Tactical Asset Allocation – November 2016

US Core rebounded on strong US equities in spite of falling bond prices. When I started work on US Core in early 2015, I had first-hand experience with a number of TAA investment strategies, including managed accounts and my own first generation strategies, which either failed to deliver acceptable returns or incurred drawdowns beyond my comfort level. My major priorities in developing US Core were to limit drawdowns and improve returns.

It was one year ago on November 30 that I shifted our entire Tactical Asset Allocation investment (then, roughly 35% of our investment portfolio) into the US Core Strategy. The test of any investment strategy is sticking with it long enough to see how it fares under duress. While the past 12 months has not seen a Bear Market, it did see the largest market decline in four years. Here is how SPY, the S&P 500 ETF, and VBINX, the Vanguard Balanced Index Fund, stack up against US Core for the 12 months:

  • CAGR: SPY @ 7.85%, VBINX @ 5.80%, and US Core @ 6.46%
  • MaxDD: SPY @ 12.7%, VBINX @ 8.0%, and US Core @ 4.0%

US Core is clearly performing well in what has been a challenging market. Enough on what has gone well.

Global Core suffered under the weight of falling bond prices, reduced US equity exposure, and falling international equities. The sudden reversal in international markets, particularly emerging, was driven by the precipitous, post-election rise in both US interest rates and the US dollar.

Global Core's performance this month was a disappointment because it was a drag on overall portfolio results to the tune of a 3.3% negative differential to US Core. That differential turned what would have been a 2.06% gain in a 100% US Core portfolio into a 0.48% portfolio gain in my personal portfolio which held an equal weighted mix of US Core & Global Core.

Our backtested performance tables have always shown that US Core modestly outperforms Global Core in both CAGR and MaxDD; however I believe that the broader ETF basket is likely to provide improved opportunities in the future. I am going to devote my December research to finding adjustments which will make effective use of the broader ETF basket but with less volatility.

TLT, the 20 Year Treasury ETF, has now declined by 17% from its all time high in July (and is down another 1% as I write this). While the drop in Treasury prices reduced our Strategy returns, I am pleased that the decline occurred while equity prices are rising. Lower bond prices will provide more room for Treasuries to cushion a future decline in equities.

Equity valuations remain extremely high; however investors are showing few signs of concern. I will not hesitate to recommend a reduction in allocation to Tactical Asset Allocation strategies should I observe a significant deterioration in market conditions which is not being reflected in our Strategies.

We remain in conservative strategies which emphasize capital preservation over growth. Both Strategies are allocated entirely to US markets for December. 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.

Strategies

Global Core Strategy

Month-to-date: 1.24% loss,
Year-to-date: 3.77% gain
Full cycle-to-date (Sep 2007): 8.97% CAGR, 9.1% 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% MaxDD

Global Core + Global Satellite Strategy

Month-to-date: 1.24% loss,
Year-to-date: 3.77% gain
Full cycle-to-date (Sep 2007): 15.47% [email protected], 13.22% MaxDD

US Core Strategy

Month-to-date: 2.06% gain,
Year-to-date: 6.58% gain
Full cycle-to-date (Sep 2007): 10.32% CAGR, 7.5%% MaxDD

Odds and Ends

Our personal funds remain fully invested in a blend of 20% Global Core and 80% US Core.

 

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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.