Evaluating Lazy Portfolios
analysis, asset allocation, portfolio

MarketWatch tracks eight lazy portfolios. Each of these simple portfolios consists of three to eleven, low-cost, no-load index mutual funds from Vanguard®. The fund membership and weights in each portfolio remain constant over time. (In theory, this implies that each portfolio would have to be perfectly rebalanced daily. This is not only impractical but also impossible because the fund’s daily NAVs, and hence their new weights, are not known until after the market close.)

Unfortunately, MarketWatch compares lazy portfolios solely on the basis of annualized returns in one-, three-, five- and ten-year periods. Volatility of returns as well as other performance measures are not taken into account. Luckily, Alpholio™ can help – not only does our Basic Portfolio service provide ample statistics, but it also allows for a selectable periodic rebalancing of portfolio positions to their original weights. For the purpose of this analysis, let’s assume a 15-year evaluation period from July 2001 through June 2016, as well as quarterly rebalancing of each portfolio.

Let’s start with the most complex Aronson Family Taxable Portfolio that consists of 11 funds. The following chart shows the cumulative return and related statistics for this lazy portfolio:

Aronson Family Taxable Portfolio - Cumulative Return - 15 Years

The fixed-income portion of the portfolio comprises inflation-protected securities (15%), long-term Treasury bonds (10%) and high-yield corporate bonds (5%). The portfolio’s holdings also include domestic (40%) and foreign (30%) equities.

The alpha and beta of the portfolio were measured against the broad-based U.S. stock market ETF, and not just a large-cap index, such as the S&P 500®. Because high-yield bonds generally have a substantial correlation to equities, it could be expected that the portfolio’s beta would be approximately between 1 – (0.15 + 0.10 + 0.05) = 0.7 and 1 – (0.15 + 0.10) = 0.75, which it was at 0.73.

The key measures of risk-adjusted performance are the Sharpe and Sortino ratios. Unlike the former, the latter penalizes portfolios with a large downside deviation.

Finally, the maximum drawdown measure is the maximum percentage loss of the portfolio value from a peak to a subsequent trough. Given the chosen evaluation period, this typically means a decline in each lazy portfolio’s value from October 2007 to March 2009.

The following chart shows rolling volatility (measured as a standard deviation of two years of monthly returns) and accompanying statistics for the portfolio:

Aronson Family Taxable Portfolio - Rolling Volatility - 15 Years

As could be expected, volatility of the portfolio significantly increased during the financial crisis. In general, a good lazy portfolio should maximize returns, minimize volatility, and reduce the magnitude of volatility changes over time.

Similar charts and statistics can easily be generated for all lazy portfolios. They are not published in this post to limit its size. Instead, here is a summary table of statistics:

Portfolio Annualized
Return
Alpha Beta Sharpe
Ratio
Sortino
Ratio
Maximum
Drawdown
Aronson Family
Taxable
6.96% 0.22% 0.73 0.53 0.76 42.08%
Fundadvice
Ultimate
Buy & Hold
6.49% 0.22% 0.62 0.55 0.81 36.58%
Dr. Bernstein’s
Smart Money
6.12% 0.18% 0.65 0.51 0.75 38.00%
Coffeehouse 6.89% 0.25% 0.63 0.59 0.86 36.16%
Yale U’s
Unconventional
7.89% 0.31% 0.69 0.61 0.88 42.94%
Dr. Bernstein’s
No Brainer
6.12% 0.11% 0.83 0.43 0.63 44.48%
Margaritaville 5.86% 0.14% 0.71 0.45 0.65 41.29%
Second
Grader’s
Starter
5.92% 0.05% 0.94 0.39 0.56 49.08%

The Yale U’s Unconventional portfolio had the highest risk-adjusted returns, as measured by the above Sharpe and Sortino ratios. This was likely due to the relatively large positions in REITs and long-term government bonds, both of which benefited from falling interest rates. Please also note that at times, correlation between returns of the REIT and total stock market mutual funds was quite high (which reduced portfolio diversification), as illustrated by the following chart:

Rolling 36-Month Return Correlation between VGSIX and VTSMX

The Coffeehouse portfolio had similar characteristics. Compared to others, this portfolio also exhibited the smallest maximum drawdown.

The Fundadvice Ultimate Buy & Hold portfolio had the third best return-to-risk profile, as well as the second lowest maximum drawdown. While bond funds in this portfolio had short and intermediate maturities, its total fixed-income component was significant, as was the case with the previous two portfolios.

For completeness, here are the statistics for lazy portfolios over a ten-year period through June 2016:

Portfolio Annualized
Return
Alpha Beta Sharpe
Ratio
Sortino
Ratio
Maximum
Drawdown
Aronson Family
Taxable
5.94% 0.01% 0.75 0.46 0.65 42.08%
Fundadvice
Ultimate
Buy & Hold
5.06% 0.00% 0.65 0.43 0.62 36.58%
Dr. Bernstein’s
Smart Money
5.41% 0.01% 0.67 0.46 0.66 38.00%
Coffeehouse 6.33% 0.09% 0.66 0.54 0.78 36.16%
Yale U’s
Unconventional
6.85% 0.10% 0.74 0.52 0.73 42.94%
Dr. Bernstein’s
No Brainer
5.64% -0.06% 0.83 0.41 0.59 44.48%
Margaritaville 4.95% -0.05% 0.73 0.39 0.54 41.29%
Second
Grader’s
Starter
5.76% -0.10% 0.93 0.39 0.56 49.08%

Over this shorter evaluation period, the Coffeehouse portfolio had the best risk-adjusted returns, followed by the Yale U’s Unconventional portfolio, and Dr. Bernstein’s Smart Money portfolio that had a slightly higher Sortino ratio and a smaller maximum drawdown than the Aronson Family Taxable portfolio. This goes to show that the ranking of portfolios heavily depends on the analysis time frame.

We hope that this analysis will give investors additional insights into historical performance of lazy portfolios. Of course, there is no guarantee that this performance will be repeated in the future.


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Rebalancing Act
asset allocation, foreign equity, market, mutual fund, valuation

As the end of the year approaches, the investment industry is gearing up for the annual portfolio rebalancing act. An article in InvestmentNews gives the following example:

Still, advisers’ plan to stick to their long-term asset allocation was likely thrown out of whack this year by the divergence of stocks and bonds. For example, a client who started the year with a simple 60/40 portfolio comprised of the $287 billion Vanguard Total Stock Market Fund (VTSMX) and the $247 billion Pimco Total Return Fund (PTTAX), the two largest mutual funds in the world, would now have 66.3% invested in stocks and just 33.7% invested in bonds, pushing beyond the typical 5% leeway most advisers give their asset allocation.

To illustrate the divergence from asset allocation historical averages, here is a chart from a Vanguard blog post:

Mutual Fund and ETF Assets under Management

While the collective allocation of mutual funds and ETFs to equities has recently reached 57%, the biggest divergence from the historical median is in international equities. Allocation to bonds is also relatively high, while the proportion in domestic equities is close to the 20-year median.

The higher allocations to international equities and bonds are at the expense of cash. Assets in money market funds are at a historical minimum of about 18% in the observation period. This has undoubtedly been caused by the low interest rate policy of the Fed, which depressed returns of such funds. The danger is that when interest rates eventually rise, bond prices will suffer:

So in an intermediate-term bond fund, with an average duration of four to five years, the loss would be about 4% to 5%.

This means that it may actually be prudent for an average investor to shorten the duration by moving a part of investment in bonds to money market funds.

Historically, the proportion of international equities in the total equity allocation has been about 19%; currently, it is about 27%. The argument for keeping it high is a relatively low valuation of foreign stocks compared to domestic ones:

Stock Valuation per Market Region

When rebalancing portfolios, it is also important that investors understand the true exposure of their mutual fund holdings to various asset classes. The recurring problem, which Alpholio™ addressed in several prior posts, is that managers in some equity funds (especially value strategies) hold a large percentage of assets in cash. As a result, asset allocation in the overall portfolio can be distorted unbeknownst to the investor.

Alpholio™ provides current information on the exposure of mutual funds to various asset classes. This information is not obtained from the regulatory filings or selective disclosures of fund holdings, which suffer from a number of problems.

In sum, when rebalancing a portfolio either on a fixed schedule or as a result of divergence from prior allocations, investors should take into account a broader market and interest rate context, rather than just follow rigid rules.

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