This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Andrew Gogerty, vice president of investment strategies at Boston-based Newfound Research.
With the start of another football season underway, I am reminded of a classic mantra: “Offense wins games, defense wins championships.” You can’t argue with the logic: To win over time, you have to be proficient in both aspects of the game.
Adding a tactical sleeve into a core portfolio allows for participation (offense) in rising markets and a risk mitigation (defense) when things become less certain than they appear today.
But just like practicing more plays than will actually be used in a game, successful portfolios have these allocations included before they are needed.
U.S. investors use a core portfolio of domestic stocks and core bonds. Within this context, even small dynamic allocations can have a material impact.
A Look At Some Strategies
As an example, for this article, we have constructed simple, backtested strategies (note these are not investment strategies that are currently managed by Newfound, and the trades and allocations mentioned below are not actual, live trades, but hypothetical only).
For each Morningstar allocation category below, we constructed a simple momentum portfolio using the underlying indices for the SPDR S&P 500 ETF Trust (SPY), the iShares Core US Aggregate Bond ETF (AGG) and the iShares 20+ Year Treasury Bond ETF (TLT).
When the S&P 500 Index’s price is above its 200-day moving average, we hold the top equity allocation (the rest in AGG), and when it is below, we hold the bottom equity level and add a TLT allocation (20-year Treasuries have historically been a valuable hedge for U.S. equities and have exhibited low total return correlation). The portfolios are updated monthly.
|Category||Price > 200 Day MA||Price < 200 Day MA|
|US allocation 15%-30% equity||30% SPY / 70% AGG||15% SPY / 15% TLT / 70% AGG|
|US allocation 50%-70% equity||70% SPY / 30% AGG||50% SPY / 20% TLT / 30% AGG|
|US allocation 85%+ equity||100% SPY||85% SPY / 15% TLT|
The portfolios improved the max drawdown impact (defense), as well as kept pace (offense) in recent years. There are five total allocation categories; for simplicity, we highlighted the low-, middle- and high-equity allocations.
Over the past 20 years, only 18 trades would have been made to adjust the allocation, and with only a small portion of the portfolio being traded, the strategy is also efficient from a tax and implementation perspective.
|US Allocation 15%-30% Equity||YTD||1Yr||3Yr||5yr||10yr||15yr||20yr||Max DD|
|Category 25th percentile||5.17||5.04||5.04||4.75||4.88||5.64||5.95||-15.66|
|Category 50th percentile||4.74||4.28||4.28||4.00||4.20||4.95||5.43||-17.99|
|Category 75th percentile||4.00||3.39||3.39||2.96||3.45||4.08||5.19||-34.05|
|US Allocation 50%-70% Equity||YTD||1Yr||3Yr||5yr||10yr||15yr||20yr||Max DD|
|Category 25th percentile||8.98||10.83||6.26||9.29||5.94||7.61||6.61||-33.31|
|Category 50th percentile||7.96||9.46||5.42||8.31||5.22||6.84||5.88||-37.15|
|Category 75th percentile||6.90||8.07||4.45||7.28||4.49||6.19||5.15||-39.82|
|US Allocation 85%+ Equity||YTD||1Yr||3Yr||5yr||10yr||15yr||20yr||Max DD|
|Category 25th percentile||12.99||16.09||7.29||11.79||5.56||8.18||7.38||-47.38|
|Category 50th percentile||11.72||15.18||6.65||11.30||5.00||7.70||6.83||-49.90|
|Category 75th percentile||10.48||13.36||5.92||10.66||4.50||7.35||6.33||-51.39|
Sources: Morningstar, Newfound Research; through 7/31/17