ETF Oriented Portfolio: Candidate For One Of Two Risk Reduction Models

While the following portfolio was not initially set up to follow any type of risk reduction model, the portfolio described below is an excellent candidate for such a model. With the current high market, now may be the time to kick in an even more aggressive risk reduction model as articulated in this Seeking Alpha article. The "Delta Factor" table below will underscore this point.

Fourteen of the sixteen available asset classes are used in this ETF oriented portfolio. The asset allocation plan is designed for a younger investor, or someone who has fifteen to twenty years of investing before retirement. Note the small holdings in the Bonds & Income asset class and the significant exposure to international markets.

The percentages with the blue-green background are the actual percentages currently held in this portfolio. All equity and bond asset classes are in balance (excluding Money Market) based on a threshold of 25%.

This data table is the Dashboard worksheet extracted from the TLH Spreadsheet, a portfolio tracking program designed for the investors interested in carefully monitoring their portfolios and appropriate benchmarks.

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In the following Quantext Portfolio Planning (QPP) analysis, the projected return for this portfolio is nearly two percentage points above that projected for the S&P 500. The portfolio carries a rather high projected 18% standard deviation or uncertainty factor. If one employs one of the ITA Risk Reduction models it is possible to dampen the portfolio volatility.

As a review, the basic rules for the risk reduction model are a slight modification of those laid out in pages 142-143 of Mebane T. Faber and Eric W. Richardson's book, The Ivy Portfolio. The above links show the modifications to the Faber - Richardson rules.

As mentioned in the first paragraph, the "Delta Factor" data table shown below indicates the current market is over priced, particularly for a number of ETFs used in this portfolio. Using a reversion-to-the-mean analysis, future growth has a low probability of significant returns for the investor. What is causing these pessimistic projections?

Note the starting point of the analysis - February 21 of 2009. The market was near its low after a crushing bear market. Since March of 2009 the market has had a huge run-up and for that reason, reversion-to-the-mean analysis projects a low probability of this continuing over the next six to twelve months. It is simple logic. This does not mean we will not have good growth. The argument is simply - the probability is low for good growth going forward.

Using the "Delta Factor" projections, it behooves any investor holding the following investments be on guard so as to protect recent three-year gains. That is the logic behind using one of the ITA Risk Reduction models.

Disclosure: I am long PG, GSG, DBC, VTI, IDV, RWX, DVY, VTV, VUG, VBK, VBR, VEU, VWO, VOE, VOT, VNQ, EIDO, BKF, BND, TIP, TLT.