ITA Wealth Management

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The moderately conservative portfolio includes more treasury ETFs than either of the last two portfolios. Listed below are the holdings and target percentages for this portfolio, also suggested by the authors of iMoney.

• SPY = 15%
• RSP = 15%
• IWM = 5%
• EFA = 10%
• EEM = 5%
• TLT = 15%
• SHY = 15%
• IEF = 15%
• TIP = 5%

This moderately conservative portfolio generates the following data when a three-year database is used for the QPP analysis.

• Return = 6.16%
• SD = 8.55%
• PA = 57.8%
• DM = 36%
• R^2 = 93.3%

The return is quite low and the diversification is still modest.

Lowell Herr

Photograph:  Fat City Cafe

To learn more about Quantext Portfolio Planner, click on the link.  Serious investors should at least take a look at a demo version, if it is still available.  QPP allows the user to enter up to 20 tickers (basic version) of stocks, ETFs, or mutual funds.  Once the tickers are in place, you then enter the percentage allocated to each investment, select a period for analysis and update the information.  As output, you receive a projected annual return, standard deviation, diversification metric and much more.

I highly recommend this Excel program.

Lowell Herr

Photograph: Woofie

I am investigating software that will aid in the development of portfolio asset allocation, reduction of risk, and give some insight into what asset classes to emphasize in the coming year.  Look for more information beginning sometime around the middle of November.  There is a high probability a new portfolio will be launched using these additional asset allocation tools. Specific details will be made available to Premium Content subscribers.

I just finished building a spreadsheet using the asset allocation targets of the Passive Portfolio.  The projected return is 11.8% with a standard deviation of 8.75%.  The S & P 500 is projected to return 8.3% with a standard deviation of 15%.  While I don’t expect to see anything close to an 11.8% return next year, I do like the fact that the SD is lower than the S & P 500 due to broad diversification.

Lowell Herr

Photograph: Venice, Italy

Premium Content subscription available for $6.99 per month.

Another portfolio I watch over is one I code as the HWEE portfolio. This portfolio is similar to the one I reported on yesterday, only the make up is different in that other ETFs are used to build and manage the portfolio.

The Information Ratio for this portfolio is higher than the HWJM portfolio with a value of 0.68.  I don’t write about the IR for the AA-Mosaic, Mosaic2, or the GLW portfolios as I don’t have sufficient information to make the calculation.  As I mentioned yesterday, one needs a minimum of three years of data before this ratio carries any meaning.  One of the reasons for reporting on the HWJM and HWEE portfolios is to provide some discussion for the Information Ratio.

Brokers such as TDAmeritrade are always looking for ways to attract customers.  One suggestion I would make is for them to develop a benchmark tracking system similar to what Bivio provides and then permit the user to select a benchmark or even better, a combination of benchmarks.  With that information in hand, the monthly statement would calculate the Information Ratio, giving the investor a feel for how high a risk they are taking in order to achieve the return.

Broker houses have all the information and they certainly have the computing power.  All they need is for a few programmers to code the information, thus providing a real service to their customers.

Lowell Herr

Photograph: Andes mountain range taken looking over the Sacred Valley of Peru.

If I were to make a recommendation to my security holding house it would go something like this.

• Set up the option to allow the investor to establish an asset allocation plan for their portfolio, much as we do in the spreadsheets for the AA-Mosaic and Mosaic2 portfolios.
• Establish appropriate benchmarks for the customer. This may be a combination of both equity and bond benchmarks or multiple benchmarks as determined by the target percentages assigned for each portfolio.
• Calculate the beta for each portfolio.
• Calculate the alpha for each portfolio.
• Calculate the sigma for each portfolio.
• From this data, determine the Information Ratio for each portfolio.
• Provide an easy method for merging multiple portfolios so one can measure the return of the portfolio compared to its appropriate benchmark.
• One should also be able to measure the alpha, sigma, Sharpe Ratio, R-Squared value, and Information Ratio for the merged portfolios.

While these requests may sound daunting, each broker house has the information to make these calculations for each and every customer.

What is in it for the security house? Why would they want to provide such a service? The bottom line is that any stock and bond security house could use the service to attract new customers. Further, such a service would help brokers work more effectively with their clients in planning and managing portfolios. Above all, the flexibility to manage portfolios in the manner would be a remarkable improvement over the current statements. 

I visualize customers establishing their own target limits just as we do in the Thomas/Lalla/Herr spreadsheet. When an asset class within the portfolio moves out of the target range, an e-mail reminder is sent to the customer warning them that one of their asset classes is out of balance. Note: It would be very important for each customer to have the flexibility to set their own target limits.

If there are like-minded readers out there, please comment on this modest proposal.

Lowell Herr

Photograph:  Your local “friendly” rodent.

Reporting on the Passive Portfolio is a regular event as this is one of the longest running portfolios I monitor.  As I recall, when I last reported on the performance results for this portfolio, the Internal Rate of Return (IRR) was 3.4% points higher than the VTSMX benchmark.  When the portfolio performance is outstripping the benchmark I know I will end up with a positive Information Ratio.  But by how much is the next question.

To keep track of the Passive Portfolio, I keep records using a software program called Captool.  Unfortunately, this software is no longer supported by the company so I am running on borrowed time with this program.  However, it is the only affordable program I know of that will calculate the Alpha and Sigma for a portfolio.  In addition, I use the Thomas/Lalla/Herr spreadsheet to give me accurate portfolio and benchmark performance results.  From Captool and the SS, I am able to glean accurate records on this portfolio.

As of 7/31/2008, the Passive Portfolio is generating a remarkable Information Ratio of 0.87.  I will put that number up against almost any money manager except the combination of Buffett-Munger.  The portfolio did lose over 10% during the last two months, a devastating blow.  Looking back over the nearly eight year record, the portfolio outperformed its VTSMX benchmark over every period examined.  That includes five-, three-, two-, and one-year periods.  This last year has been one of the most difficult for this portfolio.

The PP experienced approximately two trades per year due mainly to selling stocks contributed to the endowment fund and we did rebalance once or twice since inception.  Also, we will reinvest dividends when they grow to a sufficient percentage so as to keep commissions to a minimum.  The portfolio is skewed slightly to the value side of the equities spectrum.  This portfolio tilt was definitely the way to lean over the last eight years.  One never knows if this will change over the next five to ten years.

If anyone has questions as to the asset allocation percentages, just ask and I will try to answer all probes.

Lowell Herr

Photograph:  Carving by Howard Tibbals.

This morning I am reporting on the results of portfolio, HWJM, one that I have yet to mention in this blog. This portfolio recently turned nine years of age and it is built entirely around a few Exchange Traded Funds (ETFs). I do not have the data for this portfolio entered into the Thomas/Lalla/Herr spreadsheet so my benchmark performance is not accurate to the degree one obtains from that SS. However, I do have information on this portfolio that is not provided by the T/L/H spreadsheet and that is the Information Ratio.

If you search for Information Ratio (IR) on this blog you will find a few references.  Unfortunately, I do not have the IR value for any of the three new Mosaic type portfolios.  1) The T/L/H spreadsheet does not provide information to determine this ratio.  2) One needs a minimum of three years of data to arrive at the number.  Three years of data is needed to calculate the beta of the benchmark and then the portfolio performance is compared to the performance of the benchmark.  This forms part of the IR calculation.  The three Mosaic style portfolios are all under three years of age.

The IR value for the HWJM portfolio is 0.26.  Anything over zero is considered very successful.  An IR value greater than 0.5 is rare and over 1.0 is almost unknown.  I have seen one or more of my Passive Portfolios top the 1.0 mark.  What this means is that one is not only outperforming the benchmark by a significant margin, but one is doing it by reducing the risk of the portfolio.  Too frequently investors concentrate only on return and forget about the risk they are taking to achieve the return.  That is not our style of investing.  While we are interested in return, as that is what one carries to the bank, we do not want to take unwarranted risk to acheive outstanding results.

Let me tell you a few things about the HWJM portfolio.  When I first launched this portfolio over nine years ago, I selected individual stocks as the construction blocks.  The risk since inception is a very high 33.91%.  Part of this high number is due to a volatile market in the late 1990s and early 2000s.  While the alpha of the portfolio was positive, I was not pleased with the risk that was showing up, and will continue to do so for years.  Over time I began to sell off the stocks and replaced them with ETFs.  This move provided much greater diversity for the portfolio and the risk declined.  Here are the risk values as measured since 7/31/2008.

• Five years - 9.55%
• Three years - 10.08%
• Two years - 10.18%
• One year - 12.55%

How does one reduce portfolio risk? I just finished updating one of the portfolios I watch over and this is a portfolio where I sold off all individual stock holdings and shifted entirely to ETFs. This is a rather small portfolio that has been in operation for nine years. Using Captool sigma (standard deviation) calculations, I see where the risk has been lowered from over 34% to 10%. Yes, some of this sigma is due to the bear market of the early 2000’s, but much is due to shifting from individual stocks over to a broader diversified portfolio using ETFs. I’ve consistently been able to reduce risk in portfolio after portfolio by increasing diversification through the use of ETFs.

Lowell Herr

Photograph: This image was taken with a Canon 20D using a 100-400 zoom lens. The focal length was 100, ISO of 800, speed 1/3200, and f 10.  The racer was traveling in excess of 25 mph.

Is it time to rethink bonds? In past entries, I’ve made the argument one should not hold bonds if one can count on income from pensions, social security, and dividend paying equities. While it is always useful to consider bonds as an asset class to lower portfolio risk, now is not the time to make such a move.

• Risk reduction is an important consideration. Bonds provide a low correlation investment to stocks or equity ETFs.
• The income from bonds will likely form a higher percentage of the portfolio income vs. the growth we saw in stocks from 1982 - 2000.
• The future growth in stocks does not look as bright as it did twenty-five years ago.

Those are three reason to consider bonds.  However, the returns on bonds are so low, just avoid them at this time.
What bond ETFs might one consider for a portfolio such as the Mosaic, and where does one cut the percentages to make room for 10% to 15% in bonds? Here are four bond ETFs to consider if and when one does make a move into bonds.

• BIV Inter-Term Bond
• EMB Emerging Markets Bond Fund
• AGG Lehman Aggregate Bond Fund
• TIP Leham TIPS Bond Fund

If readers have other suggestions, please comment.

Deciding where to cut percentages in other asset classes is always a very difficult decision.  For now, we can delay that decision.

Lowell Herr

Photograph: Lucy

Photograph: Galaxy Ball

While MVO software, such as MVOPlus, is a wealth management tool, there needs to be a warning label placed on the box. Evensky provides us with such a warning and it goes like this.

“In spite of my strong defense of Markowitz’s optimization, it should be clear that I consider an MV optimizer a potentially dangerous instrument, one that needs to be heavily constrained by a knowledgeable wealth manager. Simply developing the input for an MV optimizer requires a significant leap of faith in one’s ability to divine an image of the future.”

Here are some follow up comments to Evensky’s necessary and timely warning.

• When using the MVO tool, I do not project future gains or losses for any asset class. I am not able to divine the future so I rely only on historical data.
• I place lower and upper percentage constraints on each of the fourteen (14) asset classes within the MVO database. I am forcing the portfolio into my “asset allocation shoe” of choice as a means of taming MVO. This is how one keeps the MVO software from directing the investor toward a portfolio that makes absolutely no sense.
• While MVO principles work on a theoretical basis, when permitted to recommend portfolios without constraints, there are many times when the recommendations are absurd. Percentage constraints applied to each asset class of interest brings the MVO projections into balance with the investment policy guidelines.

Lowell Herr