ITA Wealth Management

It was a losing week, both from an absolute and relative measurement reference frame.  Of the nine portfolios upgraded, seven continue to perform better than the VTSMX benchmark, while six of the nine are outperforming the ITA Index.  Most of the portfolios show excellent IR values, although we need more data for a few portfolios in order for these Information Ratio numbers to be of much value. Overall, the performance of these portfolios is very good to excellent.  We hope some of the new Efficient Frontier analysis will help to fine tune the lagging portfolios.

Portfolio Performance: 11/27/09

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Below are screen shots of the projected returns for the ETFs and the correlation matrix used in the recent EF analysis. 

The correlation matrix may be difficult to read depending on the size of your computer screen as the table is rather wide.

Over on the Bogleheads forum site I asked for favorite ETFs investors include in their portfolios.  I was looking for suggestions of ETFs I overlooked or was not aware they even existed.  While I received a number of excellent suggestions, I eliminated several ETFs due to their short records.  My preference is to have 36 months of data for the analysis.  Many of the recommended ETFs were launched too recently to meet that standard.  I did lower my preferred period from 36 months down to 32 months in order to capture a few more ETFs of interest.

I narrowed the number of ETFs down to 20, or the maximum I wanted to deal with in the analysis.  The ETFs that made the cut were: VTI, VOE, VBR, RZV, EFA, DLS, EFV, VWO, VNQ, BSV, TIP, BIV, HYG, GSG, DJP, DBC, VPU, DVY, SLV, and IEF.

When I allocated 5% to each of the above ETFs, I came up with a projected return of 9.7% and a projected standard deviation (risk) of 15.7% for a Return/Risk ratio of 0.62.  This is a little lower than we have managed in some of the “vision” portfolios shown over on the Premium Content side of the ITA Wealth Management blog.

The next step was to create a correlation matrix and feed that data into the Efficient Frontier spreadsheet for further analysis.  Using QPP to create the correlation matrix, a variance-covariance matrix was calculated, setting up the opportunity to create an efficient frontier which you see below.

If one slides along the X-axis to the 10% SD point, the “optimal” portfolio gives a projected return of 8.4% and a projected SD of 13.7%.  The Return/Risk ratio is essentially the same as that when equal percentages were allocated to each asset class.  What is significantly different in the efficient frontier analysis is the portfolio diversification.  With equal allocations, the Diversification Metric (DM) was 30%, while it increased to 55% when the percentages were allocated using the efficient frontier analysis.

Using EF analysis, the ETFs that received major allocations were BSV (43.3%), VNQ (14.7%), and EFA (13.3%).  All other ETFs were less than 4% and RZV, TIP, BIV, HYG, DVY, and IEF did not even come in at 1%.

I may run an analysis on a three to five asset portfolio to see if a very simple asset allocation plan comes close to matching the more complicated approach.

Photograph:  The first signs of Christmas.