Optimizing the “Swensen Six” Portfolio

To answer the question of how much the “Swensen Six” portfolio changes when placed under the optimization microscope, here is the following analysis.  The percentage changes from asset class to asset class are not as different as one might expect.

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Optimizer Warnings From William Bernstein and Harold Evensky

Lisbon, Portugal

Lisbon, Portugal

A few years ago I worked with a Mean-Variance Optimization (MVO) program designed by David Wilkinson for William Bernstein.  There was a mind numbing amount of manual data entry and there was the perpetual problem of data accuracy.  Was I using the right data and was it current?  The software required entering constraints, otherwise the MVO software would pump out portfolios that made little sense.  Bernstein, in his first book, warns of the inherent dangers in working with MVO software.  Let me quote Bernstein at length.  “Be aware that you are entering a sensitive area for most financial professionals.  Most ‘retail’ investment professionals such as mutual fund salespeople and brokerage ‘account executives’ are at best only dimly aware of portfolio theory and MVO.  Those that are familiar with these areas form the elite of the investment business, and tend to be managers of large investment pools.  These folks treat portfolio theory a little like the trade secrets of a medieval guild,; don’t expect a lot of help from them.”  

Bernstein goes on to explain how optimization might be helpful.  “…suppose you are wondering about the role of, say, precious metals equity (PME) in your allocation.  You would then set up a simple MVO analysis consisting of three assets: the stock and bond portions of your portfolio and PME.  You might then adjust the return of PME up or down in order to determine the returns required for its inclusion in a portfolio.  (Of course, you will need to have a good idea of its SD and correlation with the rest of the portfolio in order to do this.)  If your analysis shows that precious metals equity starts appearing in your portfolio at a return of, say, 5%, then it might be reasonable to use it.  On the other hand, if your analysis shows that a return of 10% is required, you might be wary, as the long-term return of precious metals equity is likely not that high.”

Harold Evensky provides this warning.  “Any wealth manager who unquestioningly accepts the allocations recommended by an optimizer is likely to be a threat to his clients’ financial well-being.”

With these warnings lodged in the frontal cortex, how does one make, what I consider the most difficult decision of investing – what percentage to invest in each asset class that makes up the portfolio?  Back to Evensky’s advice.  An MVO requires the wealth manager to make a decision regarding the investment time horizon and, for each asset class included in the portfolio, and estimate of the:

  • Expected return.
  • Expected standard deviation.
  • Expected correlation with every other asset class.”

Low and behold, the Quantext Portfolio Planner (QPP) software has all this data stored away ready to use.  Fortunately, an Excel guru showed QPP users a way to access the data, and by using Solver in Excel, optimize on any single metric such as projected portfolio return, projected portfolio standard deviation, Return/Risk ratio, portfolio beta, portfolio yield, Diversification Metric, or one designed by the end user.

While there is still a lot of art and “science” in the use of any MVO, by applying reasonable constraints available within Solver, one can remove some of the guesswork from the most difficult decision of portfolio construction.

Optimized Portfolio Using Core ETFs

As mentioned in the last post, I’m working on an optimization worksheet that connects directly with Quantext Portfolio Planner (QPP).  The following analysis is the result of optimizing the Return/Risk to its maximum setting using the array of ETFs shown below.  As one might expect, forcing the Return/Risk ratio to its maximum setting vs. a more modest 0.60 results in a concentration of the investment assets in a few ETFs.

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Optimizing QPP Analysis Asset Allocation Models

Kipling with Topaz Adjustment

Kipling with Topaz Adjustment

Some years ago I tested a Mean-Variance Optimization (MVO) software program that was designed for William Bernstein.  Manual data entry and knowing if it was accurate proved to be a problem.  Much to my surprise, I recently received an e-mail from the developers of Quantext Portfolio Planner (QPP), pointing me to an article that an Excel™ guru developed an optimization spreadsheet that links to the QPP program.  I expect to be working on this over the next few weeks so be patient if the number of blog posts fall off a bit while I concentrate on developing some facility with this program.  Actually, I am in the process of developing the worksheet that links back to QPP so the optimization can occur.

The following material is not available for publication elsewhere on the Internet.

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Portfolio Rebalancing Revisited

One reader requested a review of how portfolio rebalancing is handled.  There are several ways one can set up a rebalancing program and all require the investor have an investment plan.  If one builds a portfolio around individual stocks with no sector or asset class allocation model in place, this review is of little use.  Rebalancing has two primary models (listed below) and the entire concept of rebalancing hinges on setting up a portfolio plan and then keeping that plan in balance.  Some investors would say a plan of 60% invested in stocks and 40% invested in bonds is an asset allocation plan.  Yes, it is a plan, but not all that well thought through.

The “Swensen Six” portfolio relies on five asset classes.  1) U.S. Equities (VTI).  2) Developed International Markets (VEU or VEA).  3) Emerging Markets (VWO).  4) REITs (VNQ).  5) Bonds and Treasuries (TIP and TLT).  While there are other ETFs one might use, the ones I’ve chosen are examples.  This is an example of an asset allocation plan

Here is a link to another portfolio that has a specific plan to deal with prosperity, inflation, deflation, and depression or recession.  The “Permanent Portfolio” is simple and easy to implement.

And now for the two primary ways one might rebalance a portfolio.

  1. Rebalance based on time such as every quarter, year, or every few years as recommended by William Bernstein.
  2. Rebalance when an asset class moves above or below target by a specific percentage.  I use between 20% and 35% for threshold limits.

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Madison Portfolio Update: 29 January 2013

While the Madison is one of three portfolios where the individual transactions are hidden from Platinum readers, I think it is useful to show the Strategic Asset Allocation plan.  The following Dashboard is extracted from the TLH Spreadsheet and it shows how the assets are allocated.

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Tax Record Hint For ITA Spreadsheet Users

I’m in the process of going through the various taxable portfolios looking for stock and ETFs sales.  If an odd block is sold, one must record which ETF (or stock) was purchased and when.  Here is a hint as you go through your portfolio.

1.  I use First In – First Out records as that makes it simple.  That means first ETFs purchased are matched with first ETFs sold.  With the following hint you can select which ETF or stock to match up in the transaction.

2.  Color code the cells of the Buy-Sell combination.  In fact, one does not need to worry about the sold stock as it is recorded or coded, but go back up the page and identify, by color coding the cell, which shares were purchased to match up with the shares sold.

If this hint is not clear, ask questions.  This only pertains to those who are using the TLH Spreadsheet to track their portfolios.

It is times like this when one is thankful for very few sales showing up in a particular year.

TEVA: A Stock Worth Further Examination

This past weekend I was running my dividend stock screening program to see which companies passed the screen.  Then I recalled that I once had a “valuation” screen that looked for companies that were priced under numerous valuation parameters as laid out in the Stock Investor Professional, AAII’s stock screening program.  Here are the valuation parameters I used for my screen, in addition to the dividend or yield screens.

This material is not available for publication elsewhere on the Internet.  It is reserved for Platinum members.

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Music For Trumpet: Hummel Trumpet Concerto in E Flat



Yesterday, while returning from my granddaughter’s basketball game, I was listening to All Classical (89.9 FM) when I heard a familiar trumpet concerto, but could not identify the composer.  Waiting in the car until it was finished and the composer announced, I learned it was Johann Hummel.  Confident that I had the composition on my hard drive, I checked it out and sure enough I have the CD in my collection.  The piece I was listening to is Hummel’s Trumpet Concerto in E Flat, but you receive a lot more than Hummel on this 2 CD recommendation.

Don’t be put off due to only two reviews on Amazon.  This CD is well worth the expense.  Here is one of the two reviews, with a few corrections.

“I bought this CD simply for the performance Handel’s Gloria in Excelsis Deo.  The first time I heard the piece played it nearly brought me to tears.  Clear  and powerful, the organ does not over power the trumpet.  Rather it adds depth to the metal sound and a warmth unkown to it. The beauty cannot be described.  You will not be dissapointed.”


Please Turn Off CNBC!

CNBC is only a place holder for all types to Wall Street media hype.  Eschew information that is designed to keep you unsettled, nervous, and makes you feel as if you are doing something wrong and change is necessary.  Too much investment information is not necessarily a good thing for portfolio management.  If financial news sources had your best interests in mind, you would find them so boring you likely would not want to tune in.  The passive approach to investing does not grab many TV eyes, but it goes a long way toward increasing your retirement fund.  Just examine the Einstein and Schrodinger portfolios available here at ITA Wealth Management.

Avoiding CNBC, Money Magazine, and other financial hype does not mean one should cease to become educated.  Rather than be entertained, dig into the academic literature, read a few of the Top Ten Investment Books recommended here at ITA, and set a new course for your portfolio.  If you have already done the research and realize the importance of index investing, you are well on your way to financial success.  Of course this assumes our economy will continue to function without too many catastrophic interruptions.  That is a risk we cannot control.

Speaking of risk, there are various types of risk we take as investors.  Risk means we do not know what is going to happen, although we might have some clues as to a range of risk probabilities.  We use the QPP program to aid us in identifying portfolio risk.

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