In response to a question raised by an ITA Platinum member, I’ll attempt to answer how the Asset Allocation option works within the Kipling spreadsheet. I asked HedgeHunter to add this feature to the Kipling. The whole concept of building a portfolio around the idea of asset allocation is an old one and it is the idea behind the Robo Advisor or computer managed portfolios now available through various brokers. Most university endowment funds are based on this philosophy for constructing portfolios.
What the Kipling spreadsheet does not do is to hold the portfolio to the specified asset allocation percentages. The investing models will over-ride the specifications and that is what I will explain below.
Investment Quiver of Basic Portfolio
The following basic portfolio is made up of ten (10) securities plus the “overflow” ETF, SHV. Some readers will use SHY as the “cutoff” ETF.
The basic asset classes are covered in this portfolio and I want to keep it simple for this asset allocation example. In the third column from the left, we have the option to specify the maximum percentage we want to hold in each asset class. Below are my personal judgments. They follow, to some degree, the recommendations by David Swensen.
Note the highest percentage is set to TLT as I think of this treasury as my “security blanket.” TLT is where I go for hiding. I could easily set this one ETF to 100%. For example, TLT is where we are positioned right now with the Dual Momentum portfolios.
Now to explain how the Kipling works with these Max AA settings.
With the investing model set to BHS and the Target Filter (VTI) turned on or set to Yes, there is one other critical variable. I set the Maximum Number of Assets to ten (10) so there is the possibility all ten ETF have the opportunity to be invested at any one time. This would be rare as the BHS and Target Filter will generally cull the poorer performers out of the Buy zone. Right now, equity ETFs are a Sell, not a Buy.
With the maximum number of assets set to 10, only four ETFs are recommended for purchase. They are: IAU, IAGG, TLT, and AGG. I refer to gold, bonds, and treasury ETFs as conservative instruments. No equities are recommended for purchase. Very understandable considering the recent drop in equity prices.
Manual Risk Adjustments
Here in the manual risk worksheet we see how the asset allocation percentages kick into action. Check the percentages in the third column from the right. For example, gold (IAU) tops out at 5% as that is the percentage limit I set back in the portfolio tab (top screenshot). AGG hits the maximum of 25%. The total percentages add up to 55%. What happens to the other 45%? That remaining percentage either remains in the money market, or one might invest it in SHV, the cutoff ETF.
Behind the curtain something else is happening. In the Position Sizing worksheet (not shown) is the Portfolio Risk setting. I adjusted this to be between 5% and 6%. Had I raised this so that no cash remained, the recommendation for TLT would move from 15% up to 40% or my maximum setting. This is somewhat difficult to explain in words. I suggest interested Platinum members set up their own $100,000 Basic portfolio and experiment with the variables. Why is it that TLT changes? That is due to TLT holding the highest rank. Right now, TLT is the #1 ETF. The software (Kipling) will seek out the top ranked ETF and invest it to the max. Once this ETF is fully filled, the software moves to the second highest ranked ETF and so forth down to the 5th ranked ETF.
If you have question, please post them in the Comments section.