Strategic Allocation

Success of dynamic asset class allocations assumes that expected asset class returns, return riskiness and investor risk aversion change at least somewhat predictably over time. Are individual investors truly better off with dynamic (rather than static) allocations? In their October 2024 paper entitled “Victor Meets the Bogleheads: Comparing Static versus Dynamic Asset Allocation”, Victor Haghani and James White focus on the modest differences between static and logic-driven dynamic allocation strategies. Based on their experiences as research analysts and investment managers, they conclude that: Keep Reading

How can the low-volatility effect, whereby stocks with low past volatility tend to outperform the market on a risk-adjusted basis (but lag during long bull markets), help achieve common investment goals? In their October 2024 paper entitled “Leveraging the Low-Volatility Effect”, Lodewijk van der Linden, Amar Soebhag and Pim van Vliet test ways to use the low-volatility effect to support five distinct investment goals. Their low-volatility benchmark strategy each month holds the 100 of the 1,000 largest U.S. stocks with the lowest 36-month volatilities. They consider ways to exploit the effect in five ways:

1. To safely boost return, they integrate value (net payout yield) and momentum (return from 12 months ago to one month ago) with low-volatility by each month: (1) selecting the 500 of the 1,000 largest U.S. stocks with the lowest 36-month volatilities; and, (2) picking the 100 of these stocks with the highest combined net payout yield and momentum. 
2. To beat a conventional 60-40 stocks-bonds portfolio, they consider: (1) replacing 10% of stocks and 5% of bonds with a 15% allocation to Strategy 1; (2) assigning equal weights to stocks, bonds and Strategy 1; or, (3) allocating 70% to Strategy 1 and 30% to bonds.
3. To beat the stock market, they target a market beta of 1.00 via a 140% long position in Strategy 1, financed either by: (1) borrowing 40%, with credit spread plus the T-bill rate as the borrowing cost; or, (2) using equity market index futures, with annual return slippage and implicit costs 0.2%.
4. For absolute returns, they consider a 100% position in Strategy 1, offset by: (1) 48% short positions in speculative stocks (high volatility, low net payout yield and low momentum), assuming 2% annual shorting costs; or, (2) a 72% position in short equity market index futures, with 0.2% annual costs.
5. For crash protection compared to 5% out-of-the-money 1-month put options, they target a market beta of -0.50 by combining: (1) a 30% long position in the low-volatility benchmark with a 50% short position in speculative stocks, with credit spread over the T-bill rate as the borrowing cost; or, (2) a 70% long position in the low-volatility benchmark with a 100% short position in equity market index futures, with 0.2% annual costs.

In general, portfolio rebalancing is monthly. Using monthly data for the largest 1,000 U.S. stocks and for the other asset types specified above during 1990 through 2023, they find that: Keep Reading

Do target retirement date funds, offering glidepaths that shift asset allocations away from equities and toward bonds as target dates approach, safely generate attractive returns? To investigate, we consider seven such mutual funds offered by Vanguard, as follows:

• • Vanguard Target Retirement 2020 Fund (VTWNX)
  • Vanguard Target Retirement 2025 Fund (VTTVX)
  • Vanguard Target Retirement 2030 Fund (VTHRX)
  • Vanguard Target Retirement 2035 Fund (VTTHX)
  • Vanguard Target Retirement 2040 Fund (VFORX)
  • Vanguard Target Retirement 2045 Fund (VTIVX)
  • Vanguard Target Retirement 2050 Fund (VFIFX)

We consider as benchmarks SPDR S&P 500 ETF Trust (SPY), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and both 80-20 and 60-40 monthly rebalanced SPY-LQD combinations. We look at monthly and annual return statistics, including compound annual growth rate (CAGR) and maximum drawdown (MaxDD). Using monthly total returns for SPY, LQD, three target retirement date funds since October 2003 and four target retirement date funds since June 2006 (limited by Vanguard inception dates), all through September 2024, we find that:

Keep Reading

The Simple Asset Class ETF Value Strategy (SACEVS) includes an allocation to  iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) when the credit premium, measured monthly based on the difference between the  Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield, is undervalued. Arguably, iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is a more aggressive way than LQD to exploit an undervalued credit premium. To test the effect of this aggressiveness, we substitute HYG for LQD in the SACEVS Best Value and SACEVS Weighted strategies by dovetailing HYG returns to those of LQD as soon as HYG becomes available in April 2007. We then compare performances of SACEVS with and without HYG. Using monthly dividend-adjusted returns for HYG since April 2007 and data for baseline SACEVS since July 2002, all through September 2024, we find that: Keep Reading

Homes typically represent a substantial fraction of investor wealth. Are there reliable relationships between U.S. home prices and the U.S. stock market? For example, does a rising stock market stimulate home prices? Do falling home prices point to offsetting liquidation of equity positions. Do homes effectively diversify equity holdings? Measurements are:

• Monthly levels of the non-seasonally adjusted S&P/Case-Shiller U.S. National Home Price Index (Home Price Index) during January 1987 through June 2024, with release lag about two months.
• Annual median sales prices for existing homes pieced from from RealEstateABC.com [no longer available], National Association of Realtors and Federal Reserve Bank of St. Louis during 1968 through 2023.
• Annual median sales prices for new homes during 1963 through 2023.

Using these sources and contemporaneous monthly levels of the S&P 500 Index during January 1963 through June 2024, we find that:

Keep Reading

Do alternative “Cash” (deemed risk-free) instruments materially affect performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS)? Changing the proxy for Cash can affect how often the model selects Cash, as well as the return on Cash when selected. To investigate, we test separately each of the following yield and exchange-traded funds (ETF) as the risk-free asset:

• 3-month Treasury bills (Cash), a proxy for the money market as in base SACEMS
• SPDR Bloomberg Barclays 1-3 Month T-Bill (BIL)
• iShares 1-3 Year Treasury Bond (SHY)
• iShares 7-10 Year Treasury Bond (IEF)
• Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIP)
• iShares TIPS Bond (TIP)

We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics and consider Top 1, equally weighted (EW) EW Top 2 and EW Top 3 SACEMS portfolios. Using end-of-month total (dividend-adjusted) returns for the specified assets during February 2006 (except May 2007 for BIL and October 2012 for VTIP) through July 2024, we find that:

Keep Reading

Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, based on feedback from subscribers about combinations of interest, we look at three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

1. 50-50 Best Value – EW Top 2: SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 2 (aggressive value and somewhat aggressive momentum).
2. 50-50 Best Value – EW Top 3: SACEVS Best Value paired with SACEMS EW Top 3 (aggressive value and diversified momentum).
3. 50-50 Weighted – EW Top 3: SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

We consider as a benchmark a simple technical strategy (SPY:SMA10) that holds SPDR S&P 500 ETF Trust (SPY) when the S&P 500 Index is above its 10-month simple moving average and 3-month U.S. Treasury bills (Cash, or T-bills) when below. We also test sensitivity of results to deviating from equal SACEVS-SACEMS weights. Using monthly gross returns for SACEVS, SACEMS, SPY and T-bills during July 2006 through July 2024, we find that: Keep Reading

A subscriber observed and asked: “Many Bogleheads at Vanguard prefer a buy and hold portfolio of 50% SPY, 25% each BND and EFA [rebalanced annually]. How does this compare to your current strategy? And how does it compare to buy and hold QQQ?” To compare, we compute gross monthly returns for the following six strategies:

1. SPY-EFA-BND Portfolio: the specified combination of SPDR S&P 500 ETF Trust (SPY), iShares MSCI EAFE ETF (EFA) and Vanguard Total Bond Market Index Fund (BND), rebalanced at the end of each June.
2. Simple Asset Class ETF Value Strategy (SACEVS) Best Value: the best SACEVS asset, reselected monthly.
3. SACEVS Weighted: the weighted combination of undervalued SACEVS assets, rebalanced monthly (probably the most closely related to SPY-EFA-BND Portfolio)..
4. Simple Asset Class ETF Momentum Strategy (SACEMS) EW Top 2: the equal-weighted combination of the top two SACEMS assets, reformed monthly.
5. Best Value – EW Top 2: the monthly rebalanced combination of 50% SACEVS Best Value and 50% SACEMS EW Top 2.
6. Buy-and-hold QQQ: buy and hold Invesco QQQ Trust (QQQ).

We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as essential performance statistics. Using monthly dividend-adjusted prices for SPY, EFA, BND and QQQ and monthly gross returns for SACEVS and SACEMS during April 2007 (limited by inception of BND) through June 2024, we find that: Keep Reading

A subscriber requested evaluation of versions of the Simple Asset Class ETF Value Strategy (SACEVS), the Simple Asset Class ETF Momentum Strategy (SACEMS) and a combination of the two, as follows:

1. For SACEVS Best Value, which chooses the asset proxy for the term, credit or equity premium that is most undervalued (if any), use only every third signal rather than every monthly signal. We start these quarterly signals with the first available signal in July 2002.
2. For SACEMS Equal-Weighted (EW) Top 2, use only every third signal rather than every monthly signal, rebalancing to equal weights only with these quarterly signals. We align quarterly signals with those for SACEVS.
3. For the SACEVS-SACEMS combination, use 30%-70% weights (per “SACEVS-SACEMS for Value-Momentum Diversification”) and rebalance only quarterly. We align quarterly rebalancings with those for SACEVS.

The overall approach is to suppress trading by limiting portfolio reformations/rebalancings to quarterly, while retaining the informativeness of monthly inputs. We apply these changes and compare results to those for the tracked (baseline) versions of SACEVS Best Value, SACEMS EW Top 2 and their 50%-50% combination. Using monthly SACEMS and SACEVS data during July 2006 (limited by availability of a commodities proxy in SACEMS) through June 2024, we find that: Keep Reading

The four iShares Core Asset Allocation exchange-traded funds (ETF) offer exposures to U.S. stocks, global stocks and bonds semiannually rebalanced to fixed weights, as follows.

1. iShares Core Conservative Allocation (AOK) – 30% stocks and 70% bonds (30-70).
2. iShares Core Moderate Allocation (AOM) – 40% stocks and 60% bonds (40-60).
3. iShares Core Growth Allocation (AOR) – 60% stocks and 40% bonds (60-40).
4. iShares Core Aggressive Allocation (AOA) – 80% stocks and 20% bonds (80-20).

Each fund holds a portfolio of seven iShares Core stocks and bonds ETFs, thereby compounding management costs and fees. Do these funds of funds offer attractive performance? To investigate, we compare performance statistics for these funds with those for comparably weighted and rebalanced combinations of SPDR S&P 500 Trust (SPY) and iShares 20+ Year Treasury Bond (TLT), or SPY and iShares iBoxx $ Investment Grade Corporate Bond (LQD). We start tests at the end of December 2008 (about a month after inception of the asset allocation ETFs). We ignore semiannual rebalancing frictions for the SPY-TLT and SPY-LQD comparison strategies. Using semiannual dividend-adjusted prices for all specified funds during December 2008 through June 2024, we find that: Keep Reading