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You are here: Home / Portfolio Management / Portfolio Construction / What Are The Screening Processes For Portfolio Construction?

What Are The Screening Processes For Portfolio Construction?

November 2, 2016 By Lowell Herr

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What processes are followed to come up with the ETFs and stocks needed to construct a momentum oriented portfolio?  The screening model laid out below is quite different than what I use to build passively managed portfolios such as the Schrodinger.  Here are the steps I follow.

  1. Begin with the “Rutherford 10” as these ten ETFs have been shown to perform quite well when tranche momentum principles are applied.
  2. Beginning with over 125 ETFs, screen for the top 3 using the tranche momentum model as found in the Kipling Tranche 2.5.1 spreadsheet.  Add those three ETFs to the Rutherford 10 to make up what is known as the Baker’s Dozen.
  3. To add additional diversity we add three to five stocks to the Baker’s Dozen.  These few stocks are found using a proprietary value-momentum screen from over 6,500 stocks.
  4. At this point we have identified 15 to 20 securities for inclusion in the final portfolio.
  5. To better identify securities for the final portfolio, I frequently run a correlation analysis so as to avoid highly correlated stocks and ETFs.  If there is a correlation of 0.80 or higher between an individual stock and ETF, I select the ETF as it provides additional diversity.
  6. The final 15 to 20 securities are run through the tranche momentum analysis, now familiar to ITA readers, to build the portfolio.

Detailed examples of this process will show up as various portfolios are reviewed over the next several weeks.

Photograph:  I am currently in Southern Oregon photographing waterfalls found along Route 138.  This scenic highway connects Roseburg and Crater Lake and is known as the Waterfalls Highway.

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Filed Under: Portfolio Construction Tagged With: Portfolio Construction

Comments

  1. John Moyle says

    November 2, 2016 at 11:15 AM

    Hi Lowell,

    What would be your thoughts on a portfolio constructed on the following manner?

    Using Meb Faber’s IVY 5:

    When asset price is greater than 200 MA and absolute momentum is greater than cash or cash equivalent… asset is 100% invested.

    When price is below 200 MA or absolute momentum is below cash… asset is 50% invested.

    When price is below 200 MA and absolute momentum is below cash…asset is 100% cash.

    Rebalance monthly…

    Regards,

    JRM

    • Lowell Herr says

      November 2, 2016 at 3:19 PM

      John,

      This is a straight forward plan. One of my reservations is that the Ivy 5 does not provide a lot of diversification. I am still traveling so I don’t have all my computer tools available to emphasize my point. There are times when VTI and VEU or VEA are highly correlated. That narrows the list of ETFs that provide for portfolio diversification.

      When you say 100% invested, would you divide the investment among those ETFs that meet the “buy” standards?

      Lowell

      • John Moyle says

        November 3, 2016 at 7:03 AM

        Lowell,

        When I refer to 100% invested I am referring to being 100%, 50%, or 0% invested in each ETF depend about the monthly rebalancing rule.

        I used the IVY 5 as an example since the investor is either in the ETF or out.

        The ETFs I would prefer to use would be SPY (20%), TLT (20%), PHYS (20%), DLR (20%), SHV(20%)….

    • Lowell Herr says

      November 3, 2016 at 6:49 AM

      John,

      If all five ranked above their 200-Day SMA and all ranked above SHY (assuming this is your cutoff ETF), would you invest 20% of the portfolio in each?

      Have you thought about using this model with the Ivy 10?

      Lowell

      • John Moyle says

        November 3, 2016 at 7:22 AM

        Lowell,

        Yes, on both questions! In the portfolio allocations, I would be either in or out of the asset based upon the status of the 200-day SMA and rank above the cutoff ETF. I would mix money across ETFs in the portfolio.

        John

        • John Moyle says

          November 3, 2016 at 7:25 AM

          Correction: I would NOT mix money across ETFs in the portfolio!

          Too many interruptions this morning in my office…my apologies!

          • Lowell Herr says

            November 3, 2016 at 9:07 AM

            John,

            To help me better understand your model, here is a question. Suppose SPY (one of your selections) is priced above its 200-Day SMA, but is performing below the absolute momentum cut off. Further, assume all the other four ETFs are performing below the cutoff and priced below their 200-Day SMA. How much of the portfolio would be invested in SPY?

            Lowell

            • John Moyle says

              November 3, 2016 at 1:38 PM

              Lowell,

              After making the rebalancing decisions in your question above, the funds would hold the following:

              SPY – 10% (or 50% of the 20% portfolio allocation)
              TLT – Cash
              PHYS – Cash
              DLR – Cash
              SHV – Cash or stay invested

          • Lowell Herr says

            November 4, 2016 at 4:35 AM

            John,

            Your investing model is intriguing for its simplicity. This morning I ran a tranche momentum screen on the five ETFs you recommend and found only SHV is outperforming SHY. You may use a different cutoff ETF.

            If I understand your model correctly is looks like this.

            1. SPY, TLT, and DLR are all under performing SHY and all three are currently priced below their 195-Day EMA (I know you use the 200-SMA) so all three are in cash.
            2. PHYS is under performing SHY, but is priced above its 195-Day EMA so 10% of the portfolio is invested in PHYS.
            3. That leaves SHV. It is performing above SHY and is priced above its 195-Day EMA so 20% of the portfolio is invested in SHV.

            This leaves you 30% invested and 70% in cash. Hope I have this correct.

            Lowell

            • John Moyle says

              November 4, 2016 at 6:46 AM

              Hi Lowell,

              Yes, you have the model I am proposing for your thoughts and opinion!

              As a person approaching retirement, it is a model that I will have the cognitive ability to understand and maintain well in my 80s…90s. The model appears to respond to downside risk when assets are depreciating and give a modest reward based upon the long-term performance of each asset when assets are appreciating.

              Thank you for your time and insights.

              John

              • Lowell Herr says

                November 4, 2016 at 7:15 AM

                John,

                Instead of using the 200 SMA, I recommend the 195-Day EMA for several reasons. 1) It is built into the Kipling SS. 2) It is faster reacting and therefore will move one into or out of the market before the 200 SMA crowd makes their move.

                The model is risk adverse and I like that. Now I only wish we had some back-testing results to see how it would have performed during the Great Recession and the more recent bull market.

                Lowell

    • Lowell Herr says

      November 4, 2016 at 11:53 AM

      John,

      I created a crude worksheet that I think will do what you are requesting in that the SS will tell an investor how many shares of a particular ETF to purchase based on the EMA (you will need to adjust to SMA) and absolute ranking. I use SHY as the cutoff since that is what is built into the Kipling SS.

      Perhaps someone will take my first draft and spiff it up into an additional worksheet withing the Kipling Tranche 2.5.1. One could call this the Kipling Tranche 2.6 or 3.0 for simplicity. Anyone interested in tweaking what I’ve done and checking for accuracy.

      Lowell

  2. John Moyle says

    November 14, 2016 at 7:37 AM

    Hi Lowell,

    Can you send a download link to Kipling Tranche 2.5. I am unable to find a place to download the latest SS.

    Thank you,
    John

    • Lowell Herr says

      November 14, 2016 at 9:25 AM

      John,

      It should be in your e-mail in box.

      Lowell

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