In April last 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 CHF-based investor even if I (will soon) live in Zurich. Plus, I do not have any currency-specific audience that would make this series more helpful if run in EUR or GBP.
In Q4 the portfolio was up 1.0%, bringing the total performance for 2022 to -13.3%: finally a positive quarter! [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 performance, including dividends:
Below is the YTD price graph for each component of the portfolio:
The portfolio elements proved to be uncorrelated throughout the year, the goal of the strategy. The leverage provided by NTSX can lower the portfolio risk profile only if we use it to get exposure to assets that zig when the 60/40 zag.
Even if DBMF can take positions in different, normally uncorrelated, markets, what it did in 2022 can be explained by a single “broad trend”: long USD and short duration. During Q4, this trend lost its thrust and DBMF was left in a no man’s land, the worst possible situation for a trend-following strategy. EUR/USD has reversed and it might be in an uptrend now, the US 10Y is moving sideways, as is the S&P500. For DBMF to resume its run, it needs new trends.
Talking about trends, COM performance reflected as well the absence of commodities trending higher in the second half of 2022: the ETF strategy attempts to capture upward trends while minimizing risk during downtrends. The fund remained basically flat for the last six months.
Both COM and DBMF took advantage of rising oil prices in the first half of the year: this is the only instance when I am happy to see portfolio elements move in the same direction, when they print money.
The good news for the portfolio is that rates are now at decent levels, 4.5% in the US. This means that in trendless market, the fixed income part of the strategy (and COM, the fund holds cash when it is not long commodities) should bring some returns.
TAIL was a loser all year long. But it is a type of portfolio insurance that kicks in only in specific instances, when markets drop fast and correlations go to one. This quarter AQR published a research paper where they highlight how trend following (DBMF) and systematic put buying (TAIL) offer different types of protection depending on the length of the equity drawdown:
Lacking a proper Tail-Hedging solution, TAIL is still the best I have. As with my life insurance, I hope never to have to cheer on a windfall from TAIL 😉
Future Developments
As a first-year experiment, I am quite happy with what I achieved here: a relatively simple solution that delivered on its goal.
I am excited about 2023 because, after moving to Switzerland, I will be finally able to apply the strategy in real life: no more MiFiD bul*^it, no more ISA constraints, yeah!!
The real-life portfolio will be more complex:
- NTSX provides exposure to US large cap only; with the ‘sister funds’ NTSI and NTSE, I will add International and Emerging Markets stocks. I also want a tilt to some factors: value, momentum and low vol.
- Corey Hoffstein is launching new “return staking” ETFs and for sure I will have a look at them.
- I want to diversify the commodity sleeve. I will try UEQC for sure
- I want to add other, hopefully differentiating, strategies like DBEH and HFND
As Jesus once told Rick in The Walking Dead, my world is about to get a whole lot bigger.
What I am reading now:
Follow me on Twitter @nprotasoni