Model Portfolio Quarterly Update

In April 2022, I introduced on this blog The Italian Leather Sofa Model Portfolio. As a reminder, here is the portfolio composition:

• 60% stocks (via NTSX)
• 40% bonds (via NTSX)
• 20% trend (via DBMF)
• 10% commodities trend (via COM)
• 4% Tail risk (via TAIL)
• -34% cash

The idea behind the portfolio is stolen from here. The link offers the best explanation to what I think is the most common question related to it, i.e. why the portfolio uses leverage (and why in this context leverage decreases risk).

It represents a simplified version of the portfolio I have been building since I moved to Switzerland: here you can find details about the “enhancements” to this model.

Please note that the returns you find in the Model Portfolio series will always reflect the point of view of a USD-based investor. The ETFs are priced in USD and Testfol.io, the app I use to track the portfolio, does not allow me to change the reference currency.

Besides these ‘technicalities’, the focus of this series is on how to build a great and simple permanent portfolio. There are various solutions an investor can employ if they do not have the USD as their base currency and want to eliminate the FX volatility. As I wrote here about the All Weather Portfolio, I am not bothered by the FX risk, given my investment horizon and the fact that I do not consider myself a CHF-based investor even if I live in Zurich. Plus, I do not have any currency-specific audience that would make this series more helpful if run in EUR, CHF or GBP (if you want a deeper dive into FX risk, I wrote this).

After posting a 3.95% gain in Q3-24, the portfolio lost 2.25% in Q4-24:

The blue line represents the Model Portfolio, while the other two are functional references (I cannot really call them benchmarks): the 60/40 portfolio (red line) and the S&P500 (yellow line).

Since Inception, including a backtest period

Q4

Since inception plus backtest (May, 2019). VBAIX is the 60/40.

Below you can find details of each ETF performance, including dividends, in the quarter:

Below is the Q4 price graph for each component of the portfolio:

How to read the portfolio performance

I have to admit I fell for the single-line item performance fallacy. NTSX is the ETF with embedded leverage that allows the addition of “free diversifiers” to the portfolio. I, wrongly!, judged the merits (or otherwise) of leverage within NTSX, thinking for example about the implications of an inverted yield curve (NTSX borrows at the short-term rate and invests in bonds that pay the long-term rate…not great when the curve is inverted).

Leverage belongs to the portfolio.

Not only that. COM and DBMF use futures; a small fraction of the sum invested in those ETFs is posted as margin while all the balance erns the T-Bills returns. In other words, if the Bills rate is 5% and DBMF returns 3%, it means DBMF alpha, the real yield of the strategy, was -2% for that year.

This quarter felt like the midwit meme:

Aside from the SP500 part of NTSX, everything went south. Even futures’ cost of funding exploded:

(maybe this affected SPX only but I doubt it. I found it on Twitter). Some users said it is just an end-of-the-year phenomenon, cause banks want to keep cash on their BS and do not engage in arbitraging activities; others see it as degen need to leverage considering SPY performance. Let’s just hope it is going to reverse back to normal.

For the whole year, bonds got hammered back down every time they tried to rally. At least, even the 3mvs10 curve is not inverted anymore:

Truth be told, throughout the year DBMF and COM generated a positive alpha:

The “2024 August crash” was so fast, and shallow, that it was impossible (for me) to capitalise, ie sell and rebalance, TAIL. The ETF performed as expected in a year where stocks rallied, but more sophisticated products like CAOS and BTAL proved to be better insurance options.

Going Forward

In November WisdomTree launched NTSG, a better ETF than NTSX for Europoors (and Americans as well but try to explain that to them…). If I would start investing today, I would use that ETF for sure; but for this exercise, there is no history to show the merits of the fund. I still remember two years ago when I was using a 90% SPY + 60% IEF – 50% CASHX to represent a longer backtest for NTSX and the constant rebuttal I got: yes but THAT is not the REAL NTSX (it is). Anyway, for the NTSG bond sleeve, I am not even sure there is a good proxy; and if there is, there is no UCITS-fund backtest tool.

It looks like in 2025 some of the Return Stacked ETFs will arrive in UCITS land (and DBMF as well). I would like to preserve the logic behind the model, a diversified capital-efficient portfolio. Conversely, fiddling too much with its components might feel like data mining.

I like to have “something in production” to demonstrate its value out-of-sample.

So, I went back to GetQuin and started my simulation on 01/11/24 with 62% in NTSG and 38% in DBMF. I choose the % so that bonds and trend are equally weighted and I will rebalance once a year. Let’s see how long this configuration will last.

What I am reading now:

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