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

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Friday May 1, 2020.

Please note: As of March 1, 2020, we officially phased out our old rebalance calendar for both SAA and TAA. They are now always rebalanced on the first trading day of a month. 

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.

Multi-Factor ETFs And Rotation

Previously we devoted several newsletters on factor ETFs and multi-factor ETFs as we believe key stock factors can indeed improve long term returns over a vanilla market capitalization based stock index such as S&P 500 index (SPY). Specifically, we believe the following four factors can be used to construct a better US stock portfolio (again, over a broad base index such as S&P 500): 

  • Value factor: invest stocks with lower valuation (i.e. cheaper)
  • Momentum factor: invest stocks with high price momentum
  • Quality factor: invest stocks with high quality (i.e. consistent profit) underlying business
  • Low Volatility factor: invest stocks with lower overall portfolio volatility when put together

Note: low volatility factor does NOT simply mean picking stocks with low volatility, instead, it’s to choose stocks to form a portfolio with low volatility. See October 14, 2019: Low Volatility Factor ETFs.

See, for example, October 28, 2019: Multi-factor ETFs vs. Equal Weight Multi-Factor Portfolios  for more details on these four factors. 

In this newsletter, we first review popular factor ETFs and multi-factor ETFs. We then look at how our multi-factor rotation portfolio has done recently. 

Recent performance of factor ETFs 

Let’s first take a look at the four representative (and largest) factor ETFs’ YTD (Year To Date) returns:

Their more detailed return data (as of 4/20/2020):

ETF YTD
Return**
1Yr AR 3Yr AR 5Yr AR
VTV (Vanguard Value ETF) -19.7% -10.6% 3.7% 5.4%
MTUM (iShares MSCI USA Momentum Factor) -6.6% 5.4% 13.4% 11.7%
QUAL (iShares Edge MSCI USA Quality Factor ETF) -13.1% -3.0% 8.1% 8.0%
USMV (iShares MSCI USA Minimum Volatility) -10.3% 0.4% 8.7% 9.1%
GSLC (Goldman Sachs ActiveBeta US LgCp Eq ETF) -11.8% -1.1% 8.7%  
LRGF (iShares Edge MSCI Multifactor USA ETF) -16.8% -9.1% 2.9%  
SPY (SPDR S&P 500 ETF) -12.5% -2.4% 8.1% 8.0%
VTI (Vanguard Total Stock Market ETF) -13.9% -3.7% 7.3% 7.2%

From the above, we can observe what happened in the recent crisis:

  • Momentum and low volatility ETFs (MTUM and USMV) have done the best in the crisis, while Value (VTV) did the worst. In fact MTUM’s YTD loss is only 1/3 of VTV’s.  
  • Both MTUM and USMV did better than SPY YTD, 1 yr, 3 yr and 5 years. Quality (QUAL) is about the same as SPY. 
  • Value has definitely lagged behind so far for the past 5 years. 
  • Multi-factor GSLC did slightly better than SPY. On the other hand, to be fair, as most factor ETFs are choosing stocks out of MSCI stock index, GSLC did better than VTI. However, LRGF, an MSCI multi-factor ETF, did much worse than VTI. This indicates a difficulty to just simply use all four factors to outperform a broad base stock index. 

Factor rotation using composite momentum

The portfolio P Composite Momentum Scoring Factor ETFs listed on Advanced Strategies uses momentum scores to pick the top performing ETF out of the four ETFs MTUM, VTV, QUAL, USMV mentioned above monthly. Furthermore, it also uses a market indicator that’s based on broad base stock index momentum and other factors including market divergence, credit spreads and valuation to decide whether to have exposure in stocks or just simply invest in an intermediate term Treasury ETF (IEI or VFITX). For example, it decided to turn the portfolio to Treasury bonds by the end of February this year. 

The following table compares the recent returns (as of 4/20/2020):

Ticker/Portfolio Name YTD
Return**
1Yr AR 3Yr AR 5Yr AR 5 Yr Max Drawdown 
P Composite Momentum Scoring Factor ETFs -5.5% 7.1% 15.1% 12.8% -18%
Multi-factorEqualWeight -12.5% -2.1% 8.2% 8.6% -34%
GSLC (Goldman Sachs ActiveBeta US LgCp Eq ETF) -11.8% -1.1% 8.7%   -34%
USMC (Principal US Mega-Cap Multifactor ETF) -7.7% 2.3%     -30%
LRGF (iShares Edge MSCI Multifactor USA ETF) -16.8% -9.1% 2.9%   -36%
SPY (SPDR S&P 500 ETF) -12.5% -2.4% 8.1% 8.0% -34%

Multi-factorEqualWeight is a static portfolio that invests equally in the four factor ETFs. 

As a comparison, we list the table listed in last October (see this):

Portfolio Performance Comparison (as of 11/1/2019): 
Ticker/Portfolio Name YTD
Return**
1Yr AR 3Yr AR 5Yr AR 5Yr Sharpe AR Since 7/19/2013
P Momentum Scoring Factor ETFs Momentum Value Low Volatility Quality 23.2% 18.4% 21.0% 15.7% 1.11 15.7%
Multi-factor EqualWeight 22.3% 14.1% 15.7% 11.8% 0.88 12.7%
VFINX (Vanguard 500 Index Investor) 24.2% 14.1% 15.4% 10.8% 0.75 12%

Observations: 

  • The simple minded Equal Weight 4 factor portfolio did poorly compared with GSLC, which wasn’t the case when we looked at them in last October. This indicates that GSLC was able to do a better job in the current crisis. 
  • All of them did much worse than the momentum portfolio. In fact, this portfolio has done a way better job than SPY: for the past 5 years, 4.8% annually better and for the past 3 years, 7% annually better! 

We attribute the outperformance to the following three factors: 1). factor ETFs can outperform in a long period of time. 2). momentum based rotation can improve returns dramatically and 3). tactically reducing stock exposure during a market stress can further avoid big loss and improve returns. 

To summarize, factor ETF rotation with tactical stock exposure adjustment can be a very useful improvement over a general broad base stock market index such as SPY or VTI. The three factors behind the improvement are intuitive and have been widely studied and practiced. 

Market overview

We are learning more and more about the nature of Covid-19 pandemic. Several developments are worth mentioning: firstly, most of U.S. and Europe are now entering a flattened phase: declining number of infections and plateau or declining death numbers. Secondly, the total US Covid-19 death rate projected by IHME again came down a bit: it now expects the total number of death to be about 60k, lower from 68k last week. Thirdly, there have been some indications that the infection might be much more widely spread (see for example, the LA county study). If this is true, it would imply the fatality rate is much lower, probably will be somewhat comparable to a severe flu (note, even in this case, the exponential growth of infections of this pandemic is still distinctly different and more serious than a flu: it can collapse a health care system with large number of cases in a short time). Finally, there have been some good progress in terms of cure and vaccination development. 

Financial markets have staged a huge comeback. At the moment, S&P 500 index is only about 15% or so lower than its all time high in February. Investors are probably encouraged by both the central bank/government’s unprecedented strong monetary and fiscal policies, the possible reopen of economy and the rosier developments of the pandemic mentioned in the above. Even though we are now entering an earnings report period, investors seem to  simply shrug off bad earnings news at the moment. 

However, as this novel virus is a totally new thing and it takes time to fully understand, one shouldn’t draw any definite conclusion too quickly. In our opinion, even in the best scenario: if this turns out much milder than expected, the social distancing and containment efforts are still required unless the society accepts the great number of deaths (and/or possible unknown health effects on those recovered) if containment efforts are abandoned: in this case, 100 million to 200 million Americans will be infected and even if we assume a ‘flu-like’ 0.2% fatality rate, it would mean 200k to 400k deaths!

Regardlessly, the pandemic’s impact on the economy will be (and so far has been) significant, serious and damaging. As mentioned previously, for example, (more) debt burdened businesses will need a much healthier underlying economy to survive and grow. At the moment, it’s extremely hard for us to fathom such visibility in the coming months. 

In times like this,  we again emphasize the following: 

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

For more detailed current market trends, please refer to 360° Market Overview.

In terms of investments, stocks are somewhat cheaper. Investors should not be swayed by the current market volatility and economic distress, instead, they should stand ready to take advantage of the opportunities. For most Americans, we offer the following Winston Churchill’s remark made in the darkest days of World War II: “The Americans will always do the right thing, but only after they have tried everything else.” As a country, the US (and the rest of the world) will get over this, as always, even after stumbles. The past development has been very supportive to our optimistic long term view so far. 

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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