Re-balance Cycle Reminder

We just had our re-balance today. Based on our monthly re-balance calendar, the next re-balance time will be on MondayNovember 19, 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.

Asset Allocation And Fund Selection

At MyPlanIQ, we believe that asset allocation is the most important determining factor for the return and risk of an  investment portfolio. This is supported by several academic studies:  in a study of hundreds of US pension funds by Gary Brinson, Randolph Hood and Gilbert Beebower, it was found that asset allocation is responsible for over 90% of variations in portfolio return. 

Intuitively, asset allocation is about weighting in the array of assets through the underlying candidate funds. Funds in an asset class (such as U.S. stocks) are strongly correlated: meaning that when one falls (rises), it is highly possible for the other in the same class falls (rises) — in fact, these are supposed how funds are classified into a same asset class. Simply put, when the general stock market falls, it is rare to see a stock fund rises or vice versa. Academically, weightings in asset classes are called Beta factors. 

Strategic asset allocation  (SAA) tries to capture long term asset movements while Tactical Asset Allocation (TAA) tries to utilize intermediate term asset trends to position a portfolio. 

The secondary factor is to choose funds for asset exposure. Academically, this is called Alpha factor. It is debatable whether a fund selection can make how much difference. But again, several long standing studies indeed indicate that fund selection does make a difference. For example, in an article published in Journal of Asset Management (May, 2007), B. Arshanapalli , L. Switzer and K. Panju concluded that active multi-style rotation strategies can be devised to outperform the best performing buy-and-hold portfolio. 

Here are some of the factors we consider when making fund selection: 

  • Prefer funds that are broad base diversified. Avoid specialty funds such as sector or industrial funds. Or if it is desired, control the weights in these specialty funds. Specialty funds include funds like financial sector fund such as XLF (SPDR Financial Sector) or Gold mining stocks (such as GDX).  Don’t be confused with some ‘special’ specialty funds such as Gold (GLD) funds, US REITs (Real Estate Investment Trusts) funds (such as VGSIX). These funds are actually representatives for asset classes. 
  • Avoid highly volatile or risky funds — if a fund has a high standard deviation or draw down, this fund should be strictly controlled. 
  • Do not select expensive funds, only if their performance is justified. In our fund selection, we use Sharpe ratio for SAAs and Trend Score (total return weighted) for TAA. 
  • Choose index funds with lowest cost or expense ratios. 

Many times, we were asked about alternative fund selection, sometimes due to out dated funds in a plan, sometimes due to proxy funds or due to funds closed to new investors (or requiring higher minimum). Users should use the above criteria to choose a substitute fund. In general, a rule of thumb is to choose a low cost index fund (if it is possible) or a broad base diversified fund. Choosing these funds won’t go much wrong based on the property (asset allocation being the key factor)  mentioned above. However, one should be very careful about using sector or specialty funds. 

Let’s take a look at the two plans: Six Core Asset ETFs and MyPlanIQ Diversified Core Allocation ETF Plan.

The Six Core one has one fund for each asset class, so there is really no fund selection effect. The performance of its three model portfolios in the following table shows how much difference different asset allocation (especially the two SAAs and TAA) strategies can make: in the last 10 years period, TAA out performed SAAs by 2% or 3%. 

Moving to the MyPlanIQ Diversified Core plan, which has 43 funds. This plan represents a much more diversified ETF plan that has multiple funds for each asset class. For example, there are 14 funds for U.S. equity class. 

For this plan, the performance has two components: asset allocation and fund selection. One can do a diff between the two portfolios using the same asset allocation strategy — one for Six Core and one for the MyPlanIQ Diversified Core. The difference would be the fund selection contribution: 

For SAA – Equal Weight, the 10 year Annual Return (AR) difference is about 8.2%-8.1% = 0.1% out performance by MyPlanIQ Diversified Core. 

For SAA – Optiomal, the 10 year out performance is about 9.6%-7.1%=2.5%

For TAA, the 10 year out performance is about 11.2%-10.1% = 1.1%. 

Portfolio Performance Comparison (as of 10/12/2012)

Portfolio/Fund Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
Six Core Asset ETFs Tactical Asset Allocation Moderate -0.8% 5.9% 6.8% 132.0% 5.5% 49.0% 6.3% 52.4% 10.1% 84.1%
Six Core Asset ETFs Strategic Asset Allocation – Optimal Moderate -0.9% 9.1% 10.9% 101.1% 7.9% 65.7% 2.5% 12.9% 7.1% 44.3%
Six Core Asset ETFs Strategic Asset Allocation – Equal Weight Moderate -0.6% 7.5% 9.6% 91.3% 8.1% 68.6% 3.0% 15.7% 8.1% 51.3%
MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate -0.6% 6.1% 9.0% 152.0% 6.5% 57.6% 7.1% 60.7% 11.2% 94.4%
MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation – Optimal Moderate -1.0% 8.8% 11.2% 105.1% 9.0% 75.8% 4.5% 26.4% 9.6% 66.1%
MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation – Equal Weight Moderate -0.4% 7.6% 9.1% 97.1% 7.7% 73.3% 2.2% 12.6% 8.2% 58.1%

*: NOT annualized

**YTD: Year to Date

 Of course, the above comparison is just one data point. We encourage readers to look at many portfolios listed on to understand performance patterns. 

Market Overview

There hasn’t much under current change recently: risk assets are staying at high elevated levels but recently have drifted lower. Though we are entering a seasonally favorable period for stocks, fiscal cliff, on going European debt crisis and the election can all affect markets significantly, let alone we are now entering quarterly earnings report period. 

Gold and commodities also experienced some weakness. However, Gold is still in its mega up trend. 

See 360° Market Overview for more asset class trends.

We remain deeply skeptical on this rally. 

We again 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. 

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