Alternative Portfolio: Increasing Allocation to PAAIX

Last week I published two portfolios that included the private equity ETF, PSP.  Here are links to the first and the second portfolios.  In the following portfolio, the allocation to PAAIX is moved up to 24% in hopes of pulling down portfolio volatility.  The assumptions in this analysis are identical to the previous two portfolios.  I did include last Friday's data in this Quantext Portfolio Planner (QPP) analysis.

This material is not for publication elsewhere on the Internet.

The first screen shot shows the makeup of the portfolio.  The projected return over the next six to twelve months is 7.14% or slightly above the 7.0% projected for the S&P 500.  The projected standard deviation comes is 14.7% or below our goal of 15%.  However, the Return/Risk ratio at 0.49 is well below the goal of 0.60.

The Diversification Metric at 22% is well below the goal of 40%.  This is not unexpected due to all the highly correlated ETFs (see table below).  Over the nearly five years of operation, this portfolio generated a respectable 4.0% yield.  This is higher than most portfolios tracked here at ITA.

Correlation Matrix:  As in the prior two portfolios, we pick up lower correlated holdings through bonds (BND & PCY) and commodities (DBC).  ETFs with a value of 80% or higher (yellow background) are deemed to be highly correlated.

Delta Factor:  Looking out over the next six to nine month, the ETF with the highest probability of returning a reasonable rate of growth is PSP, the private equity holding.  VEA, VWO, and DBC are next in line to add value to the portfolio.

Disadvantages of Passive (Index) Investing: Are There Any?

The arguments in favor of passive investing are far too compelling to completely ignore.  If there are any disadvantages, what are they?

1.  At one time the availability of passive or index funds were limited, particularly in certain asset classes.  Availability of index funds is no longer a problem as ITA readers know.  We can find an index ETF to fill every asset class.  The problem of fund availability has been eliminated.

2.  Passive investors miss high performing stocks such as the recent run experienced by Apple.  Yes, Apple is most likely a small piece of one of the index funds we hold, but it does not have the same impact when held inside an ETF as it would if owned as an individual stock.  However, we are not taking the same risks when we use index instruments.

3.  Passive investing requires patience, something not in the DNA of many money managers.  Index investing, in particular, feels like one is not doing anything.  The Schrodinger Portfolio is an example where month after month passes with nary a trade.

4.  Passive investing may result in holding on to securities while the market declines in value.  This could result in larger than necessary losses.

5.  Index investing eliminates the option of holding individual stocks.  Mosaic investing does not place this collar on the manager.

The choice to be an active or passive manager is frequently based on the research one reads.  Different personality types will gravitate toward one style or the other.  Be sure to do your own research and develop a benchmark method for testing both performance and risk results.