Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

We did portfolio re-balance today. For regular SAA and TAA portfolios, the next re-balance will be on next Monday, September 30, 2013. You can also find the re-balance calendar for 2013 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.

Please note that we now list the next re-balance date on every portfolio page.

Risk Management: Implementation Risk

In the previous newsletters, we address the two symmetric risks facing investors:

This newsletter discusses the third type of risk: implementation risk. 

You can have the best theory in the world but you can still end up being poor if you can not execute and apply your theory to the real world correctly. The implementation aspect of an investment strategy is an integral part in portfolio management. In fact, we have seen many great investors had some solid and convincing frameworks or theories but only stumbled in the actual implementation. 

There are two major types of implementation errors: 

  • Inconsistency: this is by far the most common error. For various reasons, investors behave inconsistently in portfolio management. Examples include
    • Second guess the pre-decided plan or strategy, refuse to follow rebalance and/or transaction instructions. 
    • Instead, commit to over trading: some become impatient, either because of recent low returns or because of seeing other people getting ahead, they would like to change their rebalance frequency on the fly. They think they can use shorter term trading strategy, just for this period (well, they are confident this period is very special). They think they can outsmart the market because of last time’s ‘success’. Well, just like gambling, if you execute based on your own hunches, you will mostly end up poorer after many games! 
    • Under trading: too busy to follow the strategy; don’t want to look at the portfolio when it has been down: remember in 2008-2009, most investors refused to even open their brokerage or 401k statements because they knew it won’t be pleasant. They would rather not touch them at all!
  • Trading errors: when executing rebalance orders, some people make mistakes such as executing orders at the open (we have stated many times that we don’t recommend open orders, for your ETF and/or stock orders, you should at least put your orders 30 minutes or an hour later). We did hear some users have trouble implementing their ETF portfolios. For those inexperienced or time pressing investors, low cost (index) based mutual fund portfolios are the way to go. They have much less chance to commit a trading error. 
  • Trading cost: most people just simply ignore the trading commission cost. Fortunately, we are seeing more and more brokerages provide extremely low cost or even free ETF tradings. For ETF and mutual fund investors, this problem is no longer as serious as it was before. 

Implementation risk specific to investment strategies

Like both downside and upside risks, different investment strategies can be subject to different implementation errors.  Again, we will discuss the two popular asset allocation strategies MyPlanIQ uses: 
  • Strategic Asset Allocation (SAA):  the good news for SAA is that it is less sensitive to implementation risk. For example, if you miss one re-balance in a well planned SAA portfolio with proper risk profile, it won’t be a big deal. Furthermore, the strategy is simple enough such that investors have much less chance to second guess it (assuming they are comfortable with the portfolio’s risk — which is the key). 
  • Tactical Asset Allocation (TAA):  Unfortunately, same can’t be said for TAA: compared with SAA, TAA is way more sensitive to implementation details. Furthermore, it is more error-prone. Because of the nature of TAA’s less diversification (at any period of time, TAA tries to overweight some assets while underweighting others, though it can select these assets and funds from a diverse array of candidates), errors such as skipping a re-balance can affect a TAA portfolio more seriously than an SAA portfolio. 

How to evaluate a fund (manager)

It often puzzles investors that from time to time,  many famous fund managers often falter in the mutual funds or ETFs they manage. However, these managers do have published (or continue to publish) their investment strategies or rationale for the economy or markets. Often these published strategies are sound and convincing. So what happened? 
Well, most times, these managers stumbled in implementation. Some of the errors we can see are
  • Did not follow the exact preaching: we know for sure some funds invest in a many sector or specialty segments, unlike the simple published model. Why? the most likely explanation is that the manager tries to out perform his own theory. But unfortunately, they often failed. 
  • Due to the fund size, some funds have issues implementing their strategies without affecting the market itself. This is especially true for some stock funds. Fortunately, for MyPlanIQ’s strategies, we focus on large segments: the lowest segment we recommend for most investors is stock style ETFs or mutual funds. These large major asset classes (such as US small cap value stock style or emerging market stocks) are large enough to trade or invest without creating any market distortion. 
  • Falters in small picture, right at big picture. Some macro based funds are right for the intermediate and/or long term market and economic trends. However, these funds fail to execute well in their daily portfolio management. Sometimes, the accumulated short term errors can amount to a large loss that is hard to be recovered, even if you are right eventually. Again, implementation matters. 
To summarize, implementing a well designed strategy is not a trivial task. It has to deal with both psychological challenge and technical details. Many investors overlook this area and make a series of mistakes. Implementation errors should be treated as a first class risk such as the downside risk. Investors should treat this as a must checked item when evaluating their own investments, investment strategies they use and investment mutual funds or ETFs

Portfolio Performance Review

Permanent and risk parity portfolios (see February 25, 2013: Risk Parity All Weather & Permanent Portfolio Review for some detailed discussion) took a big hit this year because of the weakness in bonds and precious metals. 

Portfolio Performance Comparison (as of 8/26/2013)

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
Bridgewater All Weather Portfolio Risk Parity -5.6% -3.5% 4.2% 5.8% 1.31 6.3% 1.29
Bridgewater All Weather Portfolio -4.0% -3.4% 5.9% 6.5% 0.98 7.7% 1.15
Harry Browne Permanent Portfolio -3.3% -3.9% 5.9% 6.9% 0.85 7.7% 0.93
Permanent Income Portfolio -3.8% -4.7% 4.8% 5.3% 0.74 6.2% 0.85
VFINX (Vanguard 500 Index Investor) 17.7% 19.7% 18.7% 7.4% 0.29 7.2% 0.3
VBINX (Vanguard Balanced Index Inv) 9.6% 11.5% 12.4% 7.1% 0.47 6.9% 0.49

*: NOT annualized

**YTD: Year to Date

See the more detailed year by year comparison >>

We expect the weakness of fixed income might continue (at least in a longer term time frame). These portfolios might enter a less favorable period. 

However, as illustrated in Permanent Portfolio Down But Their Active Version Keeps Humming, the TAA portfolio using the funds in the permanent portfolio holdings as candidate funds is just doing fine at the moment. 

Market Overview

We are no cheerleaders to the current market environment. So far, US stock markets are hanging tough while European markets following just fine. However, REITs, emerging market stocks and fixed income bonds are under constant pressure. To say the least, this is not a strong market. We call for cautions. 

For more detailed asset class trends, see  360° Market Overview.

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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