Tactical Asset Allocation – December 2016

2016 is in the books and what a wild year it was! We remained in our conservative Tactical Asset Allocation Core Strategies for the entire year which reigned in the volatility while providing decent returns. US Core is up 0.86% for December and 7.53% for the year ... nearly the same as the Vanguard Balanced Index Fund but with much lower drawdowns. The original Global Core is up 1.14% for December and 4.99% for the year.

The original Global Core benefited from a modest rise in US Equities. A 20%+- higher weighting in Small and Mid Caps provided extra return compared to US Core. Strategy returns were reduced by the continued sharp realignment of prices in the Treasury market. For 2017, the original Global Core has been replaced by the upgraded Global Core ... more on that below.

US Core also benefited from a modest rise in US Equities while maintaining a higher allocation to less volatile Big Caps. Strategy returns were reduced by the continued sharp realignment of prices in the Treasury market.

2016 is ending on a much better note than it started. Our Risk Model warned of "Hostile" market conditions at the end of November 2014 and remained in that state through year-end 2016. . Our Core Strategies went to cash on December 30, 2015  just in time to avoid the January/February correction in equities. Core Strategies took a liking to bonds for February and March then moved to equities in April and stayed there for the remainder of the year. Global Core also took a small position in precious metals for March through September and a November in (and then out) of International equities.

My mid-month blog post, "Upgrading Global Core", detailed my research and analysis of the original Global Core and the approach used to upgrade it. I excerpt  two key paragraphs:

"Another key to success in the financial markets is in quickly recognizing and correcting mistakes. In this case, a broader ETF basket is ideal but the combination of conditions which resulted in an over-sized allocation to riskier assets was not. My research objectives for fixing Global Core became quite simple: 1) maintain exposure to international and precious metals asset classes, 2) reduce the risk of that exposure, and 3) approximate the performance of US Core in both Compound Annual Growth Rate and Maximum Daily Drawdown.

As it turned out, the solution was rather simple. I put the original Global Core aside and began working toward “globalizing” the US Core. I also tightly controlled exposure to the additional funds. The results achieved all three objectives."

While the overall [email protected] of the upgraded Global Core is very close to US Core ( 10.18% vs 10.33%), we do see a 0.58% reduction in Maximum Daily Drawdown (7.48% to 6.90%) while reducing equity exposure by 0.11% and increasing alternative asset exposure from 0% to 1.71%.

The upgraded Global Core is an incremental improvement to US Core. I believe that the upgraded Global Core Strategy will better serve subscribers (including our personal portfolio) than US Core. The tax consequences of shifting holdings from US Core to the upgraded Global Core are not material.  Effective with the December 30 rebalance, I am moving all of our TAAS Strategy investments to the upgraded Global Core.

Speaking of taxes, a look at my year-end brokerage statement shows that 26% of our TAAS Strategy holdings have been held for one year or longer, and 92% have been held for at least nine months. This indicates a much lower than expected turnover rate in the TAAS portfolio. Given reasonably stable trends, the Strategies adjust at the edges rather than the core. Using a last-in, first-out (LIFO) tax lot selection works very well in maintaining low-turnover core positions.

Equity valuations remain extremely high; however investors are showing few signs of concern (per my Weekly Market Analyst blog). We remain in conservative strategies which emphasize capital preservation over growth.

TAAStrategies is undergoing a major upgrade. The email upgrade is already complete. An all new website will make its debut in mid to late January..

Tactical Asset Allocation Fund Basket Performance

Global Core Strategy (original)

Month-to-date: 1.14% gain,
Year-to-date: 4.99% gain
Full cycle-to-date (Sep 2007): 9.02% CAGR, 9.09% Max Daily Drawdown

This strategy has been replaced by the Upgraded Global Core Strategy:

Global Core Strategy (upgraded)

Month-to-date: 0.86% gain
Year-to-date: 7.72% gain
Full cycle-to-date (Sep 2007): 10.18% CAGR, 6.9% Max Daily Drawdown

Global Satellite Strategy

Month-to-date: hibernating since Nov 2014
Year-to-date: hibernating since Nov 2014
Full cycle-to-date (Sep 2007): 25.90% [email protected], 13.2% Max Daily Drawdown

US Core Strategy

Month-to-date: 0.86% gain,
Year-to-date: 7.53% gain
Full cycle-to-date (Sep 2007): 10.33% CAGR, 7.48% Max Daily Drawdown

 

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I will be rolling out upgrades to the Tactical Model and Adaptive Strategies beginning with the November 29 rebalance for the month of December. In each case, the focus has been on improving control over the upper bounds of portfolio volatility, improving the consistency of annual returns, and on reducing fund turnover.

In order to provide the fullest possible disclosure, the Chart and Table displays on the website will include tables for both the original (labeled “Repl Dec 2019)” and upgraded Strategy beginning with the next update in early December.

The primary benefit of minor changes to Adaptive Global is reduction in both Standard Deviation of Monthly Returns and the Ulcer Index:.

  • Fund basket and condition eligibility: no change was made to fund baskets or condition eligibility
  • Fund selection: no change to fund selection method (Adaptive Dynamic Momentum)
  • Weighting of selected funds: Volatility Weighting was replaced with Limited Portfolio Volatility Weighting which is employed to cap the expected total portfolio volatility when high volatility funds (especially equities) are used. This slightly reduces both risk and return.
  • Position Optimization: Upgraded which slightly improves holding periods and performance.

Full cycle: CAGR decreased slightly from 15.0% to 14.6%;  Max Monthly Drawdown declined from 8.7% to 7.9%; and the Up/Down Ratio decreased slightly from 228.7% to 228.4%. The Ulcer Index declined from 3.7% to 3.6% and Standard Deviation of Monthly Returns declined from 9.5% to 9.1% reflecting improved consistency of returns.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

I will be rolling out upgrades to the Tactical Model and Adaptive Strategies beginning with the November 29 rebalance for the month of December. In each case, the focus has been on improving control over the upper bounds of portfolio volatility, improving the consistency of annual returns, and on reducing fund turnover.

In order to provide the fullest possible disclosure, the Chart and Table displays on the website will include tables for both the original (labeled “Repl Dec 2019)” and upgraded Strategy beginning with the next update in early December.

The primary benefit of changes to Adaptive Income is a broadening of the fund basket and reduction in both Standard Deviation of Monthly Returns and the Ulcer Index:

  • Fund basket and condition eligibility: the number of fixed income ETFs was increased from 5 to 6 to broaden the basket to include an investment grade ETF.
  • Fund selection: no change to fund selection method (Adaptive Dynamic Momentum)
  • Weighting of selected funds: Adaptive Income employed a single selection, 100% weighting to the best performing fund. Limited Portfolio Volatility Weighting is employed to cap the expected total portfolio volatility when higher volatility funds (especially high yield) are used. This forces the allocation across a second, lower volatility fund when the cap is exceeded.
  • Position Optimization: Upgraded which slightly improves holding periods and performance.
  • Full Cycle: CAGR increased slightly from 10.6% to 11.1%; Max Monthly Drawdown increased from 2.9% to 3.8% however Max Daily Drawdown remains unchanged at 7.1%; and the Up/Down Ratio rose from 503.0% to 556.9%. The Ulcer Index declined from 1.3% to 1.2% and Standard Deviation of Monthly Returns declined from 5.6% to 5.1% reflecting improved consistency of returns.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

 

I will be rolling out upgrades to the Tactical Model and Adaptive Strategies beginning with the November 29 rebalance for the month of December. In each case, the focus has been on improving control over the upper bounds of portfolio volatility, improving the consistency of annual returns, and on reducing fund turnover.

In order to provide the fullest possible disclosure, the Chart and Table displays on the website will include tables for both the original (labeled “Repl Dec 2019)” and upgraded Strategy beginning with the next update in early December.

This upgrade to Adaptive Innovation improves performance while significantly reducing volatility.

  • Fund basket and condition eligibility: The existing long duration Treasury ETF was added to the eligible funds for Balanced conditions. This allows strongly performing Treasuries to complete effectively with the Innovation equities for selection. A short duration Treasury ETF was added to provide a higher yielding alternative to cash.
  • Fund selection: no change to fund selection method (Adaptive Dynamic Momentum)
  • Weighting of selected funds: Volatility Weighting was replaced with Limited Portfolio Volatility Weighting which is employed to cap the expected total portfolio volatility when the higher volatility Innovation funds are used. This forces the allocation across a second or third fund when the volatility of the primary fund(s) exceeds the cap.
  • Position Optimization: Upgraded which made no change in holding periods and performance.
  • Partial cycle: CAGR increased slightly from 26.3% to 28.4%,  Max Monthly Drawdown and Maximum Daily Drawdown remained unchanged at 12.2% and 19.2% respectively; and the Up/Down Ratio increased from 280.2% to 336.9%. The Ulcer Index declined from 5.6% to 5.1% and Standard Deviation of Monthly Returns declined from 15.7% to 14.9% reflecting improved consistency of returns.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.