In April this year, I introduced 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 use leverage (and why in this context leverage decrease risk).
It represents the core portfolio I would invest in if I could access those ETFs (and if I was not so prone to slice and dice the equity and bond allocations to try several strategies like factors). 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 Composer, the app that tracks the portfolio, does not allow 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 in case they do not have the USD as their base currency and wants to eliminate the FX volatility. As I wrote here about the All Weather Portfolio, I am personally not bothered by the FX risk, given my investment horizon and the fact that I do not consider myself a GBP-based investor even if I live in London. Plus, I do not have any currency-specific audience that would make this series more helpful if run in EUR or GBP.
In Q2, the portfolio was down 9.8%, bringing the year-to-date performance to -11.8%. In the last quarter, the tune did not change and the portfolio added a 5.3% loss [as a reminder, Composer allows users to share their symphonies models, send me an email/write in the comments if you want the link].
The yellow line represents the Model Portfolio, while the other two are functional references (cannot really call them benchmarks): the 60/40 portfolio (blue line) and the S&P500 (red line).
Below you can find details of each ETF price performance. Some of the ETFs paid dividends in the period that are included in Composer returns but not in my table:
Below is the YTD price graph for each component of the portfolio:
The overall portfolio performance was again negative in the quarter but the portfolio elements remained uncorrelated, in particular in the second half of the period, which is a good news.
The rapid rise and fall of the S&P500 in Q3 did not allow TAIL to provide any positive upside to the portfolio. For TAIL to work, the market has to drop big and fast. So far this year, the VIX closed above 35 just a few days and none in Q3: the fear index is still not showing any fear.
COM did not pay any dividend in the quarter, so this time the graph reflects its actual performance. I choose COM over a standard long-only commodity index because it has a momentum tilt; trends in the commodity space became messier compared to the beginning of the year, when all prices exploded upwards: COM performance was steadier compared to the plain-vanilla CRB index:
DBMF is a managed futures strategy I wanted in the portfolio to provide protection for periods like the one we are in now. It is acting as intended but unfortunately its performance did not go unnoticed:
The ETF should (better to be conservative here, eheh) invest in very liquid instruments like futures on equity, commodity and rate indexes; the “ARK risk”, the reflexivity of a fund that invests in small-cap stocks driving their prices up and down when it buys or sells, should not be an issue here; but anytime an investment vehicle becomes so popular in a short period of time, it is better to pay attention.
In a real portfolio, I would always suggest the investor to diversify by employing different funds within the “trend following” bucket. The model portfolio here is just that, a model. There is a value in keeping it simple. There are not that many alternatives at the moment anyway, but given DBMF success is easy to bet that many clones will arrive in short order.
What about our beloved NTSX?
A recent research piece from Leuthold Group highlights something important: “this year joint stock and bond routs have significantly improved the expected returns of both asset classes, and the 60/40 may be ready to rise from the ashes”. The levels reached by both assets in 2021, 1.12% yield for bonds and 3.25% earning yield for stocks, were one of the lowest readings in the last four decades.
Today, 10-year Govies pay more than 4% and the S&P500 is trading at 15.9 times projected earnings, below its historical average of 16.2 . These are not screaming-buy levels but definitely more normal yields that should lead to higher future returns.
What I am reading now:
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