Monthly Archives: April 2017

Performance Tracking April 2017

For calculation methodology see this post.

Stocks had a good back half of the month in April, gaining almost 1%. Bonds almost matched that giving the 60/40 benchmark a 0.96% gain for the month of April. My passive accounts gained 0.7%, dragged down by PMs. PM miners provided a greater headwind to the active accounts. This is the first month I broke out growth stocks and fixed income CEFs from within the active accounts. The blended total of DGI and growth stocks slightly bested SPY. There is still cash to be deployed and I have been making changes to the DGI portfolio. The FI CEFs are again outstanding. The last big batch of purchase was around the hick-up on Mar 9th and they’ve been going up ever since. I still have some money to be allocated in them and will complete my purchases at the next hick-up which typically occurs every two or three months. The active accounts gained 0.85% leaving the total portfolio up 0.78% in April trailing the benchmark. YTD the total portfolio is up 5.32% vs. 4.86% for the benchmark.

Compared with the strategies tracked at AllocateSmartly, my April return is in the bottom quarter while YTD is still in the top 1/3. There is some cash drag in my portfolio: cash position is 14% in my active accounts; in addition, I count the emergency fund as well. This month I decided to pare down my emergency fund allocation and moved a CD to the active accounts to better take advantage of this bull market. I expect to be fully deployed by July.

Decision Time

This is another market commentary following my post on March 23rd, A Correction May Be Upon Us; and 29th, Lightly Held Opinions. The prediction was a drop then bounce in April, then a deeper drop in May that could potentially last into July. The bounce in April was flagged to have the potential to make a new high in the 2nd post. So what has happened so far?

The chart is of the S&P where the low of 2322 was reached on the 27th. There was a retest of the low on Apr 13th as concerns with North Korea reached a fevered pitch. The bounce up to 2398 was just shy of the 2400 peak on March 1st. The other indices behaved slightly differently: the DOW made a lower low whereas both Nasdaq and Russell 2000 made new highs on the bounce. Overall, I’d say things played out as predicted. The bigger question is, will the deeper correction come?

I’m leaning towards “yes” on that one, although I would temper the probability for the most severe scenarios — retesting of the election or even the Brexit lows. If you take a look at the Fibonacci levels in the first post, 2280 would be the first target, the breaking of which will put into question the 2240 level which is also the current 200 DMA. I would expect the next support at 2200 to hold in most cases. In terms of near term catalysts there is plenty: the FOMC meeting, April employment report and the French election all within a week’s time, not to mention North Korea. That said I always view external events as excuses for releasing the internal pressure: in this case there being too many people along for the ride, and the market never makes it easy for everyone to make money.

What I’ve done in the mean time

I added to a couple names on weakness. I sold puts on Apr 13th when there was well over 1% premium on 2-week OTM puts. They have expired worthless. I also sold some covered calls and 1 stock in the last two days. Not a whole lot different if I was just DCA in the absence of any directional views. The biggest portfolio change was deciding to trim my emergency fund allocation. I sold a CD and moved that money to the active accounts such that its cash position is now 14%.

What if I’m wrong and the market goes straight up from here?

First of all, I don’t see a bear market developing, and if that’s your view you should examine your information sources and your logic. If the correction doesn’t come, I’ll continue to DCA into the names I already picked out. Fortunately we should know the answer soon. One thing is for sure: I’ll not leave cash on the sidelines when this bull market takes off.

So why pay so much attention to this particular intermediate low when my stated approach to market timing is to avoid the real nasty bear markets and hold through the shorter gyrations? First, to constantly validate our hypothesis against the market is how we learn and improve. Second, there are leveraged bets that require a margin of safety that comes when “there’s blood on the street”. The flip side to avoiding the bear market is to fully take advantage of the bull market, both require accurate reading of the situation.

Investing Philosophy

I’ve been meaning to update the my portfolio post which is linked under the “portfolio” navigation tab, but I’m in the process of deploying cash as part of the on-going correction. So I figure I’ll write a separate post about my investing philosophy.

Below is a list of the basic tenets that I try to follow:

  • Long biased
  • Globally diversified
  • Minimize taxes and expenses
  • Diversify sources of return
  • Strategy diversification
  • Market timing according to cycles of years of duration or longer
  • Use options to generate income and smooth the ride

The first three bullet points are in the “main stream”. As a rule, I don’t have a regular “cash” allocation in either passive or active strategies. Instead, there is a separate emergency fund component in the total portfolio. I’m also far more comfortable being long than short. In the passive accounts at least, I maintain a 50/50 US/international split in equities, although the composition such as large/small US equity or international developed/EM can be fluid. To the third point, I maximize tax deferred contributions every year, including back-door Roth. All assets in the passive accounts are tax-advantaged with the exception of physical PM bullions. In the active accounts, the taxable fixed income CEFs are in tax advantaged as are about half of PM miners and bullion funds. Expenses are minimized by using best-of-breed funds for each asset and doing everything myself. In passive accounts, that means Vanguard index funds/ETFs or equivalent. For individual stocks, I use InteractiveBrokers where the commission is usually under 1 basis point, and partially covered by the interest from security-lending. My expense ratio for holding stocks is at least one order of magnitude less than that of the lowest cost index funds.

The fourth point “diversify sources of return” motivates me to look beyond the traditional stocks and bonds. It’s the reason I have a significant allocation to leveraged fixed-income CEFs (target 24% of active). Taxable multi-sector CEFs have equity like returns and volatilities but are no more than 40% correlated to equities (e.g. VTI, correlation is period dependent, cf. PortfolioVisulizer.com). Leveraged muni CEFs provide tax-free income and even lower correlation to equities (same comment as before). In contrast, sub-sectors within equities are correlated to whole at 90% or above. In the context of mean variance optimization, assets with reasonable returns AND low correlations are extremely valuable in portfolio construction. This is contrary to the Bill Bernstein view that one should take risks in equities and fixed income is for safety — a view that unsurprisingly leads to equity dominated portfolios and equity dominated risk profiles. Note that when the fixed income allocation is viewed across my entire portfolio, the risk profile is a “bar-bell”: stable value funds in passive and leveraged CEFs in active. Diversification is also a reason behind my overall 15% allocation to PMs which I discussed here. The blog post by Charlie Biello is highly recommended — I think of it every time I read a straw man attack on gold along the lines of: gold is thought of useful as an inflation-hedge, data shows it is not; therefore gold is useless. Another often-heard objection is based on the inclusion of gold’s return data just 1975 when gold ownership was again legal despite data from PortfolioCharts shows gold’s ability to lower volatility from multiple starting and ending dates. From a portfolio construction perspective, the only requirement for the inclusion of gold is the low correlation to other assets. I haven’t seen any evidence or prediction that this correlation is going to change in the future.

The fifth point “strategy diversification” speaks to my adoption of both passive and active approaches. The passive/active debate is all the rage in financial media today. Passive is clearly winning and the shift is far from over. Lower fees is undoubtedly beneficial to the investing public. However in so far as the democratization of investing makes it easier to invest and funnels more capital to assets, their valuation must rise thus suppressing future returns. A recent post from the always-insightful PhilosophicalEconomics discussed from a similar perspective. As passive grows in dominance, another danger is the synchronization of investor’s emotional response to market declines. This is a major reason I employ both passive and active strategies so as to be able to hedge from within the active accounts when the time comes. I also try to avoid the most obvious pit falls in active, i.e. high fees, lack of diversification, to at least give myself a shot at beating my benchmark.

The sixth point “market timing” is perhaps the most controversial. My reasons were laid out this post. The primary objective is to avoid large draw downs in preparation for early retirement within 10-12 years. If my portfolio should suffer a 30% draw down, there would be a significant impact on the quality of retirement or alternatively the retirement date. I haven’t been able to find a static asset allocation that provides adequate protection while simultaneously provide a high return – that pretty much captures the main dilemma facing all investors. A more diverse allocation can reduce the size of the hedges necessary but no static allocation can ever be truly “all weather”. I believe the solution is market timing but only at the right intervals. The tools I rely on are a specific equity pricing model and technical analysis. A second objective of market timing is to enhance returns. I have been say since last November that we’re entering a blow-off phase in the stock market; the view reinforces my long bias and allows me to increase my equity exposure from a baseline of <50% overall. My current projection for the market top is S&P 3000+ sometime around Q4’18 to Q1’19. I also see PMs in a bull market which gives me license to go above a baseline allocation of 10% gold bullion to include silver and mining equities that are leveraged to gold. My current view is that PMs will top after equities, probably later in 2019. Gold should be over $3500 and has a good shot at $5000/oz.

Lastly I use options to enhance returns. More opportunities are provided by directly owning individual stocks than an index as the parts will move more than the whole. I’m a premium seller since it’s known that realized volatilities are lower than implied volatilities. I predominantly sell margin/cash secured OTM puts on stocks I’d like to own while use technical analysis for entry points. From time to time, I also use options for leveraged longs as discussed here.

So there you go, these are the seven tenets that guide my investing decisions. People attach an almost religious fervor to their chosen investment approach, so I’m not out to convert anyone. It is a human condition that no amount of back testing or modeling can predict the actual returns which will only be known at the end of our investing lives by which time it’s too late to change. I have made peace with my path and will accept anything that comes my way.

Performance Tracking March 2017

For calculation methodology see this post.

March capped off one of the best quarters for stocks with SPY returning almost 6% YTD. But the strength came in the first two months and March itself saw a gain of only 0.13%. My overall portfolio returned 0.69% for the month, significantly above the 60/40 benchmark which returned a barely-above-flat-line 0.05%. Compared with the myriad of strategies tracked at AllocateSmartly, mine would have ranked 2nd in March which pulled its YTD return of 4.67% into the top quartile. Overall, I’m pleased with the performance and hope it continues climbing out of the hole it dug for itself in 2H’16.

One thing I realized as I poured over these numbers was that I was using “cash basis accounting” for my DGI stocks; i.e. recording the dividends in the month of the pay-date rather than “accrual basis” which would have recorded them in the month of the ex-date. It’s a wash in the long run but in the short run it moves returns from February to March since the 3rd month of the quarter has the highest dividend payouts. I’m making a note of it and will just leave things as they are.

Even though there is only a 9-months history, I am concerned that the DGI performance is lagging that of SPY significantly. As such, I’m taking the opportunity arising from re-jigging my asset location to revamp my DGI stocks. Since they will all occupy taxable space, I’m eschewing current payout for growth. It is consistent with my view of where we are in this bull market.

Active Allocation and Performance Attribution

I have more or less fixed the asset allocation in my active accounts: 15% PMs, 24% fixed income CEFs, 45% DGI stocks and 15% growth stocks – defined as those that don’t pay a dividend. There is an additional 1% that I’ve allocated to alternatives that is currently comprised of options and crypto currencies. I’m dabbling in the latter and will write up my experience in a future post. The allocation being the goal, there is still 12.6% cash waiting to be deployed into CEFs, DGI and growth stocks. My plan is to do so gradually into the names I’ve already picked out, effectively DCA’ing during what I anticipate to be an intermediate correction (see here and here).

In the monthly summary table, I’ve been breaking out the “Passive w/o PM” as the more traditional Boglehead-like 85% slug of the passive portfolio. By inference, it also tracks the PM allocation which is 95% comprised of bullions in the passive portfolio. For the active portfolio, starting from next month, I’ll also track the growth stocks and the FI CEFs in addition to DGI stocks in order to pin-point the sources of over/under-performance. CEFs vs. AGG and the stock picks vs. SPY are the key head-to-head comparisons I’m after.