New Portfolio Tracker – Robust Asset Allocation

One of the primary goals of Scott’s Investments is to educate individual investors by creating and tracking relevant investment strategies. Some of the strategies are my own, while others like the Ivy Portfolio are inspired by others.

This week I added a new portfolio spreadsheet to my site, the Robust Asset Allocation (RAA) strategy.  The portfolio was inspired by a December article from Alpha Architect, an asset management firm who describes their mission as “empowering investors through education”. They currently offer their services via ETFs and managed accounts. They also have a very active blog and an abundance of free online resources for investors.

A December 2014 article from Alpha Architect, Our Robust Asset Allocation (RAA) Solution, makes a compelling argument for combining value, momentum, and risk management in a single portfolio.  The strategy is based on the premise that the momentum and value anomalies have been shown to outperform historically. In addition, risk management techniques via time series momentum and moving average rules have historically worked to reduce portfolio risk.  They also provided a follow-up article here with additional backtests.

So what does this mean in application? Invest in ETFs which provide exposure to value and momentum. Overlay a trend filter via 12 month price momentum and a 12 month simple moving average rule.  Below is an illustration from Alpha Architect:

Starting at the top left of the illustration, we allocate 15% of our portfolio to a domestic equity momentum ETF (“style” & “weight”).  However, before investing we must evaluate the “risk” profile of the ETF.

If the excess return of the ETF is greater than 0 (or the return on a risk-free asset like cash, which in today’s low rate environment is near 0) over the past 12 months, go long risky assets (“time-series momentum risk management rule”). Otherwise, go long alternative assets (T-bills/cash). In addition, if the current price of the ETF is greater than its 12 month simple moving average, go long risky assets (“moving average risk management rule”). Otherwise, go long alternative assets (T-bills/cash).  These signals are reviewed once each month.

If both of the risk management rules signal to go long risky asset – in our example the domestic momentum ETF – invest 15% in the ETF.  If one rule signals to go long risky asset while the other signals to go to cash,  we invest half, or 7.5%, in the ETF. If both signal to go to cash then we invest 0% in the ETF and hold cash in lieu of the ETF:

The Alpha Architect RAA article did not recommend specific value and momentum ETFs. I took the liberty of selecting ETFs which I believe represent these anomalies:

The RAA spreadsheet will track signals for these ETFS.  An allocation percent will be displayed for each ETF depending on the risk management signals. If the SMA signal says “invested” and the 12 month price momentum is positive we invest the full amount of the target allocation. If one risk management signal is positive and the other negative we invest half of the target allocation. If both signals are negative we invest the target allocation in cash:

Note: GVAL will have 12 months of price history in early March. Until then, the 12 month momentum signal will show “N/A” on the spreadsheet.

There are new value ETFs (including one from Alpha Architect), fundamental Real-Estate and Bond ETFs and new commodity ETFs entering the market. As the ETF space matures and evolves, we may find better alternatives then the current ETFs in the portfolio.

The strategy has its limitations. Currently it has investors holding 32.5% cash.   This is certainly a viable position and will reduce portfolio volatility, part of the appeal of the strategy. However, more aggressive investors may seek to put cash balances to work in higher risk/higher return investments or to utilize leverage in order to achieve a targeted portfolio volatility.

Finally, it should be noted that tax loss harvesting is also a component of the original Alpha Architect RAA strategy.  It will not be tracked on my spreadsheet.

To access the RAA spreadsheet please go here.  While signals update daily, it is not an endorsement to frequently check signals.  The risk management filter is intended to be reviewed once per month, with an annual portfolio rebalance back to target allocations.

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