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

We just had a rebalance today. For regular SAA and TAA portfolios, the next re-balance will be on Monday, August 11, 2014. 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.

Portfolio Behavior During Market Corrections

One of our key investment principles is to observe market behavior objectively and scientifically. That means data analysis of historical markets, funds and portfolios under various market conditions or economic, political and other major events. These events can have a substantial impact on markets and portfolios. 

However, financial markets are full of noises. This problem is exacerbated by many hearsays, fables and even rumors from financial media and literature. Again, the best way to avoid this is to look at data objectively. 

Last week, we briefly mentioned the history of market corrections that exceed 10%. In this newsletter, we will try to utilize a powerful data and event analysis tool to understand how portfolios have behaved during these corrections. 

The following chart shows the total returns (i.e. dividend reinvested) of several portfolios and S&P 500 index fund (Vanguard 500 index fund VFINX) since 1991:

(Click to enlarge)

The portfolios in this study are as follows: 

  • P Relative Strength Trend Following Six Assets: this portfolio is a representative tactical portfolio using  MyPlanIQ Tactical Asset Allocation strategy. It has one of the longest back tested history since 1991. It uses the following mutual funds that have longest history in their asset classes: 
    • 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. 
  • Balanced Global Stocks: this portfolio has equal weight (33.3% each) on the three stock asset classes in the above. It is rebalanced annually. It is a Strategic Asset Allocation – Equal Weight portfolio.
  • Balanced Global Stocks and Bonds: in addition to the three stock asset classes, this portfolio also has US bonds. They all each have 25% equal weight. 

Each event represents a more than 10% correction that S&P 500 (VFINX) had. Since 1991, there have been 12 such corrections. The last one was 4/29/2011 to 10/3/2011.  The portfolios are compared: 

Portfolio Performance Comparison (as of 7/7/2014):

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
Balanced Global Stocks 5.0% 20.8% 10.1% 14.6% 7.3% 0.3
Balanced Global Stocks and Bonds 4.5% 16.9% 8.5% 12.1% 7.0% 0.41
P Relative Strength Trend Following Six Assets 5.8% 21.9% 10.1% 13.8% 11.8% 0.83
VFINX (Vanguard 500 Index Investor) 7.6% 24.3% 16.6% 18.7% 7.7% 0.34

See more detailed comparison data >>

What we found

 The following table shows the statistics for each portfolio (and VFINX): 

  P Relative Strength Trend Following Six Assets Balanced Global Stocks Balanced Global Stocks and Bonds VFINX (Vanguard 500 Index Investor)
min return -11.14% -53.18% -40.95% -50.74% 
max return 7.96% -1.85% -1.59% -10.79% 
average return -2.92% -19.74% -14.41% -20.59% 

 From this table, we can make the following observations: 

  • A simple diversification across stock markets, like Balanced Global Stocks which is diversified across US, European and Asia Pacific stock markets, does not reduce the maximum drawdown (or loss). In fact, in our study of the last 23 years, it’s biggest loss even exceeded US stock market’s biggest loss! Even in terms of average returns during these market corrections, the stock diversification across regions does not help that much (-19.74% vs. -20.59%). 
  • However, if one adds an equal amount (25%) of US bonds, both min return (or max loss) and average return have been improved a bit more than 25%, indicating a real diversification effect in terms of fixed income or bonds. 
  • The tactical portfolio has a dramatic improvement over the strategic buy and hold portfolios in these periods. The average loss is reduced to almost 1/10 of the VFINX and Balanced Global Stocks while maximum loss is reduced to 1/5!

The take away is that stocks and bonds should be really mixed to defend portfolio loss during market downturns. Geographical stock diversification does not help in these downturns. The real winner in the downturns is the tactical strategy. 

Portfolio Review

A simple trend following tactical strategy is to use a simple moving average for each asset class. When the index fund in an asset class falls below the moving average, this portion of the portfolio goes to cash. P Diversified Timing On Endowment Asset Allocation Model SMA 10 Months With Long Treasury is such a portfolio that allocates equal amount to 5 core asset classes. 

(as of 7/7/2014):

Ticker/Portfolio Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
P Diversified Timing On Endowment Asset Allocation Model SMA 10 Months With Long Treasury -0.3% 6.6% 10.1% 2.04 3.7% 0.56 8.7% 0.9 7.0% 0.7
VFINX (Vanguard 500 Index Investor) 0.9% 7.6% 24.3% 2.41 16.6% 0.98 18.7% 1.18 7.7% 0.34
VBINX (Vanguard Balanced Index Inv) 0.2% 5.5% 15.3% 2.42 10.6% 1.1 14.0% 1.45 7.3% 0.52

Such a simple portfolio has done very well over time, considering that it has achieved similar results as a buy and hold portfolio (such as VBINX) but with a much smaller maximum drawdown (or loss): 11.5% vs. VBINX’s 36%!

Market Overview

Although there have been several indications that global economies (especially the US) have slowly recovered back, given its pace and the currently excessive stock valuation, we are cautious. In fact, we have been holding such an attitude ever after the financial crisis. However, in our investment portfolios that have been carefully planned out for their risk tolerance, we stay on course and follow them. So far this (along with historical evidences, has serves us well. 

At the moment, risk assets are bubbly. However, as history has taught us numerous times, the timing for bubble burst is hard to predict. The best one can do is to prepare/scale back our risk exposure to a comfortable level while in the meantime, don’t second guess markets and follow a solid investment plan.  

For more detailed asset trend scores, please refer to 360° Market Overview.

We would like to remind our readers that markets are more precarious now than other times in the last 5 years. It is a good time and imperative to adjust to a risk level you are comfortable with right now.  However, recognizing our deficiency to predict the markets, we will stay on course. 

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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