Three Models for Portfolio Construction
Readers new to ITA Wealth are sometimes overwhelmed with all the information available on this blog. There are times when a basic or refresher post is helpful. This is such a post. Below are three portfolio management styles or ways to construct a portfolio. In outline form, they are:
- Strategic Asset Allocation (SAA) model or what I use with the Bethe, Schrodinger, Copernicus, and Pasteur portfolios. In the following example I will be using the Bethe Dashboard to illustrate this model.
- The Dual Momentum model is as simple as it gets for anyone wishing to build a portfolio around the absolute and relative momentum concept.
- The Tranche Momentum model is an extension of the Dual Momentum model.
Bethe Dashboard: SAA investors lay out a business plan much as we see below. In the following Dashboard eight asset classes are used. There is definitely a tilt toward value. The logic behind skewing a portfolio toward the value side of the investing spectrum is the research that shows value outperforms growth over the long run. As they say, “Growth stocks are priced to decline.”
The first step for SAA investors is to determine what asset classes to use. The second, and most difficult step is to set the target percentages. I think the asset class percentages for the Bethe are an excellent start. The third step is to select ETFs or mutual funds that represent a particular asset class. For example, VTI is the ETF used for the Large-Cap Blend asset class. VEA and VWO represent Developed International Equities and Emerging Market Equities respectively.
Once these three decisions are made, the only requirement on the part of the money manager is to keep the asset classes in balance. This is a “boring” portfolio as changes are rarely from month to month or quarter to quarter. This is your buy and forget portfolio. Well-nearly so.
Dual Momentum Recommendations: The second model also requires little attention, particularly if you are using the Kipling spreadsheet. Dual Momentum rules are simple to follow.
- Select three ETFs to represent U.S. Equities (VTI), International Equities (VEU), and Bonds (BIV). Note that VEU is used for international equities as it includes both developed and emerging market equities. Bonds is not as straight forward. You can use BND, AGG, TLT or even TIP. I highly recommend using commission free ETFs for any of these choices.
- We are looking for VTI or VEU to rank above SHY, our cutoff ETF. Right now VTI ranks higher so we invest 100% of the portfolio in VTI. Had VEU ranked above SHY and VTI we would invest 100% in VEU.
- If neither VTI or VEU rank above SHY we are then 100% invested in bonds or BIV.
- The look-back period is one year or 252 trading days.
- We review the portfolio every 33 calendar days.
Tranche Momentum Recommendations: Only slightly more complex than the Dual Momentum model is the Tranche Momentum model. In this model the look-back periods are changed and we expand to 12 tranches so as to reduce the luck-of-review-day. More ETFs are selected for additional diversification. In the example below, I am using the tranche worksheet for the Huygens portfolio as this portfolio will be reviewed tomorrow. Individual stocks are also included in the investment quiver for a few portfolios.
If you follow portfolio reviews you will learn how to effectively use the Tranche Momentum model as it is used with the majority of actively managed portfolios.
If you have questions about any of the above three models, post your questions in the Comments section of this blog.