An interesting, albeit quick, discussion broke out in the comments of yesterday's post about buy and hold, versus the DFA version of buy and hold versus doing something that is not buy and hold.My basic take was you can glean any conclusion you want from the data (and reasonably support that conclusion). I think it boils down what sort of path you want to take to what is likely going to be a similar long term result regardless of the path you choose.
That is just an opinion, it makes some assumptions, feel free to disagree but that is how I view it.
It got me to thinking about an article I recently wrote for TheStreet.com which was about a portfolio concept for people who just throw in the towel on the stock market as a function of realizing they just cannot stomach bear market volatility despite the very cyclical nature of it.
While I think this idea makes things very difficult on several fronts the fact is some folks are better off emotionally not doing too much in the stock market.
The basic idea was a little buy write fund, a little emerging market bonds (as a proxy for foreign equity exposure), a lot in absolute return, a lot in inflation protected bonds and then save like hell.
I would expect a mix like this to lag a lot but I think it would go down a lot less too. And while particulars may or may not be a good combination the big picture strategy makes sense for some folks. In addition to people that cannot stomach volatility it might also be worthwhile for people who are way ahead of where they need to be.
A building block here is that, in the case of the buy write fund, the US stock market is not forever broken. Average returns may be less than what we're used to but the stock market still works. Assuming that is the case, the market will work higher at some rate and the buy write fund will either lead or lag but be reasonably close. The long term track record of the emerging market bond fund was very strong and long enough to convince me they can keep it up and so on. To be clear I am aware there are gaps galore in the concept.
Assuming you are neither way ahead of where you need to be and can tolerate normal ups and downs it still might make some sense to take a little off the pedal especially if you save a lot. I view this as part of the thought process for managing portfolio volatility which I obviously think at times volatility should be increased and at other times, like now, it should be decreased.
On a different note the Barron's interview is with Eric Sprott and he has some gloomy things to say about energy prices (he says they are going way up).
The picture is the trail down to Kalaupapa on Molokai.
10 comments:
A service provider showing due diligence and process usually is a good predictor of how well they'll perform, compared to their peers. What do you say to your clients who've read too many doomsayers on the intertubes?
No mention of "sterling plummeting against the dollar" (from FT.com)? Short-term cable will probably bounce but long-term it is, according to the Big Mac index, still expensive compared to the US. Sterling's fall has been widely expected but such a dramatic drop confuses me. Sorry to thread jack.
I find the DFA approach very compelling, but I'm also convinced that I'm smarter than the market (LOL.) I've finally settled on a "core and tweak" strategy that indulges both sides of my brain.
The DFA portfolios, along with others, were instructional in my basic asset allocation and helping me quantify risk and volatility from a life stage standpoint. I recognize the need to manage down risk as I age and am fortunate enough to be a little ahead of the game. Your admonitions to damp down volatility in this market are welcome (at least by my left brain!)
Have you ever tracked the annual turnover in your generic portfolio, Roger? Would you characterize your approach as active portfolio management?
Thanks for an interesting post.
i don't think i have had any conversations like that. this might be because i have been writing about what the market might do for many many months both on the blog and in occasional emails i send out to clients.
but the bottom line is the market above or below the 200 dma. if demand is unhealthy regardless of the reason we will take some sort of defensive action (as we have done and as I have disclosed).
being right about why demand is unhealthy means almost nothing to someone's account value versus recognizing it is unhealthy and being properly positioned.
don't know what my exact turnover number is.
a fully implemented portfolio has 40-45 equity holdings. i average 3-5 trades per quarter, I would say, but many of the trades are modifications to existing positions.
i don't think of it as a lot of trades but that sort of thing is very subjective.
DFA's approach based on the fama french model is very compelling. I understand what Roger is saying with data mining however the financial academics behind DFA are substantiated with evidence.
Based on pure capitalism, just like stocks will always offer a higher risk premium the same can be said for value versus growth and small versus large. Tilting one's portfolio to value and small will offer the DIY investor an opportunity for greater returns versus the total market and/or closet indexing approach.
In summary DFA is based on equilibrium investing strategies and is not based on indices. They filter out the bankrupt companies and tilt their portfolios in order to capture the value premium. the latter has been argued however no one has been able to disprove that the value premium will continue to persist.
A simple portfolio can be established with a DFA US core, US small Value, US REIT, DFA Int's Developed Core, Emerging Market Value, Int'l small Value, Int'l Real Estate, DFA Global Bonds, TIP and WIP. There is no perfect portfolio however this one is as close to optimal as one can get for a classic asset allocation policy.
As a 40 year reader of Barron's I have two comments to make about the magazine.
a.Often wrong but never in doubt.
b. It should appropriately be called "Bear"ons.
Not that they occasionally don't get it right
One slant on smoothing the ride is to use less, but more risky assets.
For example, 100% total stock market returns and about half the volatility can be approximated with author Larry Swedroe's DFA portfolio:
10.5% US small value
10.5% Intl small value
4% EM value
3% DJ AIG commodities (PCRIX)
6% TIPS
66% intermediate length individual AAA and AA munis.
The TIPS are limited because of tax advantaged account space. Ideally you'd have a lot more of them.
This follows Roger's idea of smoothing out the ride yet still keeps returns decent.
Paul
Roger,
I believe this would make good for a possible post this week. Long time reader of yours and all these comments about DFA, passive BH and their dogmatic view against anything active "since no one can effectively time the market."
You have commented a lot about positioning clients portfolios when equities are not healthy (below 200DMA) and you have touched upon re-equitizing when demand turns healthy again. My question centers on how does one effectively determine when to being to re-position the portfolio for the upturn. After all if we wait for it to exceed the 200DMA, depending on how low it goes one would miss out on substantial gains from the low back to the 200 DMA. Your comments are welcome.
anon, i have touched on that before.
that issue you raise is why i don't believe in zero weight in equities even when demand is poor.
the goal is not necessarily beat the market at every single turn. looked at in terms of the entire cycle if you can sidestep a big chunk of the bear market you should add dramatically to the returns for the entire cycle.
I would add that the period of time, relative to a multi year cycle, from the real bottom to the final cross over is quite short.
at underweight equities, versus zero, you would lag the move in that short period of time not miss the move.
I wasn't sure exactly where to post this.
One of the themes over the past several months is that this is likely to be your standard run-of-the-mill bear market with the S&P 500 down around 30% peak to trough and lasting around 18 months or so, and then it is back to the races onward and upward. That thesis has pretty much been what I've been operating from as well. Some of the comments on the blog have pushed back on that notion that maybe this bear market will be different due to the unwinding of the massive credit bubble and financial excesses that took place.
Anyways, just read this piece, and it is a thought-provoking note in terms of considering this bear market may be deeper and last longer then anything we've experienced in a long time. Definitely a must read piece IMO.
http://www.contraryinvestor.com/mo.htm
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