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 Arch Indices Portfolio Backtest, the app I use to track the portfolio, does not allow me to change the reference currency. Yes, after Composer shot me down introducing the 2FA, PortfolioVisualizer also decided to change plans…introducing paid plans: the creator of PortfolioVisualizer monetised his tool by selling it to a company that offers services to Family Offices and they decided to severely limit what an user can do on the platform for free.
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 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.
After posting a 7.4% gain in Q1-24, the portfolio reached a new all-time high by growing 3.2% in Q2-24.
The blue line represents the Model Portfolio, while the other two are functional references (I cannot really call them benchmarks): the 60/40 portfolio (yellow line) and the S&P500 (red line). I still use the legacy version of PortfolioVisualizer for the following graphs because it looks nicer than the Arch Indices tool.
Since Inception, including a backtest period
Q2
Since inception plus backtest (May, 2019). Portfolio 1 is the Model Portfolio, 2 is SPY and 3 is AOR (60/40).
Stats are more precise than PortfolioVisualizer because the Arch Indices tool looks at daily movements, not monthly.
Below you can find details of each ETF performance, including dividends, in the quarter:
Below is the Q2 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.
For the second quarter in a row, DBMF was the best performer in the portfolio. But we do not care about this. What is more relevant is that…drumroll…today even Europoors (investors that have to kiss the MiDiF II ring) can buy the (mutual) fund! This is the ISIN code, LU2572481948, and it is available on IBRK with no minimum investment size. It is also slightly cheaper than the ETF, .80% management fee instead of .85% (there might be a 1% exit fee that so far has never been charged).
Considering that NTSX has been available for almost a year, albeit no one really noticed considering its AUM, Europoors can build a great diversified portfolio with just 2 ingredients: NTSX and DBMF. Or this can be the starting point to add more diversifiers like gold and/or $UEQC, a carry-commodity ETF that I presented on this blog one year and a half ago. The possible portfolio configurations are not endless, if investors want to keep the CAGR above, let’s say, 6% because the only capital-efficient option available is NTSX. And let’s not forget it provides exposure only to the S&P500, not a globally diversified index…
[If you are thinking “Well, also the bond component is liked to US Treasuries-only”, I think it is a bit of a mistake. As long as the US remains the US, and no, China is not remotely close to becoming a valid alternative and unfortunately Europe will never be, the issue is more linked to the fact that Treasuries are USD-denominated. But we tackled this issue at the beginning of this post, innit? The FX fluctuations are the main issue here…if you care]
DBMF is far from perfect as a product: by doing regression analysis on other Trend funds, the ETF invests looking at the rear-view of other rear-view mirrors. Their model gets every signal with a big delay. And yet…it works! Also, I have read research highlighting the fact that trading only 10 markets doesn’t necessarily put the fund in a less desirable position, considering the inverse relationship between the trend-following performance and the number of independent risk factors required to explain it. 10 markets are more than enough when it matters, i.e. when stocks and bonds are going down the drain.
There will be many crises in the future. Or maybe none, AI will solve everything. The main benefit of the Model Portfolio is that I do not have to care about either of those things. Would I be able to pass on this strategy to my wife one day, as the infamous Ray Dalio’s story? Not yet. First I need a truly globally diversified NTSX (which exists for US investors, it is $RSSB) and then a Vanguard/BlackRock version of DBMF (yeah, I can trust Andrew Beer up to a point ahahahahah). I would definitely be fine with this new 60/40 for my family: 60% RSSB and 40% Vanguard-DBMF.
What I am reading now:
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9 Comments
Cif · July 10, 2024 at 1:02 pm
Have a look at https://testfol.io/ as well, which I like better than the Arch thing. It has more features and is also able to simulate many tickers a long way back if you need it – read the Help page for more info)
TheItalianLeatherSofa · July 10, 2024 at 2:45 pm
thank you, I’ll def have a look
Federico B · July 11, 2024 at 8:33 am
As always, great post!!
What are the advantages of a Vanguard/BlackRock version of DBMF?
From my understanding, RSSB is 100%stocks and 100%bonds!? what? From Switzerland is it possible to buy the RSSB? (I can see it on IBKR)
TheItalianLeatherSofa · July 11, 2024 at 8:45 am
DBMF offers “beta” exposure to trend but it has a model/counterparty risk (it is not like SPY-S&P500 because DBMF cannot simply look at a list of stocks/weights and buy them accordingly). Vanguard and BlackRock would not eliminate the issue but might offer comfort in the sense that they are bigger, more established players.
yes, RSSB is 100/100 global stocks and Treasuries and you can buy it from Switzerland 🙂
Federico B · July 11, 2024 at 9:36 am
I looked back at the enchantment version of the model portfolio. I comment here because the comment section there is closed.
Again, super interesting post, just one confirmation.
To be clear the final portfolio composition will be:
– 70%NTSX ->(relative 60%NTSX, 30%NSTI, 10%NTSE) -> (absolute 42%NTSX, 21%NSTI, 7%NTSE),
– 20% DBMF ->(5% RSBT, 7.5% DBMF and 7.5% CTA),
– 10%COM ->(5%COM, 5% GDE),
– 4%TAIL
Is this correct or did I misunderstand something? 🙂
Another small thing I missed in the model portfolio series is about 4%TAIL, how does it add up to the 100% composition? I don’t understand this -34% cash instead of -30% cash.
My core question is-> at the end of the month if I have to invest in these model porfolio, how do I split the money between the ETFs?
TheItalianLeatherSofa · July 11, 2024 at 11:31 am
“enchantment” is a power that belongs to financial advisors eheheheheh
it is 66% NTSX not 70% 😉 because 66% is then equal to 60% SPY and 40% IEF.
Anyway, the idea of starting from these % was simply driven by the fact that the normie investor is well accustomed with the 60/40: the model portfolio gives you back the SAME 60/40 and then adds something on top. It deviates from the path the normie is used to but not too much to becoming scary.
But from here you can take whatever direction you are comfortable with. Stock/bond/trend do quite well equally weighted (my next post will show that). You want to diversify each bucket, stocks for international exposure and trend model-wise. You might want to add other risk premia, like gold, long-short factors, carry, short-vol, etc…
Nothing is set in stone. other than more diversification (real diversification) is better than less. you can pick your desired target return or desired risk level by setting the appropriate leverage.
to implement the strategy, you can build a simple excel that links the “money weights” (66% in NTSX in above example) to the risk weights (60% SPY and 40% IEF), so the risk weights tell you where you have to invest/divest (vs your target allocation) and the money-weights tell you how much.
Federico B · July 11, 2024 at 11:35 am
Perfect! Thanks a lot! That is exactly what I wanted to understand.
I wanted first to have a clear view of the “standard” situation before modeling it on my personal situation.
Luca S. · July 12, 2024 at 4:21 pm
Hi Nicola, nice post! 🙂
This UCITS ETF could be an alternative to TAIL or it’s just a useless product? IE000HGH8PV2.
It covers market drawdowns between -5% and -35% but only on an annual period basis.
There is also a quarterly version but it covers from -3% to -12% : IE000EPX8KB7.
For what I’ve understood, TAIL covers losses on monthly basis from 0% to -30%, so it seems much better, but I’d like to know what do you think about these Europoor’s products 🙂
TheItalianLeatherSofa · July 14, 2024 at 7:08 am
Hi, the “tail” in their name is just marketing. these are defined outcome products and they work in a very different way. The point of having SPY and TAIL is to have convexity on both side of the distribution or, in other words, to enjoy (almost) 100% when the market goes up and be 100% hedged when it dives hard. Obv this comes at a cost: the bleed of TAIL is a “constant tax” that reduces returns when you are in the belly of the curve.
Defined outcome products do exactly the opposite: you sell the right tail of the distribution but take on your face all the >30% crashes. But when mkts go up/down gradually, you enjoy even (margianlly) higher returns.
The point is that markets rarely behave like their average. I have wrote (a couple of?) posts on defined outcome products, there the whole thing is explained better 😉
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