Darwin Portfolio Review: 2 December 2022

Arizona Landscape

Last week I took an early look at the Darwin Portfolio and, while I don’t like to change too many parameters for these reviews (so as to provide a reasonable example of performance that might be expected from use of the various models used), I decided that the setup was probably too aggressive – even for myself, as a reasonably aggressive investor with a relatively high tolerance for risk – and, certainly, for more conservative investors.

The Darwin Portfolio is close to a “Buy-and-Hold” style portfolio in that all assets available in the “quiver” are held at any point in time. The portfolio uses the Dalio methodology of Risk Parity to allocate funds to each asset such that the risk from each asset should be equal. The portfolio is re-balanced periodically if calculations show that holdings are significantly out of balance with the Risk Parity expectations. On top of this I add a small allocation (10%) to a volatility ETF for a little system diversification.

This portfolio management style is not my personal favorite (hence the small size of this portfolio), although it is certainly a legitimate candidate for consideration, especially for conservative investors, since it allows control over portfolio volatility.

Because the management style it is not my personal preference, when I started this portfolio ~18 months ago, I chose to be aggressive by setting maximum volatility levels for each asset to 10%

This means that, if the five assets in the quiver were perfectly correlated, that maximum portfolio volatility could be ~50%. Of course, asset selection is such that assets are not that highly correlated (and specifically chosen for this very reason) and actual portfolio volatility has run at ~18% over the 18-month period. Performance is also influenced by the fact that I have allowed for 25% leverage if called for – and, with 10% allowable volatility, this leverage has been called upon reasonably frequently adding borrowing costs to the performance equation.

Performance to 25 November looked like this:

or, in stacked format:

Calculated (annualized) Internal Rate of Return (IRR) over this period was -17.2% – about the same level as the draw-down in US Equities so far in 2022.

Because this performance is not likely to satisfy too many investors (even though not disastrous) it would not seem to justify the level of effort needed to manage the portfolio and has not controlled volatility to a level that might be acceptable to a conservative investor. Consequently I have chosen to “turn the wick down” going forward and have reset maximum volatility levels for each asset to 3% (from 10%):

This has reduced the calculated holdings in each asset as shown above. Allocations were adjusted on 28 Nov as follows:

Thus, going forward we will be following the performance of a $7,000 portfolio with less than 15% (5 x 3%) portfolio volatility – likely 7-8% (we’ll see). Of course, this more conservative approach will likely result in lower returns going forward if/when the markets turn bullish again. This is always the compromise – for any system. I have allowed for up to 50% leverage, although at the 3% max risk level this is not likely to be called upon. At the moment only ~75% of available funds are invested as a result of the low volatility risk limits.

We’re off to a flying start – with ~410% (annualized) IRR in the first week 🙂 – obviously meaningless at this early stage. Here’s how the allocations look graphically:

and, in stacked format:

Let’s see how this goes over the next few months. If we move into a new (confirmed) long-term uptrend from here I will obviously regret turning down the wick – but this may be a more attractive portfolio for conservative ITA readers to follow.

David