Tactical Asset Allocation – July 2016

July proved the pundits wrong ... just as they were wrong for April, May, and June. What the pundits told us would be a bad year has turned out pretty well, although the year is not yet over. The pundits are telling us August will see a give-back. Maybe they'll be right ... the market has had a good run.

One of the great things about using a Tactical Asset Allocation Strategy is that the Strategies don't know what the pundits are saying and don't change direction with every new economic release. The Core Strategy Models look for longer trends and tell us how to position the portfolio for the month ahead. We rebalance it and forget it until the next rebalance. Is it perfect? No. But over the long term it does better than most humans and does so with very little effort and relatively small drawdowns.

The US Core Strategy returned 2.89% in July. For the Year-To-Date: return is 6.79%, Compound Annual Growth Rate is 12.03%, Maximum Daily Drawdown is 3.7%, and Daily Standard Deviation is a very low 6.5%. Full metrics for the past 9+- years are included in the Performance Tables.

The Global Core Strategy returned 3.09% in July. For the Year-To-Date: return is 7.81%, Compound Annual Growth Rate is 13.89%, Maximum Daily Drawdown is 2.1%, and Daily Standard Deviation is a very low 5.1%. Full metrics for the past 9+- years are included in the Performance Tables.

While this year's Compound Annual Growth Rates for both Strategies are impressive, it's hard to see the market continuing to provide us with the returns we've enjoyed so far this year.

The Satellite Strategies remained in hibernation during July. The performance tables for the Satellite Strategies have new metrics for Compound Annual Growth Rate (CAGR). [email protected] covers the term of the report as in 12.96% for Sep 2007-Jul 2016 (107 months). [email protected] covers only the months during which the Satellite Strategy was actually invested as in 26.76% for 55 months. With the Satellite Strategies invested just 50%+- of the time, I think [email protected] provides a useful metric for evaluating the risk and reward of moving funds from Core Strategies to Satellite Strategies when market conditions are Favorable.

I spent much of July working with the market Risk Model. While I developed a number of variations which yielded small incremental improvements, the major takeaway is that the model, which uses widely dissimilar inputs, produces similar results with a broad variety of settings. This suggests that the Risk Model is robust and should continue to serve us well in the future.

 

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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.