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 Composer PortfolioVisualizer, the app that tracks the portfolio, does not allow to change the reference currency (unfortunately Composer introduced a 2FA and without a US phone number I cannot access it anymore 🙁 ). 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 want 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 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.

We are celebrating the second anniversary of our model! It might feel like an eternity, especially when I look at my son who is on the cusp of turning two and see the remarkable growth and transformations he’s undergone. Yet, when we reflect on the underlying principles that our portfolio is built upon, these two years seem but a mere blink. The portfolio’s mission is simple, yet powerful: curb drawdowns and bolster the Compound Annual Growth Rate (CAGR) to harness the magic of compounding to its fullest. Of course, this means that our little portfolio won’t always be the star of the show, outshining its ‘benchmarks‘. After all, stocks have a tendency to climb more often than not.

After posting a 11% gain in 2023, the portfolio grew 7.41% in Q1-24 and finally surpassed its previous all-time high registered at the end of 2021.

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

Since Inception, including a backtest period

Q1

Since inception plus backtest (June, 2019)

Stats are a bit less precise than Composer because they look only at month-ends.

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

Below is the Q1 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.

After a bad 2023, DBMF and COM are back generating alpha, returns above the cash rate. They are trend funds, so they need…trends to deliver. COM in particular needs positive trends and thankfully the market delivered.

DBMF manager published a nice deck about the fund performance (unfortunately it is updated as of the end of Feb) that explains where returns came from:

The 10 big circles are the markets traded by the fund and the small ones are non-core instruments correlated with them. The central tenet of the strategy is that it does not need many markets to replicate the SG CTA index (Andrew Beer, the fund manager, wrote a paper in which he highlighted that you can even use just 4).

TILS model has some positive overlaps:

• GOLD and OIL up drive both DBMF and COM up
• S&P500 up and rates down (more US10 than US2) drive both DBMF and NTSX up

The reverse is untrue because if the S&P500 craters, for example, DBMF will go short. But this does not mean there cannot be instances where the whole portfolio components have a negative return at the same time…just wait a few months and you will see what circumstances are needed (I am that lucky). Basically, a trendless market with sharp reversals that eat all the positive carry of the portfolio.

A slide worth 1.000 words. Imagine investing for 19 years and achieving two meaningfully different results because the starting points were just 4 years apart from one another. AGG excess return got cut in half: so much for the “volatility dampening” asset 😉 That said, the lesson here should be more about that 10% yearly average return you expect to receive investing in stocks.

TILS model is designed to avoid these types of timing experiences.

Lastly, the usual TAIL refresher, the -EV strategy of the portfolio. We “invest” part of the gains in an insurance that pays during fast crashes and helps the portfolio in its mission to “compound better”. As you might suspect from what you have seen so far, we didn’t file any claim to our insurance counterparty this quarter.

What I am reading now:

Follow me on Twitter @nprotasoni