Following last week's publication of the May issue, we received some interesting questions/requests in the Comments section concerning the cover article. I thought it might be helpful to address those in today's blog post. I've altered the questions slightly for clarity.
Could one assume you could split your portfolio into 50%-50% SMILX and SMIDX funds to achieve 60/40 stocks/bonds example in the article?
There are three 60/40 portfolios charted in the article. I assume Pat is referring to the one in Chart 2, in which case the answer is yes. That portfolio does not, however, include a Sector Rotation component. If that is desired, the allocation would be 50% SMIDX, 40% SMILX, and 10% SR.
According to the data on the Advanced Strategies page, DAA has experienced an average return of 13.0% with a relative risk of .59. This compares very favorably to portfolios #10, #11, and #12 in Chart 3 in the article. Am I interpreting things correctly? What would the arguments against following DAA exclusively be?
The interpretation is correct, although with a small variance. The test period in the article included 1999 whereas the data on the Advanced Strategies page does not. For the 1999-2013 test period, a 100% DAA strategy returned 12.5%/year.
I don't really have an "argument" against following DAA exclusively. Because of its historically lower volatility, many risk-averse readers will want to do just that. We created DAA for the reader who might say, "I don't need to hit home runs on the upside. I just don't want to risk losing much on the downside." For further information, review the original DAA introductory article.
The reason many would opt for combining strategies is because they hope for better returns during bull markets. Last year (2013) was a good example: Upgrading +34.5%, DAA +16.2%. This kind of disparity can make it difficult for many investors to stay with DAA over the long haul. They don't like the "left behind" feeling.
During the test period, the best 12-month period for DAA was a gain of 32.1% (helped along by a strong and lengthy bull market in gold which may not repeat itself). Pretty good, but the best 12-month periods for the combined portfolios were better: 42.0% for #10, 38.9% for #11, and 36.6% for #12.
Whether to follow Upgrading alone, DAA alone, or combining them as suggested in the article is a personal call based on your personal goals and attitude toward risk. But we believe the 50-40-10 portfolios in Chart 3, or something similar, is a good starting point as you make this decision.
I would very much like to see data showing the worst 12-month periods for sets 5-12. It is one thing to see reduced volatility; it is another to see just how bad (historically) it can get following a particular strategy.Here are the worst 12-month experience an investor in these portfolios would have endured during the 1999-2013 test period:
|#1 -42.8%||#5 -26.8%||#9 -25.4%|
|#2 -35.8%||#6 -23.3%||#10 -22.6%|
|#3 -31.6%||#7 -20.6%||#11 -20.5%|
|#4 -26.2%||#8 -17.5%||#12 -17.9%|
As you can see, the worst-case scenarios dropped along with the lower volatility as expected. Interestingly, while Chart #3 showed that adding the SR allocation increased volatility (compare portfolios #5-#8 with #9-#12 in the cover article), there's not a lot of difference in the worst-case scenarios between the two sets. In fact, the worst 12-month result actually improved slightly when adding SR in three of the four comparisons.
One thing to keep in mind when looking at studies like these is they show results only for the period tested. The next 15 years will not be a rerun of the past 15 years. The study is suggestive of what will happen, but not predictive. So, take the cover article as providing clues, not promising a sure result.