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Simple Steps for a Diversified Portfolio

path to a diversified portfolio
A diversified portfolio will reduce your portfolio volatility and allow you to sleep better at night. But, what does it actually mean to have a “diversified portfolio?”

Simple Actions for a Diversified Portfolio

Put half your money in an S&P 500 Fund (VFINX – Vanguard 500 Index in yellow) and half in US Treasuries (VUSTX – Vanguard Long Term Treasuries in green).

The red line is a 50%-50% blend, rebalanced monthly. The result is a nearly straight line up with very little volatility. In fact, you’ve heard that you should put some money in bonds and some in stocks. But you never understood why. This is called good risk-adjusted return and is the result of a quality diversified portfolio.

diversified portfolio - stocks and bonds

In the most recent market downturn since 9/20/2018, your red portfolio lost 4.81% while the yellow broad market lost 8.19%. Simple . . . but there is more.

A simple analysis to shift assets between bond and funds over the last 30 years turned $100K into $2,765,000 million with lower risk than owning just equities.

FastTrack’s database includes history back to 1988, so we can analyse these, and any other, strategy through multiple business cycles, bull and bear markets, interest rate hikes and cuts, and much more.

30 year history of a diversified portfolio

Only Scratching the Diversified Portfolio Surface

In this example we used two very big, very broad, very popular Vanguard indexes. Adding Emerging Markets, Commodities, Sectors, etc will further enhance portfolio diversity and boost returns. FastTrack’s software can easily model a new, extended portfolio of more funds, ETFs or stocks.

Next Steps

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Read more about Reduce Portfolio Volatility or visit our blog: https://investorsfasttrack.com/blog/

Reduce Portfolio Volatility

Portfolio VolatilitySince the S&P 500’s recent high on 9/20/2018, the S&P 500 has lost 8.47%. However, smart investors have options to reduce portfolio volatility, as there are many strong funds and stocks in sectors which:

  • Are attracting safety conscious investors
  • Have less volatility than the broad market
  • Are not highly correlated to the S&P 500
  • Funds are inherently diversified (Individual stocks are too risky for this analysis)

The remainder of this article describes the use of FastTrack tools to find these attractive, low volatility, diversified funds to reduce portfolio volatility (risk) and increase return of a portfolio which is losing value in current markets (Increase risk adjusted return).

Defining an Investment Universe

Defining a universe of candidates with FastTrack requires the Sieve. We start start with all no-load, low-fee, oldest share class, open end funds, plus all ETFs not including ETNs.
Use sieve to remove all bond funds. Bias toward all equities.

  1. Use sieve to remove all Short (bear) funds. No market timing gimmicks.
  2. Use the FastTrack spreadsheet to remove all funds with correlation >90% to the S&P 500. Bias toward reducing exposure to a broad bear market.
  3. Use Spreadsheet to remove funds with less than 1-year of daily history.
  4. Use the spreadsheet to remove all funds with recent volatility greater than the S&P 500 OR less than half the S&P. Bias toward less risk.

Analysis – Reduce Risk, Increase Return

We’re looking for funds that would increase return and reduce volatility of the S&P 500 index. First, ranking the 207 issues in the selected universe for the trailing one year (11/24/2017- 11/26//2018). Using a metric risk and return metric called NCAlpha, we picked three diverse funds from in the top 10 funds ranked by NCAlpha:

  • PSL – Invesco DWA Consumer Staples Mom ETF
  • PDFDX – Perkins Discovery
  • IHF – iShares US Healthcare Providers ETF

Below is a chart the shows a 33% / 33% / 34% mix of PSL / PDFDX / IHC rebalanced quarterly.

Returns
YTD
1 year
3 year
5 year
10 year
RDV$
22.8%
27.6%
45.9%
73.3%
392.0%
SP-DA
2.1%
5.1%
36.4%
63.9%
271.8%
Stats
Rtn
Ann
SD
UI
Corr
RDV$
73.3%
11.6%
3.9%
5.9
83.1%
SP-DA
63.9%
10.4%
3.7%
3.3
100.0%
DrawDown Stats
Max Draw
Length
Recovery Length
Peak Date
Valley Date
RDV$
(21.6%)
6
14
8/5/15
2/11/16
SP-DA
(13.1%)
7
2
7/20/15
2/11/16

Result – Reduced Volatility

The new portfolio found funds that backtested consistently better than the S&P 500 over many years, and had less drawdown than the S&P 500 for the period 9/20/2018 to 11/25/2018. While, the final portfolio was less diverse than the S&P 500. The top-ranked funds benefit from successful fund manager and index construction and the recession-proof nature of the health industry.

Next Step

Since the portfolio is optimized for down-trending markets, it will require reallocation to take full advantage of a bull market. Step 5 above should be changed to have a bias toward more risk.

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FT4Web Spreadsheet of Top Ranked Funds

FastTrack-Spreadsheet Top Ranked Funds

Smart Beta and High Yield

We’re highlighting smart beta and actively managed ETFs again this week. While still a small portion of the overall market (see the attached article), increased market volatility and rising interest rates are bringing investor interest back to active.

For now, mostly in bond products, but re: the attached article, international and emerging market products are picking up, with $239 billion in fund flows last year vs $692 billion flowing into passively managed funds

Here’s how you would use FT Cloud to investigate the investment prospects of the active high yield funds highlighted in the article.

  1. Load spreadsheet and click “Load Family” in upper right. 
  2. Expand the tree to “Funds & ETFs” >> “Fixed Income” >> High Yield. Double click high yield to load all high yield tickers into the grid on the right.  
  3. Next, expand “Funds & ETFs”>> “Company”>> “ETF.” Then single click “All-ETF” and the press the “And” button on the upper right. This remove any tickers that are not in both the “High Yield” and “All ETF” family. This will leave us with only the High Yield ETFs.
  4. Next click load and start analyzing the ETFs in the spreadsheet. Rank by risk, return, correlation, and performance compared to the benchmark. See last weeks article on how to choose a benchmark (https://goo.gl/fCQgHd)

https://www.cnbc.com/2018/03/19/seeking-downside-protection-investors-check-actively-managed-etfs.html

How to Choose an Benchmark – Market Indexes

We get lots of questions about indexes, specifically what are the appropriate indexes to use on the spreadsheet benchmark field. The short answer is… for US Equities use an US equity benchmark (SP-DA – S&P 500 div adjusted) and bonds use a bond benchmark (AGG-X – Barclays Aggregate Bond Ix) .

But, if you’re doing a more specific analysis, use a more specific index. For example:

High Yield: MLHY- Merrill Lynch US HY Master II H0A0 Index
Financial Equities: IYF-X ETFINDEX Financial Index
Preferreds: PFF-X ETFINDEX S&P US Preferred Stock Ix
Semiconductors: SCY-X ETFINDEX Semiconductor Index
BioTech – DJ-BT Indexfam DJ US Biotechnology Index
Global STocks – DJW-X Indexfam DJ Global Index
China – DJ-CB Indexfam DJ China Broad Market Index

FastTrack’s got an index family that lists all indexes in the database. Today we have over 400 and are adding more as they appear. Also, in FT Cloud you can click the “search” link at the top of every page to open the search window. There are you can ticker and key word search all indexes (as well as the rest of the database.)

While we’re on the topic of indexes, here’s an interesting article on the makeup of the popular AGG Aggregate bond index. Below is a great quote from the article. Like many traditional indexes, AGG is a market cap weighted index. While we all can understand this in equities (larger the value of combined equity the larger the weighting). For bonds though, it’s the larger the total outstanding debt, the larger the weighting. So… more debt (and sometimes leverage), the higher the weighting. Its not quite the same math.

“If you think about the construction of traditional indices, a market-cap weighting structure. It makes more sense in equities. On the bond side, it gets a lot harder. A market-cap weighting system where you give the highest weight to the most indebted issuers is not ideal,” ….

https://www.marketwatch.com/story/are-investors-getting-more-risk-with-passive-bond-funds-than-they-bargained-for-bis-asks-2018-03-14

A New Twists on Smart Beta

Smart beta is getting a lot of attention from the financial press and new products are coming to market daily. FastTrack is adding 20-30 a month. A great quote from the linked article speaks to the scale: “Investors handed $184 billion to smart beta ETFs from 2015 to 2017 while pulling $308 billion from equity mutual funds…”

What is smart beta? Essentially, a fund/ETF that tracks an alternative index vs a traditional market cap weighted index. The alternative index emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. Some more popular alternative index factors are equal weight, momentum, volatility, P/E, and combinations of them all.

Typically these indexes are re-calculated monthly or quarterly, with the security investments doing the same.

FastTracker’s have been there from the beginning, one of the first products launched was SPLV – powershares low volatility S&P 500 ETF launched in 2011. (If you’re a long time FastTracker, this should sound pretty familiar. Think… Sharpe ratio momentum model.)

What makes the Vanguard funds different and worth mentioning? Essentially its the trading frequency. Instead of re-balancing or re-allocating once a quarter, these securities take a more active approach and trade holding daily if necessary. This way as factors change, the holdings update immediately vs waiting for the end of the quarter. Per Vanguard, this should give a more effective factor exposure.

We’ve added the new securities to our database and I’m interested in a comparative analysis vs what’s on the market now. A great exercise for FT Cloud+ users is running a daily rebalanced portfolio vs a monthly or even a yearly rebalance momentum model. You’ll see trading more frequently rarely adds to return. I’m interested in seeing if these deliver something different.

VFVA – U.S. Value Factor ETF
VFLQ – U.S. Liquidity Factor ETF
VFMO – U.S. Momentum Factor ETF
VFQY – U.S. Quality Factor ETF
VFMF – U.S. Multifactor ETF
VFMV – U.S. Minimum Volatility ETF
VFMFX – U.S. Multifactor Fund Admiral
VMNVX – Vanguard Global Min Volatility Admr

https://www.bloomberg.com/gadfly/articles/2018-03-09/vanguard-crushed-active-investing-now-it-could-save-it