I have become very comfortable with the Tactical Asset Allocation Strategies (TAAS) Core Strategy. I’ve had substantial funds invested in the Strategy for some time now and it has treated me well during this Central Bank sponsored market volatility.
But as a TAA researcher and designer, I know that the TAAS Core Strategy has an Achilles Heel … too much reliance on US markets. Now renamed “TAAS US Core Strategy”, its maximum international exposure is 7.5%. Just because this has worked well for the past 9 years does not mean it will serve our needs in the future. While recent history has been favorable to US equities and fixed income, this has not always been the case historically.
So I began with a clean slate with two major objectives in developing the new TAAS Global Core Strategy: 1) broaden asset class exposure and 2) maintain the low volatility of the TAAS US Core Strategy.
I use Exchange Traded Funds (ETFs) exclusively for their low trading costs and lack of the trading restrictions imposed by many Open End Funds. The challenge in using ETFs is that most are of relatively recent vintage. There are relatively few which offer history through at least one Bear Market (Sep 2007) , have adequate liquidity to insure we can enter and exit positions without affecting market prices, and low fund expenses. My selections for Global Core included US equities (big, medium, and small cap), large cap developed market (ex-US) equities, large cap emerging market equities, US investment grade bonds, US Treasuries, and precious metals. I was unable to find suitable international fixed income exposure; however that is a minor issue because fixed income tends to be a “flight to safety” investment and US bonds are the most attractive on that score.
Tactical Asset Allocation involves selecting the best choices for each rebalance period from a basket of funds. Each fund inclusion or exclusion alters the competitive balance and therefore the results of all other funds in the basket. This is where my two year investment in developing the TAAS Model pays off. I load a proposed strategy into the model and proceed to run hundreds of iterations during which I examine how each fund in the basket is performing and the effects of different selection and timing algorithms. The TAAS Model Report (note 1) provides insight into the performance of the overall strategy. During early development stages, I pay particular attention to the U/D Ratio which is the sum of the gainers (Sum >0%) divided by the sum of the losers (Sum <0%).
Once the fund basket has been selected, I turn my attention to the volatility of the strategy. For the Core Strategies, I target a Standard Deviation of daily changes in portfolio balance of 8% (Maximum Daily Drawdown under 10%) which the Model tells me is about the right balance between decent return and low volatility. For reference, SPY (the S&P 500 ETF) has a Daily Standard Deviation of nearly 22% (Maximum Daily Drawdown of 55%) and VBINX, the Vanguard Balanced Index Fund has a Daily Standard Deviation of nearly 13% (Maximum Daily Drawdown of 36%). This step, which I term “Targeted Volatility” is proprietary; however, it adjusts the Strategy volatility to desired levels.
All finished, right? Not yet. Recall that ETFs are a relatively recent innovation and we are able to go back just one Bear Market. I use Open End Funds, many of which go back to to at least 2000, to reconstruct the proposed ETF-based Strategy. I then use the OEF-based strategies in the TAAS Model to test the proposed Strategy through two complete market cycles beginning with the 2000 Bear Market. I am finished when I am satisfied that the results from two full market cycles using OEFs validate the results I am seeing from the proposed ETF-based Strategy. There are many times when the OEF validation sends the proposed Strategy back to the drawing boards.
After nearly four months of development, the TAAS Global Core Strategy was released to subscribers effective with the June 30, 2016 rebalance. I began phasing into Global Core with a 20% allocation shifted from US Core.
And that folks, is the Rest Of The Story.
Note 1: The TAAS Model Report is a PDF. Some portions have been redacted for proprietary reasons.
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