November 30, 2020: Higher Return Portfolios: Part 2 | Better Financial Future -- MyPlanIQ

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 Tuesday December 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.

Higher Return Portfolios: Part 2

Our previous newsletter has drawn considerable interests from readers. Some are particularly excited on P Composite Momentum Scoring ARK ETFs. As this portfolio only invests in a subset of technology ETFs, we want to caution our readers that, from risk point of view, its diversification sits at the bottom of the chain Global Asset Allocation, Factors and Styles in US stocks, Industry sectors and then technology sector subgroup. The following table summarizes the types of the portfolios (see also Advanced Strategies):

Ticker/Portfolio Name	Diversification Level
P Composite Momentum Scoring Global Risk Assets	Global Asset Allocation
P Composite Momentum Market VFINX	US Stocks Index Level
P Composite Momentum Scoring Factor ETFs	US Stocks Factors
P Composite Momentum Scoring Style ETFs	US Stocks Styles
P Composite Momentum Scoring Fidelity Select Funds	US Stocks Industry Group
P Composite Momentum Scoring Industries ETFs	US Stocks Industry Group
P Composite Momentum Scoring ARK ETFs	US Tech Stock Sub Group

So the ARK ETF portfolio has the least diversification and thus highest risk/volatility.

In this newsletter, we want to look at the Industries ETFs portfolio in the above in more details and see that one can probably reap most benefits from this more diverse portfolio than the pure ARK ETF portfolio.

Industry ETFs

P Composite Momentum Scoring Industries ETFs was lastly mentioned in June 29, 2020: Industry Sector ETF Rotation With Composite Momentum. The portfolio consists of industry level ETFs (and many sectors or even broader level ETFs such as QQQ) as its candidate ETFs. It employs our standard composite momentum rotation strategy: our composite momentum indicator signals whether to have equity/stock exposure or just to invest in a safe intermediate term Treasury fund (IEI). If it’s safe to invest in stock ETFs, it will select two highest ranked ETFs from the candidates based on their trend/momentum scores.

The criteria to select the candidate ETFs includes minimum AUM (Asset Under Management) size: should be more than $500 million to ensure basic liquidity. We also eliminated redundant ETFs. Currently, the candidate ETFs are as follows:

Currently, there are 35 ETFs. Unfortunately, the AUM of SPDR S&P Insurance ETF (KIE) has fallen below $0.5 B ($500 M) because of the weakness in insurance sector, mostly caused by the pandemic and ultra low interest rates. We are still keeping this ETF (while monitoring it) as we believe there will be a good chance for these stocks to bounce back once the pandemic is over.

In the meantime, we are adding 5 additional ETFs to the list. ESPO, ARKQ and ARKF were too small six months ago but their AUMs have grown to be over $500M minimum requirement.

We would like to comment on ESPO, the gaming ETF. In general, the gaming industry is one of those ‘good’ industries. By ‘good’ industries, we mean there are certain industries (business models) that are inherently more profitable (because of little capital expenditure required, for example) and more defensive (i.e. the business has wide moat to defend against new comers) for established players. Basically, not all industries are created equal. O the other extreme, the famous examples of ‘bad’ industries include airline industry that requires high capital spending (for airplanes and maintenance etc.) and no much differentiation (commodity like as people mostly care about plan ticket prices than services). Gaming companies also enjoy enormous network effects as most games are naturally social (and thus companies don’t have to have huge user acquisition costs). In fact, it would be very interesting to formulate a portfolio that only consists of ETFs representing ‘good’ industries as candidate funds. This belongs to a separate subject.

The industry ETF portfolio vs. Fidelity Select portfolio vs. ARK portfolio

The following table compares the returns of the three high return portfolios:

Portfolio Performance Comparison (as of 11/27//2020):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR
P Composite Momentum Scoring Fidelity Select Funds	41.0%	49.3%	15.5%	19.0%	16.5%	16.8%
P Composite Momentum Scoring Industries ETFs	72.7%	78.4%	27.8%	33.8%	24.0%	19.0%
P Composite Momentum Scoring ARK ETFs	102.2%	100.6%	33.8%

Let’s first compare the Fidelity Select portfolio with the ETF portfolio since the ETF portfolio starting date (12/31/2000):

These two portfolios have almost identical returns for the whole period. However, one can see that the ETF portfolio lagged behind the Fidelity Select one until the middle of this year. If we narrow our comparison to the period since 2009 (as many ETFs have just recently started), we can see the two portfolios are very comparable until mid 2017 when the ETF portfolio started to outperform the Fidelity one dramatically:

If we look at the ETF portfolio’s historical holdings, we can see that the portfolio actually started to invest in ARK ETFs in 2017 or so:

So apparently, the ARK ETFs are the main factors for the ETF portfolio caught up with the Fidelity Select portfolio in recent years.

Now let’s compare the ARK portfolio with the industry ETF portfolio:

Though the more diversified industry ETF portfolio underperformed the ARK ETF portfolio somewhat, the difference is actually not big: 36% vs. 41% annually. The diversified industry ETF portfolio, for example, had a similar total returns in September 2019 when it invested in GDX (Gold Miners ETF) and ITB (iShares US Home Construction) (you can see the historical holdings by visiting this page and scroll to click on ‘Historical Transactions & Holdings’ tab and move the horizontal bar to any time to see the portfolio’s holdings). It actually invested in many other non-ARK ETFs from 2017 to 2019.

To summarize, the industry ETF portfolio provides more diversification than ARK ETFs and it captures majority of outperformance from ARK ETFs. On the other hand, the diverse candidate ETFs gives this portfolio an edge when the subset of tech companies invested by ARK ETFs loses favors.

Market overview

Investors are unfazed by the surging Covid19 hospitalization cases and daily number of deaths (we believe these two factors are more important than the number of infectious cases as this depends on the availability of testing). Economy will probably be affected, but hopefully not as bad as in March/April.

Economy wise, the Q3 earnings picture is very interesting: based on Factset, as of 11/20/2020, even though the S&P 500 is reporting a year-over-year decline of -6.3% in earnings, excluding just 3 worst industries, Oil, Gas, & Consumable Fuels, the Airlines industry, and the Hotels, Restaurants, & Leisure industry, the earnings would have grown 4% year-over-year for Q3! So investors pretty much forgo the few bad industries and nevertheless push stock prices to all time highs.

Ironically, the current bad-but-with-hope (vaccine) economy becomes the best friend for speculators: the bad situation keeps the government and central banks from loosening up their do-whatever-it-take stimulus policies while the hope presents a not far from distance bright future that all companies need to have eventually. But we all know that however how much farther the current markets can rise, the extreme over-valuation will eventually to push stocks back to their reality. For now, this doesn’t seem imminent.

As always, we should be very clear that all of the above reasons are just reasons. Given the current market conditions, one should be prepared for the worst. We should follow our strategies to navigate through this period:

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.

Stock valuation now reached another high. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that 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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