Since the Huygens is one of the portfolios managed using the Mosaic Model, I am breaking the analysis into two parts. This way I can illustrate to new readers how the Tranche Momentum Model works (Part I) and then how the added layer of a passively managed portfolios (Part II) results in what I call the Mosaic Model. In this blog post I focus on the Tranche Momentum Model. In Part II I will show how the portfolio migrates to the Mosaic Model.
I already have my potential list of ETFs selected for the Huygens and those include the “Rutherford 10” plus BIV and REM. BIV provides bond exposure and REM is a high yield REITs that adds income when it is one of the held securities.
Tranche Momentum Recommendations (All cash position): The current value of the Huygens is nearly $149,000 so we begin our analysis as if the entire portfolio is in cash. Based on 7/12/2016 data and the default settings such as 12 portfolio offsets separated by one offset period, we see the following tranche recommendations below. If we apply no risk constraints, coming later in the Position Sizing worksheet, five ETFs are recommended. The current recommendations are VNQ and REM, positioned #1 and #2 respectively. None of the ETFs are priced below their 195-Day EMA so none are quickly eliminated from consideration.
My preference is to work with blocks of shares or 100 share units. For example, I would hold 400 shares of VNQ, 100 shares of GLD, and 4200 shares of REM. This leaves two recommendations, DBC and TLT. Since TLT shows up in only one of the 12 tranches, I would likely buy 50 shares of TLT and use the remaining cash to buy shares of DBC, rounding to the nearest 100 shares. We could stop the analysis right here and wait another 33 days before we look at another tranche ranking and rebalance the portfolio. However, many of us have risk concerns so we now move down to the Position Sizing worksheet to see how we might reduce portfolio risk.
Position Sizing Recommendations (Based on all cash position): Within the Position Sizing worksheet we can control four variables. Personally, I leave the Volatility Period set to 63 and Fwd Days to 23. In the following example I have the SD Multiplier set to 1.5 so the Probability of Stop settles in at 13.4%. If this is too high, and for some portfolios it is, I raise the multiplier to 1.6 which pulls the percentage down to 11%. Some investors may want to pull down the risk even further.
The other critical variable is the Max Trade Position Risk percentage – set to 1.1%. I adjust this so the Maximum Portfolio Risk comes in at 6% or below. With the 1.1% setting the risk is 5.5%.
With these settings the recommended number of shares changes from the tranche worksheet shown above. For example, the Position Sizing worksheet recommends 1249 shares of DBC vs. 3286 shares recommended in the tranche momentum worksheet.
Instead of holding zero in cash, the Position Sizing worksheet recommends a cash holding of $56,000. Remember, we can lower that cash holding if we take on more risk with the Huygens. What the Position Sizing worksheet does is help the investor control risk based on changing a few variables.
In Part II I will show how to use the Manual Position Sizing worksheet as this is where you set the shares to be held in the portfolio for the next 33 days or whatever period you use to review the portfolio.