Sector Bullish Percent Indicators are relatively new to ITA Wealth management. While I am not a believer in building a portfolio through sectors, I do follow them as there may be opportunities to add a particular sector to a portfolio built around asset classes. For this reason, I track the Bullish Percent Indicators (BPI) as shown in the data table below. The reason I favor asset allocation vs. sector allocation is that all sectors do not cover all asset classes, but all asset classes will cover all sectors.
How does the performance of a DFA oriented portfolio perform when compared with the Euclid Portfolio, one of the older portfolios tracked here at ITA Wealth Management? I selected the Euclid as it is one of the poorer performing portfolios over the last thirteen years. The reason for the lagging performance is that I allowed too much cash to site idle in the portfolio for long periods of time. In other words, stupid portfolio management.
Keeping in mind the inherent possible errors when making comparisons between portfolios, here are the results between what I will call the DFA Portfolio and the Euclid Portfolio.
Beginning on 6/18/1999 and ending on 6/329/2012, the DFA Portfolio had an annualized return of 5.8% with a standard deviation of 9.11%. That is a low SD considering the market volatility over the past 13 years. Over this same period, the QPP software indicates the S&P 500 had an annualized return of 1.3% with a SD of 16.1%. The DFA Portfolio performance was far superior to benchmark standards.
My calculation for the VFINX, a mirror of the S&P 500, had an annualized return of 4.2%. Why the huge difference between QPP results and my results gleaned from the TLH Spreadsheet? Tracking the Euclid Portfolio using the TLH Spreadsheet takes into account the cash added to the Euclid over the 13 year period. Cash flowing into the portfolio was not trivial and that gives rise to the difference between the 1.3% reported by the QPP software and the 4.2% value calculated by the TLH Spreadsheet. This difference is one of the inherent potential errors I mentioned when I wrote about the difficulties of comparing portfolio performances. The link to this blog article is provided above.
How well did the Euclid perform? Not well as the annualized return from 6/18/1999 through 6/29/2012 is 2.4% or well below that reported for the DFA Portfolio. Subtract 90 basis points from the DFA portfolio and it still outperforms Euclid by 2.5% points each year. That is anything but a trivial difference. I would have been better served to pay the fees and turn the portfolio over to the DFA advisor.
How well did the DFA Portfolio perform when compared with the total U.S. Equities market (VTSMX)? Minus fees, the DFA portfolio outperformed the VTSMX by a mere 0.1% point. Yes, it did better than the U.S. Equities market, but the difference is slight. If there was any slippage in rebalancing the DFA Portfolio, it is highly unlikely any alpha was added by the DFA advisor. It is impossible to answer this question with any certainty.
There you have it. By selecting a poor performing portfolio from the ITA stable, I was able to find a situation where a DFA portfolio performed much better than one of the ITA Wealth Management portfolios.
Just a note to Platinum members. If you closely monitor your portfolio, take a broad diversification approach to portfolio construction, and avoid three sigma bear markets by implementing the ITA Risk Reduction model, there is a high probability you will not need professional help.
Is it fair to compare performance results of different portfolios? ITA Platinum members have see a number of comparisons on this blog and I plan to publish more results. However, there are inherent problems when it comes to portfolio performance comparisons. Let me list a few as it is important to keep in mind these problems.
1) When selecting a sample portfolio from a web site or using the "Swensen Six" as examples, there is no way the asset allocation is going to stay in the exact percentage balance over the course of the study. This leads to incorrect performance results from portfolio to portfolio. See rebalancing issue below.
2) In most portfolios, cash flows in and out of the portfolio. Calculating performance results based on starting and end dates does not take cash flow into consideration. Those changes are recorded in portfolios tracked by the TLH Spreadsheet, but not in the portfolio picked off the Internet.
3) Strategic Asset Allocation plans differ from portfolio to portfolio. Direct comparison is difficult to pull off.
4) Exactly when asset classes are rebalanced differs from portfolio to portfolio. This will throw off the comparison results.
How could one set up a situation for a fair comparison? The best way is to divide a sum of money equally between two investors. Agree on a starting date and then check results 20 years later.
Bullish Percent Indicator (BPI) information is a relatively new addition here at ITA Wealth Management. It is another investment arrow we are including in our investment quiver. A major change I made this week is to move from an arithmetic measurement of the box size to a log or percentage scale for calculating the box size. Just as it makes sense to calculate portfolio increases or decreases in percentages, the same is true when examining the box sizes of a Point and Figure graphs. This shift from an arithmetic to percentage scale did result in the NYSE moving from O's in the right-hand column to X's in that column. Regardless of the switch, the absolute number of stocks moving into bullish territory increased this week, indicating the market strengthened. Below is the latest information on the major indexes.
The Schrodinger Portfolio is our premier passively managed portfolio that has been operational since 12/01/2000. Looking back over the past five years (6/29/2007 – 6/29/2012), how well has this portfolio performed when compared to a portfolio made up of DFA mutual funds with a similar asset allocation plan? The results are rather stunning in favor of the Schrodinger.
Schrodinger Portfolio = 4.17% annualized return with a standard deviation of 19.1%.
DFA Portfolio = 1.4% annualized return with a standard deviation of 17.13%. Advisor fees of 50 to 90 basis points need to be subtracted from the 1.4%. In other words, net of fees, the DFA Portfolio returned below 100 basis points annually over the past five years.
The Schrodinger outperformed the DFA portfolio by over 3% points annually.
Disclaimer: I need to examine performance over different periods as this may have been a particularly bad period for DFA mutual funds.
Save the Fees
Save the fees and manage your own money using low cost ETFs. You are going to be dollars ahead and here is the evidence. Let me describe the process I went though to come to this conclusion – and I am not finished with the analysis. This data is not going to win me friends among DFA advisors.
I logged on to one of the premier web sites on the Internet to find examples of recommended portfolios. There were ten options and I have yet to analyze all of them. I first selected the most aggressive portfolio, expecting it would yield the greatest returns as the five-year period includes the great bull market beginning in March 2009. The period of analysis I selected runs from 6/28/2007 through 6/28/2012. When the data available, I can include information from today.
Return from Portfolio X = 1.43% annualized with a standard deviation of 23.38%. These are actual historical results, not projections into the future. I can provide projected data, and will at some point.
Platinum readers have frequently read about the "Swensen Six" portfolio, so I ran the numbers on that simple portfolio. Here are the results.
Swensen Portfolio = 5.28% annualized with a standard deviation of 16.9%. The Swensen outperformed the aggressive Portfolio X by 3.85% annually, and did it with lower risk.
There are no fees associated with the Swensen as all six ETFs are commission free for TD Ameritrade customers. With Portfolio X, management fees are somewhere between 50 and 90 basis points depending on the size of the portfolio. And the fees are annualized so choose one of the numbers and subtract that from the 1.43% return. The annualized return is below 100 basis points annualized.
With this data in mind, are you going to believe the sales talk that an advisor can add alpha to a portfolio by providing access to DFA mutual funds?
Disclaimer: 1) Other time periods need to be selected to make sure this was not a unique case. 2) Other asset allocation plans need to be tested. For example, I will run a test using the Schrodinger Portfolio as it is a passive portfolio. 3) Less aggressive portfolios need to be selected from the Internet web site. Below is the data from one more portfolio.
After running a test on the most aggressive portfolio, I selected the portfolio smack in the middle of the tame to aggressive line-up of portfolios. Here are the results.
Portfolio Y = 1.86% annualized return with a standard deviation of 12.8%. While this portfolio was less risky compared to the Swensen Six, the performance still lagged by 3.42% points – annualized. Once more, one needs to subtract at least 0.50% from the 1.86% return. Fees are a drag on performance.
Platinum members can manage their own portfolios. Cut fees, increase returns, and do it with a less risky line-up of non-managed index ETFs.
With all the negative news one picks up, are you aware that the stock market is showing signs of strength, particularly when the different sectors are analyzed? Tomorrow, I will be posting the latest data on the Bullish Percent Indicators (BPI) for the broad markets as well as ten sectors.
This morning the NYSE BPI is showing that the offense has the ball as there are X's in the right-hand column. When I checked the ten sectors, five were positive. The specifics will be posted tomorrow.
My last sector test was to examine ten individual sector ETFs. These are not to be confused with the BPI for the ten sectors. Of the ten individual sector ETFs, nine are currently showing X's in the right-hand column. We need to watch what happens in July as these positive results may be due to money managers polishing their portfolios for the end of the second quarter.
When one has been saving and investing as long as I have, it is easy to forget many of the initial steps necessary to launch and manage a portfolio. In this blog post, I will attempt to fill in a few gaps, and even with this effort, I will most likely miss something. That is why I appreciate questions. I am using the Gauss Portfolio as my model for several reasons. 1) It is a young portfolio and therefore does not have a lot of entries. Beginning investors can adapt it for their own purposes. 2) All seventeen asset classes are used and activated. It is easier to not use one or more asset classes vs. want to use them but not have them available in the portfolio. 3) It is one of the five ITA Risk Reduction model portfolios. Readers tracking this portfolio can see how I am using this model to increase return while reducing risk.
Gauss Dashboard: After saving sufficient monies to open a discount broker account, one of the first required steps is to lay out an asset allocation plan. I've written about a number of model portfolios over the years on this blog. There are many models available on this blog. If the seventeen asset class portfolio shown below is too complicated, then examine the "Swensen Six" as explained in this article. Determine the number of asset classes to use and then locate commission free ETFs to populate each asset class. If anyone has any questions as to what ETFs I use for the different asset classes, a list is shown in the second screen shot.
Portfolio ETFs: In this blog post I am not interested in the performance numbers. Instead, readers should concentrate on the individual ETFs that make up this portfolio. Note how the selection of the ETFs provide global coverage. Diversity is one of the keys to setting up a portfolio that has the potential to serve the client well over a lifetime of investing.
After the broker account is open, asset classes identified, and percentages allocated to the different asset classes, what does one do at this juncture? Let's use U.S. Equities or VTI as the first example. Since we want to be involved in the U.S. market, I will assume all investors will hold some percentage of VTI in the portfolio. If you are using another investment vehicle to represent the U.S. market, the principles will be the same.
Is it time to buy VTI or should I wait? As I am writing this, the price of VTI is slightly above its 195-Day EMA. That indicates a buy is in order. However, our second check is the Point and Figure graph (PnF) and it is telling us to be cautious. Here is the link to the PnF graph. Please note that this can change today if the market were to move up sharply. What would I do? I would invest approximately one-fourth of my Large-Cap Blend (VTI) allocation to this ETF and continue to do so each month so long as the price stays above its 195-Day EMA. If the price drops below the 195-Day EMA, I would suspend adding new money until the price goes back up above the EMA.
Should the slope of the line in the PnF graph flip from positive to negative, I would consider selling off my positions in VTI, but be careful not to incur any short-term trading costs. If the price of VTI were to rise sufficiently to cause the PnF graph to show X's in the right-hand column, I would max out the investment in VTI or the Large-Cap Blend asset class.
Now let's take another example asset class that is not on the cusp of a buy as we have for VTI. Examine the situation for VOW, our emerging market ETF of choice. Once more, VWO is a low cost ETF with an expense ratio of 20 basis points. For TD Ameritrade customers, it is commission free so long as you sign up for this service. There is no reason not to request this service.
Once more we examine two graphs for VWO. 1) The price and 195-Day EMA graph is our first point of examination. The current price is not even close to moving from below to above the 195-Day EMA as the separation is a few dollars. We need to look further into the PnF situation. 2) Examine the PnF graph for VWO. This graph is also telling us to stay in cash with our VWO monies or emerging market dollars, as we are in a state of decline. Supply exceeds demand in this asset class and it is not time to make a purchase.
We walk through both of these technical graphs for each ETF, making decisions one at a time. Let's take one more example, real estate. If you look at the above Dashboard for the Gauss Portfolio you will observe that REITs are well below the target percentage. If today were review day for the Gauss Portfolio, what would I be doing with VNQ, my domestic REIT ETF of choice?
Not visible on any of the screen shots, but available within the Gauss TLH Spreadsheet is a table telling me how many shares of VNQ are required to bring the REIT asset class back into balance. Twenty-six shares are required so I would place a limit order for 25 shares of VNQ when the timing signals are positive. So let's look at the two critical graphs to see what they are telling us.
Examining the price and 195-Day EMA graph, I see where the price of VNQ is above the Exponential Moving Average. That is definitely a Buy signal. Now we move on to the PnF graph for confirmation. This graph confirms VNQ is a Buy. Since we are dealing with a commission free ETF we can purchase it in small increments. I suggest setting limit orders for five shares at a time until we have purchased the required 25 shares needed to bring this asset class back into target.
If this were the fall and the election were over, I would likely jump in and purchase all 25 shares and be done with it. However, as we enter the summer months, there is a high probability we will be provided with the opportunity to pick up shares of VWO at lower prices than are currently available.
Index Funds Advisors Asset Class Comparison: As promised yesterday, the third video talk from Index Funds Advisors is located at this URL. Mark Hebner provides the large picture of the relationship between return and risk. If you missed the first two presentations, go back to this blog entry to pick them up. While you are on the IFA web site, I recommend each reader take the Risk Capacity Survey if you have not already done so. It is free and it will give you an idea how much risk you are willing to take with your investments. Most of the portfolios here at ITA fall between 55 and 80 on the IFA portfolio risk number scale.
Just a few comments about the make-up of IFA portfolios. In my opinion, holding anything below 3% in an asset class does not make sense as small percentages will not contribute significantly to portfolio performance. My preference is to hold a minimum of 5% in an asset class. Otherwise, one is playing mental feel-good games with the asset allocation plan.
You will note that Hebner does not advocate using Large-Cap Growth or Small-Cap Growth asset classes in his portfolios. From my studies, pushing these two asset classes that far down into the South East Quadrant is not born out of the facts. In other words, the return is higher and the risk lower than he shows on his Big Chart. As an investor, if you wish to reduce the number of asset classes in a portfolio, you can gain plenty of exposure to the growth side of the investing spectrum by using VTI, VO, and VB. In particular, VO and VB as blend ETFs will provide exposure to stocks that fall into both the growth and value sides of the U.S. Equities market. I don't want to quibble with Index Funds Advisors on this point as they are interested in skewing portfolios to the value side and I understand that bias. It is based on Fama-French studies.
Where Dimensional Fund Advisors (DFA) investors have an advantage is access to small-cap international value index funds. Also, there are pricing advantages in how DFA construct their index funds. The negative is that one pays 90 to 100 basis points for this access as one must go through an approved advisor to purchase DFA funds. Over a lifetime of investing, this fee adds up to a lot of money. If you doubt this fact, check out this article and all the associated links for more information.
Remaining on the right side of the market is critical to reducing portfolio risk. Platinum members should be well aware of the ITA Risk Reduction model, our first line of defense. Remember Faber's axiom that ETFs are more volatile when they are priced below the 200-Day Simple Moving Average. Here at ITA we use a faster EMA, but the difference is not significant and the principle is the same. Most investors will want to stop right here and work with this basic, and easy to understand risk reducing model. Investors wanting a little more protection in addition to the price and 195-Day EMA relationship can move to the second line of defense.