. We are working hard to fix glitches. We thank you for your patience. 

One noticeable change in the new system is that will only provide back testing results for moderate risk portfolios that have been built and monitored for each plan. These portfolios are monthly re-balanced and they have risk profile 40. To see back testing results of other settings (including risk profile and frequency etc.), you’ll need to be an expert subscriber. The reason we do this is to reduce our server load. 

In the coming weeks, we will introduce more new features including a new Strategic Asset Allocation strategy that is more calibrated in terms of asset allocation (as opposed to the current equal weight SAA).  Please watch this newsletter for more changes. 

Taxonomy of Momentum, Relative Strength and Trend Following Strategies

Recently, a user made a very insightful comment on our newsletter titled as August 27, 2012: Trends Can Be Fickle But Still Are Your Friends. Here is the comment: 

John Hussman’s article is actually shocking to me. I have been going by
trend following since about 2009, and all of my research showed that it
was pretty good. After reading that article I tried to duplicate his
results. I could only get data back to 1987, not back to 1950, however
the result was clear — Trend following can reduce the volatility of a
portfolio, avoiding most of the horrible drops of 2008 and 2001.
However, it misses out on a lot of the gains. If your backtest
experiments are only 10 to 12 years long, trend following looks just
great. If you include the boom years of the 1990’s and late 1980, trend
following Stinks!

MyPlanIQ seems to do a lot of 5 to 10 year backtesting….

His comment prompted us to write an article on 

Longest History (21+ Years) Trend Following Or Relative Strength Over Real Index Funds

As we consider this is a very important issue, we would like to construct a taxonomy of momentum and trend following techniques with respect to asset allocation to clarify various confusions and claims in this area. 

First, some of the terminologies: 

  • Momentum: it is used to measure the price or total return of a particular stock, a fund or even an asset class. For example, the trailing 12 month total return can be used as a momentum indicator. 
  • Relative strength: it is about to invest in a group of stocks or funds. You use momentum scores among these candidate stocks or funds and then you choose the ones with the highest rankings. Since the momentum rankings are relative to each other in this group of securities, thus the name ‘relative strength’. 
  • Trend following: you will only invest in stocks or funds that exhibit up trends or you will short stocks or funds that exhibit down trends. There are many ways to decide whether a trend is up or down. Moving average is one of them. Hussman’s study mentioned in August 27, 2012: Trends Can Be Fickle But Still Are Your Friends uses moving averages. 

From the above simple explanations, one can see these three terms are very related and have been used sometimes loosely by media. Terminologies aside, what is more important is to understand how these have been used in investing.

Individual stock investing

Momentum is most well known in stock investing as people have used this to speculate in fast and furious stock markets for ages. Momentum investing has also been accused as ‘bubble chasing’ and ‘hot hands’ etc. When it comes in individual stock investing, it has been found by academic studies that momentum is one of the four factors that mostly decide (or explain) returns of a stock portfolio. The other three factors (called Fama-French 3 factors) are stock market, size (small vs. large) and value (value vs. growth).  Fama and French have tracked how these factors have performed in its website

Momentum (relative strength) driven individual stock investing can be on 

  • m1: A group of individual stocks such as Dow Jones 30 or Nasdaq 100 etc. 
  • m2: A group of industrial stock funds such as Fidelity’s famous Fidelity Select funds
  • m3: A group of stock sector funds such as SPDR’s S&P sector ETFs such as SPDR Select Energy (XLE) etc. 
  • m4: A group of stock style funds such as Russell large, mid and small cap stock ETFs. 

Our position for using momentum in investing individual stocks is that momentum can be an effective factor but it is very volatile and unpredictable in short terms. We do not recommend momentum individual stock investing for average investors. In fact, we believe the first 3 styles of momentum investing (m1 to m3) in the above are too fickle for average investors to deal with. 

However, we believe momentum based stock funds, as other style stock funds such as large value or small growth etc., can be useful as they represent one of the 4 factors in stock investing.

Furthermore, the style level rotation (m4) can be useful when it comes to select stock funds.  In fact, the fund selection algorithm used in MyPlanIQ Strategic Asset Allocation(SAA) strategy is a variation of momentum driven algorithm that is based on Sharpe ratio ranking, among other factors. 

Some well known funds using momentum in stock investing including

  • AQR Momentum (AMOMX): AQR is a hedge fund extended to mutual fund company that specializes in momentum investing. 
  • DWA Technical Leaders (Dorsey Wright & Associates) (PDP): DWA is a well known firm specializing in relative strength investing. 

Single stock, fund or asset class trend following

These are more or less so called all in and all out market timing: 

  • m5: single stock index (fund) buy/sell decision

Hussman’s study is on the effectiveness of using moving averages to get in (buy) and get out (sell) an S&P 500 total return fund such as SPY. 

Based on our own research and other published research, m5 (all in and all out market timing) is fickle but not very effective. 

Momentum (Relative Strength, Trend Following) Based Tactical Asset Allocation

When we move one level above in terms of granularity of securities in momentum investing, it is really about relative strength investing in 

  • m6: A group of diversified and somewhat uncorrelated asset classes such as stocks, bonds, real estates (REITs) and their minor asset classes such as long term bonds, international bonds, gold etc. 

At this level (m6), we believe momentum or relative strength has been very effective. MyPlanIQ’s Tactical Asset Allocation(TAA) is one of these strategies. 

We would like again to discuss this portfolio 

P Relative Strength Trend Following Six Assets

This portfolio has about 21+ year back testing history. 

Inception date: 6/28/1991. 

This portfolio tries to use the funds with longest price history. The international and emerging market and REITs are the ones with shorter history.

Funds used in this portfolio:

  • U.S. stocks: Vanguard 500 Index (VFINX), inception:3/27/1987
  • European stocks: Vanguard European (VEURX), inception: 11/1/1990
  • Pacific stocks: Vanguard Pacific (VPACX), inception: 11/1/1990
  • US REITs: Vanguard REITs (VGSIX), inception: 6/28/1996
  • Gold: GLD, inception:1/4/1971. Before ETF GLD’s inception on 11/18/2004, we use London spot gold price (monthly closing). 
  • US Bonds: Vanguard Total Bond Index (VBMFX), inception: 6/4/1990
  • CASH: calculated using 3 month T-Bill interest. 

This portfolio has the following important characteristics: 

  • It uses index mutual funds only.
  • It does not have survivability issue that has been cited as one of the biggest issues in many back testing studies.
  • It does not have slippage or trading friction issue as mutual funds are only traded at the closing price.
  • It has the longest history for public mutual fund or ETF based portfolios. As the moment, it has more than 21 years back testing history.
  • It uses geographical diversification among stocks. The reason to do so has more to do with the longevity of mutual funds: Vanguard European and Pacific stock funds have much longer history than Vanguard Total International Stock Market fund or Vanguard Emerging Market Stock Fund. This is the main difference from Six Core Asset ETFs.

The 21+ year result is more than impressive: 

From 6/28/1991 to 9/4/2012, The following table shows the performance between VFINX (Vanguard 500 Index) and this portfolio: 

Return Metrics VFINX P Goldman Sachs Global Tactical Six Assets
Annualized Return 8.572% 11.5%
Sharpe Ratio 34.141% 89.0%
Standard Deviation 18.866% 10.6%
Maximum Drawdown 55.3% 17.3%

See latest comparison >>

So no only it had more than 3% annual return compared with VFINX (Vanguard 500 index, an S&P 500 index fund), the portfolio achieved this by having only 60% of the risk. Furthermore, its maximum drawdown (the all important factor for many conservative investors) is 17% vs. 55%!

However, trend following/relative strength/momentum based tactical allocation is not without drawbacks. The two most important ones are: 

  • It is very sensitive to rigorous implementation: if the investor slacks off and does not follow the strategy closely, it can materially affect the performance: we have heard from our users stories like: 
    •  I forgot to get into US stock last month, now it has risen so much, what do I do?
    • I didn’t want to purchase the stock ETF on the day of re-balance as it has risen so much. I would like to wait for a few days to get a better price. But it kept going up, what do I do?
  • Tax impact: by our estimate, for people in upper tax brackets, the TAA strategy can shave off 1-2% return for a taxable account. 

The first drawback is extremely important for many people: people sometimes are not paying attention (though just monthly or so) or what is worse, they would resist the re-balance instructions, hoping to get a better deal.

On the contrast, Strategic Asset Allocation, is more robust in terms of re-balancing timing as well as tax impact. But on the other hand, the buy and hold strategy can suffer from severe loss. It is thus the best to construct a so called core satellite portfolio that has both portfolios. This has been MyPlanIQ’s recommended investing style. 

Market Overview

Markets finally went on risk on uniformly across all risk asset classes.  From the major asset class trend ranking table on 360° Market Overview, all risk assets including Gold (GLD) and emerging market stocks (VWO) rose above cash (SHV). 

We copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

Portfolio Review

We compare two MyPlanIQ representative Tactical Asset Allocation portfolios with 3 other tactical allocation funds: 

Portfolio Performance Comparison (9/10/2012)

Portfolio/Fund Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
DWTFX 0.8% 5.8% -2.6% -31.9% 6.7% 43.5%        
GDAFX 0.8% 7.4% 4.9% 65.4%            
GTAA 1.1% 4.2% 0.8% 12.2%            
MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate 1.0% 6.5% 2.1% 31.6% 9.0% 77.9% 9.3% 78.2% 11.4% 95.6%
Six Core Asset ETFs Tactical Asset Allocation Moderate 0.2% 5.8% 1.2% 14.5% 6.3% 64.1% 8.0% 69.4% 10.1% 84.4%

*: NOT annualized

**YTD: Year to Date

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