May 18, 2020: Core Satellite Portfolios In The Current Pandemic

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 Monday June 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.

Core Satellite Portfolios In The Current Pandemic

We have always advocated using both of Strategic Asset Allocation (SAA) (core) portfolios and Tactical Asset Allocation (TAA) (satellite) portfolios together (see here for a list of articles). The idea behind a core satellite portfolio is to combine the strengths of both types of portfolios:

The steady (buy and hold) nature of an SAA portfolio to complement/remedy losses caused from whip-saw or false negative risk reduction in a TAA portfolio.
The avoidance of big loss from a TAA portfolio to hedge the inherent market loss in an SAA portfolio.

The following table illustrates the benefits in different phases of a market:

	Early Bull	Late Bull	Bear	Side Way
Passive Buy and Hold (Strategic Asset Allocation)	Good	Good	Bad	OK
Tactical Asset Allocation	Miss	Good	Good	Bad

It’s thus interesting to revisit some of the core satellite portfolios we proposed before and see how they have performed so far in the current pandemic that probably falls into either Bear or Side Way phase.

50-70 Percent Risk Core Satellite Portfolios

The core satellite portfolios mentioned before consist of three parts:

Strategic buy and hold stock portfolio (portion)
Tactical stock portfolio (portion)
Bond portfolio (allocation)

50-70 Percent Core Satellite Balanced Portfolio shown in the following table is a balanced/moderate core satellite portfolio that can have at most 70% stock allocation. The portfolio consists of the following components:

(Core) Strategic stocks: 10% in DividendStocks VDIGX, 5% in USREITs VGSIX
(Satellite) Tactical stocks: 55% in a 200 day simiple moving average based portfolio: when S&P 500 is above its 200 moving average, buy S&P 500 (Vanguard 500 index fund VFINX), else invest in the total return bond fund portfolio same as below
(Core)Bond portfolio: 30% in a bond portfolio that chooses a fund with the top momentum score among a selected list of total return bond mutual funds. See fixed income investment portfolios.

The rationale behind this portfolio:

The strategic buy and hold stock portion is kept to be about 15%. It’s known that a conservative portfolio that always holds 10%-20% stocks can result in even better (lower) portfolio risk than an all bond portfolio. So we feel comfortable to allocation about 10% to 20% to a core (stratgic) stock portfolio, even for a conservative investor. Of course, this allocation can be even purposely increased when stocks are extremely undervalued. This is a topic warrants a separate discussion.
The allocation to the tactical portion can vary based on investors’ risk profile. For example, a conservative investor can allocate 10% to the core SAA portfolio and another 10-30% to the tactical part.
As always, we believe a tactical (active) bond portfolio can add major value. In our case, we want to utilize our total return bond portfolio that has outperformed even the best intermediate bond mutual funds for the past 10 years.

Steady portfolio performance

In the following table, we also add a new portfolio 50-70 Percent Core Satellite Global Balanced Portfolio that invests in a global tactical portfolio (based on AAC strategy) instead of the S&P 500 index moving average portfolio (US centric).

Portfolio Performance Comparison (as of 5/15/2020):

Ticker/Portfolio Name	MaxDD	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	Since 2001 AR
50-70 Percent Core Satellite Balanced Portfolio	17% (17%)	2.4%	4.1%	4.9%	9.1%	9.6%	9.6%
50-70 Percent Core Satellite Global Balanced Portfolio	16.3%(16.3%)	4.2%	6.2%	5.0%	8.3%	9.5%	10.2%
PRWCX (T. Rowe Price Capital Appreciation)	27% (42%)	4.8%	8.4%	8.4%	10.8%	9.1%	9.5%
VBINX (Vanguard Balanced Index Inv)	23% (36%)	4.7%	6.7%	6.3%	8.6%	7.1%	6.2%
VFINX (Vanguard 500 Index Investor)	34% (55%)	2.3%	8.0%	8.2%	11.8%	8.4%	6.2%

*AR: Compound Annualized Return, MaxDD: Maximum Draw Down (Peak to a following trough loss). In MaxDD column, the first is the MaxDD in Year To Date (2020) and the one in paranthesis is for the whole period since 2001. So YTD MaxDD for PRWCX, for example, is 27% and it has 42% MaxDD since 2001.

Last 3 month chart:

See detailed comparison data here.

We note:

The two core satellite portfolios have outperformed even the ‘best’ moderate (Morningstar 50% to 70% risk allocation category) mutual fund PRWCX for the past 15 years or longer.
They have outperformed popular Vanguard moderate index fund VBINX or S&P 500 index fund (SPY or VFINX) by very large margins (2-4% annually).
They achieved this with much less risk. In fact, about half (in the current pandemic period) or only 1/3 since 2001.
The two portfolios’ biggest drawdowns happened in the current pandemic, much bigger than those in 2008-2009.
50-70 Percent Core Satellite Balanced Portfolio had a whip-saw loss in the end of 2018 because of the false alarm of S&P 500 200 day moving average signal (it went to bonds in the end of October 2018 and then went back to S&P 500 in the end of November and then went to bonds again in the end of December). See below. However, the loss was mitigated with the strategic portion there.

To summarize, always holding 10% to 20% stocks in a portfolio can help stabilize portfolios returns, especially during a market turmoil. At the moment, as most tactical portfolios are sitting out of stocks due to the severe correction in March, this portion of stock holdings help to mitigate investors’ anxiety of being totally left behind in a strongly recovered market. On the other hand, the satellite tactical portion helps to avoid severe portfolio loss if the current crisis deepens to something more serious.

Market overview

The prolonged containment measures have worn thin many people’s patience. In addition, the US and many other European countries have entered a flattened and reduced Covid-19 pandemic curve (in terms of infection and death numbers). It’s no wonder that any good news such as the successful phase 1 Moderna’s vaccine trial will help propell strong stock strength. Unfortunately, soon, investors are pulled back to a reality in which economy recovery will take time and will be very uneven. Our opinion is that, given the existing high stock valuation, stocks will probably range bound for a while. Think another way, even in the absence of the pandemic, stocks will probably not go up very much in the current level.

Of course, as we have learned again and again, one’s subjective opinion is faulty all the time. That’s why we need to rely on a sound and reliable strategy (process). In reality, whether our subjective stipulation is correct or not is not important. What’s important is for us to stay the course and stick to our strategies. 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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