I am starting a new “live” portfolio that I have named the “Rutherford” Portfolio. Unlike the Hawking Portfolio that considers 100 ETFs for possible inclusion in the portfolio and uses Cluster analysis to narrow the list down to 4 ETFs, the Rutherford Portfolio will draw from a small list of only 10 ETFs (plus SHY) from which the portfolio will be constructed.
The method used for portfolio construction/asset selection is a momentum strategy that utilizes the “standard” momentum ranking sheet (available for download on this site) with which Platinum members will be familiar. “Standard” momentum periods of 91 and 182 (calendar) days ( 3 and 6 months) are used but the volatility (mean variance) period is changed from 10 to 63 (trading) days. Reasons for this are provided below. The relative weightings of the 3 parameters (to determine the “Overall Rank”) are kept “standard” at 50% (ROC1), 30% (ROC2) and 20% (Volatility).
This will be a VERY SIMPLE portfolio in that it will comprise only TWO ETFs (providing they rank higher than SHY; i.e. SHY momentum is used as a Risk Management filter.
In addition, the Asset List for the Rutherford Portfolio is based on the Swensen 6 portfolio that has been the subject of many posts on this site and should be familiar to regular readers.
ETFs used to represent the six “Swensen” asset classes are:
- VTI – Domestic (US) Equities;
- VEA – International, Developed Market Equities;
- VWO – Emerging Market Equities;
- VNQ – US Real Estate;
- TLT – US Treasury Bonds;
- TIP – US Treasury Inflation- Protected Securities.
In order to add more diversification I have added 4 additional ETFs:
- RWX – International Real Estate;
- PCY – Emerging Market Bonds;
- GLD – Gold (inflation hedge);
- DBC – Broad Commodity ETF (Oil & Gas, Agriculture, Metals)
Current Rankings are shown in the Figure below:
TLT is presently ranked #1 and will be purchased for the portfolio.
PCY is tied with SHY in the rankings and so is marginal at best. The 13 day EMA is currently below the 49 day EMA generating a “sell warning” signal. Also, the “absolute acceleration” is negative signifying decreasing momentum (in fact the 91 day momentum – ROC1 – is negative). Price has also only recently risen above the 195 EMA. For these reasons I will not be purchasing PCY at this time, but will put it on a “Watch List”.
Allocations:
I shall not be using a Strategic Asset Allocation (SAA) Plan as suggested by Swensen, rather, allocations are based on 3 important characteristics of asset behaviour, correlation with other assets, volatility and momentum.
This is a further modification of the Modified Risk Parity (MRP) weighting strategy that I have alluded to in a few earlier posts but uses the 91 day Sharpe Ratio (this is why the 63 (trading) day volatility is used in the ranking sheet) rather than volatility alone. Using the Sharpe Ratio integrates inverse volatility (naive Risk Parity) into the adjustment, since volatility is contained in the denominator of the Sharpe Ratio. The numerator of the Sharpe Ratio reflects the returns on the asset and so is proportional to momentum.
I shall refer to this as the Sharpe Weighting (SW) strategy.
Suggested allocations are shown in the figure below:
I plan to purchase 400 Shares of TLT to-morrow. I will keep the balance in Cash for now.
The Rutherford Portfolio will be reviewed every 33 days and data will be posted on this site.
Notes:
I had intended to use the Sortino Ratio (using semi-variance – variance of negative returns) in preference to the Sharpe Ratio, reasoning that this might be more effective since it does not penalize positive returns (that we want). However, in back-tests there was really no discernible difference – with the Sharpe Ratio showing slightly better (but not statistically significant) results.
Allocations based on the Modified Risk Parity (MRP) method mentioned previously are also shown in the figure above. Using MRP allocations (in back-tests) results in a more conservative performance in that portfolio volatility is lower at the expense of returns – same old story. However, the Sharpe ratio of performance is better. It is my choice to accept the higher volatility (risk) in exchange for (hopefully) higher returns.
Late addition to Post:
In a recent post, Lowell mentioned the preference, by many investors, to choose low Beta assets. Note that the Beta of a portfolio containing TLT, PCY and SHY using SW weightings would be -0.10 or practically uncorrelated to VTTVX that I am using as the benchmark/reference. However, be a little careful since calculating the beta of a bond with reference to equities (although VTTVX contains 30% bonds) is not too reliable as indicated by the low r-squared values. Only VTI, VWO , VEA and RWX are high beta assets.
David
See Comments below – Stop Loss placement on TLT:
David
David
I like this new portfolio!! I am alsu using one very similar from http://www.cxoadvisory.com
Maybe you have backtesting for this portfolio, that would be great to see
Anyway thanks very much
David,
I’ll write a post showing back-test results when I have a little time.
David
I too follow the CXO advisory recommendations. If I understand the CXO and Rutherford there are a few differences.
Rutherford follows 11, including SHY instead of 9 (including SHY). Rutherford includes TIP, RWX, PCY and SPY instead of Large Cap (IWB), Mid Cap (IWM) [IWB and IWM seem always very highly correlated!].
Rutherford also factors in 3 mo + 6 mo return (with absolute acceleration) combined with volatility. CXO, I don’t believe, considers volatility and while it has CASH in its ‘universe’ it has never indicated it as 1st choice and only in the darkest days of 2008 as its second choice.
I like Rutherford. Nice ‘universe’ of diverse ETFs; return over 3/6 months; and a component for volatility! As shown in the current (first ‘live’ Rutherford) Cash figures prominently in the allocations.
As Lowell suggest below, if 2 positions is uncomfortable, you may use 3 or 4 positions; although David will give you the Sharpe Ratio Weighted allocations for only the top two positions (three in this case, since PCY and SHY are ‘tied’). [Do I understand this correctly?]
Also, ITA Wealth Management through the published SS gives you the supporting detail behind their rankings. With CXO you don’t know who came in 4th and how close the top 3 were to each other.
Very nice, I like it! Dan
Dan,
I think you’ve just about summed it up correctly – except that SPY is not in the Rutherford list – just VTI representing US Equities.
David
To all readers of ITA. To kick off the Rutherford Portfolio I highly recommend you Tweet this URL and place the link on your Facebook page. Also talk it up on StumbleUpon and the other share options.
Lowell
HedgeHunter,
Will cash rest in a money market or do you plan to invest it in SHY?
Lowell
Lowell,
At present I’ll keep it in cash until I see how PCY (or other ETFs) perform. If everything seems to be going down, then I’ll put it in SHY. It probably isn’t going to make a big difference to the bottom line.
David
Nothing seems to be pushing the SHY filter too hard so I’ve decided to “park” the cash in SHY (600 Shares). Thus, the 2 assets now held in the Rutherford portfolio are TLT and SHY.
David
Unfortunately I was a little busy this morning and missed the “opening bell”. When I finally logged on, the S&P 500 was down and bonds (TLT) were up. However, rather than wait I decided to get this portfolio rolling and bought 400 shares of TLT at 117.97 (probably the high of the day 🙂 )
We’re off and running!
David
Far from the high of the day but market history is going against you with TLT. We should see a market upswing through the 1st quarter 2015 if the almanac is correct.
Marc,
I think I’ve mentioned in other posts that I (personally) find it very difficult to “invest” in bonds at the present time. However, if I am to have confidence in any “system” I must trust that system and follow its recommendations – otherwise, when things get tough there is too much temptation to abandon it – usually just before things turn around.
I was rewarded (and pleasantly surprised) by today’s nice move up in TLT – but it can just as quickly reverse to-morrow.
As for market history and what the almanac predicts for the first quarter of 2015, I’m not too worried about that since I am monitoring frequently and reviewing monthly, so the charts and analysis will tell what’s really happening.
David
Holding just 2 stocks can be really risky if they happen to be high volatile etf’s like gold and commodities. I don’t know if I’m willing to bet 50%, or more, of my retirement account on whether gold is going to go up in the next 30 days.
Bob,
There alternatives. 1) Don’t limit the number of holdings to 2. Up it to three or four. I think HedgeHunter will show that one gives up return with this move. 2) Eliminate GLD and DBC and substitute two value securities, VOE and VBR. Of course VOE and VBR are highly correlated with VTI so that may not be the ideal tradeoff.
Psychologically, there is something that goes against the grain when one limits the holdings to 2. This despite the fact that we really are holding many pieces of individual securities. That is a mental barrier one may need to overcome and it is easier to do with a small portfolio.
Lowell
Bob,
I agree it’s a big leap of faith to restrict a portfolio to 2 assets – but all the back-tests I’ve done indicate that, over time, performance can be impressive. And yes, I know all the arguments and skepticism regarding the value of back-tests – I’m probably as skeptical as anyone – but the results do appear to be as unbiased as possible considering the limited time period for which historical data for ETFs is available. Although we think of assets such as gold and commodities being volatile (and they certainly can be) looking at the 3 month volatilities in the ranking sheet above shows they are not out-of-line with equities and real-estate – and,maybe surprisingly, with Treasuries (TLT).
At least you’ll be able to follow the performance of a “real” 2-asset portfolio going forward 🙂
David
“At least you’ll be able to follow the performance of a “real” portfolio going forward :)”
And possibly more than one. 🙂
Lowell
David
I really do like this idea and will do the same except use Absolute Acceleration as the picks instead.
Stephen
Hedge Hunter–is there a spreadsheet available for the various allocation methods?
Thanks
Bernard,
Not yet. There are 2 problems:
1. The SS I’m using requires the Hoadley Add-in to be installed and most Platinum members don’t have this add-in. Even if not using the Cluster analysis portion of the SS, the MRP and SW weightings require a correlation matrix and I use the Hoadley Exponentially Weighted Moving Average (EWMA) method of calculating this matrix. I suppose it’s possible to generate this matrix without Hoadley – but it would be a lot of work.
2. With all the options, the SS gets a little complicated and difficult to understand if you’re not familiar with it. I would therefore have to simplify it considerably or write a detailed mini-manual (and I know the “guys” don’t generally like reading manuals – the “gals” are usually mutch better at that 🙂 ).
Either way, this all takes time – and time away from my (very time intensive) back-testing and development work. We’ll get there one day – but I can’t be sure when. In the meantime, the best I can offer is the regular screenshots.
David
David,
What do you mean for “Mean Variance”?is it The Classic standard deviation Or what else?
Thank you
Michele,
Yes, “Mean Variance” is the same as the classic Standard Deviation.
David
Steve et al.,
I’ve posted a figure at the end of the above post to show where I’ve placed stop loss orders on TLT ($112.72). I’m presently holding TLT in both the Hawking and Rutherford Portfolios. I don’t expect this to get filled any time soon and it may get adjusted at some point – but it’s there, in place, in case I forget to check or there’s a panic as if the world’s coming to an end and I’m too busy doing something else. In addition to being below the lows of the last “golden cross” area, it’s also below the 195 EMA. I would expect to see TLT drop below SHY in the rankings before this order was filled.
I’ve posted this as an addendum to my response to comments in the Rutherford Back-Test post.
David
David,
Thanks again for all the work and your October 13 Rutherford back-tests did answer most questions, although the out performance of an “inverse” weighted portfolio still does seem a paradox, even after reading Arnott’s paper. Quick question is how you are setting up your stop-loss triggers? Especially if one is creating a 1 or 2 asset portfolio from the Rutherford 10, we do need stop losses . . . even with the near perfect tool you have created : >)
Robert
Robert,
See also my response to similar questions at https://itawealth.com/2014/10/13/rutherford-portfolio-back-tests/#comments
David
Thanks David,
Appreciate your comments on October 9 post on the AMLP stop-loss decision making
Robert
Robert,
I posted a response earlier but it seems to have got lost in the “blogosphere”.
To avoid repetition make sure you read my Oct 14 response to Steve Clark in the above-referenced Oct 13 Post.
David