ITA Wealth Management

Photograph: Nautica cruise ship in the Greek Islands

How well is the AA-Mosaic Portfolio performing during this miserable market? In absolute terms, lousy. In relative terms, outstanding. Here are the facts.

The annualized return for the young AA-Mosaic Portfolio is negative 28.9% (-28.9%). The annualized return for the VTSMX benchmark is a negative 45.3% (-45.3%). These are Internal Rate or Return (IRR) figures. No, the VTSMX has not declined 45.3% since last December. Rather, this is an annualized rate.

The spreadsheet I am using to track this portfolio was designed by Jim Thomas and later modified by Bakul Lalla and Lowell Herr. This SS tracks the performance as well as an index such as the VTSMX. Note that new cash inserted into the portfolio is also inserted into the benchmark. That is why we have an “apples to apples” comparison between the two.

Photograph: Fisherman on the Island of Rhodes, Greece

Back in 2006 I was asked to watch over a portfolio for a relative. The portfolio was invested in individual stocks with a concentration in the growth asset classes. After entering all the data in what is known as the Thomas spreadsheet (with modifications from Lalla & Herr), I found the portfolio to be lagging a total market index (VTSMX) by approximately 6% points. The first thing I did was to develop an asset allocation strategy knowing that the research points to the importance of this activity. The second move was to sell most of the stocks (there are still four in the portfolio) and invest the proceeds in ETFs using the asset allocation road map.

After the close of the market today and updating all the dividends for 2008, I ran the numbers and found the portfolio is within one percentage point of the VTSMX benchmark. In a little over a year, the well-diversified portfolio picked up nearly 6% points on the benchmark. This is another example of the importance of asset allocation.

The next plan is to analyze the current asset allocation plan, add commodities to the overall asset mix, and rebalance the portfolio over the next year. The goal is to add alpha to the portfolio while reducing sigma or risk.

Photograph: Rhodes Island, Greece

Below is the Top Ten list from this weeks “Creme List.” Consider these ten stocks as candidates for more detailed analysis.

• CSCO
• INFY
• JNJ
• ORCL
• FISV
• COH
• SBUX
• TEVA
• QCOM
• FDS

These are potential stocks one might use to add to a well-diversified portfolio built around the concept of asset allocation.

What is the relationship between return of a portfolio and the associated risk involved?

Again, I am quoting from the “Active vs. Passive” paper I found in my files.

“High potential returns always involve high potential risks.  There are no low-risk/high-return investments.  Investment risk comes in many forms but, to most investors, risk means the potential for losing investment capital and the duration or permanency of that loss.  Through analyzing the best available long-term data, researchers have carefully defined the risk/return ratios of all major asset classes and identified the correlation or interdependence of different types of investments.  These findings provide our best approximation of future risk and return for any given asset class or mix of asset classes, and clearly show that there are no high return, low risk asset classes.”

Let me raise the question again as I did a few days ago.  Do you have an accurate method for tracking the internal rate of return of your investments?  And now the more difficult questions, do you have any means to track the risk measurement of your investments?  By your investment decisions, are you adding value or alpha to your portfolio?

Unfortunately, few software are set up to accurately measure portfolio risk.  It is possible to find programs that do a good job calculating the Internal Rate of Return (IRR) of the portfolio.  The spreadsheet used to track the AA-Mosaic Portfolio does an excellent job of making this calculation, and with proper data entry, it also does an excellent job of tracking the performance of an index such as the VFINX or VTSMX.  What the spreadsheet does not do is calculate how risky the portfolio.