Part 2: Using Relative Strength To Invest In The Ivy Portfolio (DBC, VEU, VNQ, VTI, BND, SPY, SHY)

Yesterday I began some tests on ETF Replayof the ETF portfolios in Mebane Faber’s  The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. Today is a follow-up with some additional tests/parameters.

When backtesting a portfolio consisting of (NYSE:BND), (NYSE:DBC), (NYSE:VEU), (NYSE:VNQ), and (NYSE:VTI) and buying the top 1 ETF at the beginning of each month based a combination of 3 month returns, 20 day returns, and 20 day volatility (each weighted 40%/30%/30% and lower volatility receives a higher weighting), the results are below. Please keep in mind that test results are from the beginning of 2007 even though (NYSE:BND) and (NYSE:VEU) did not begin trading until mid 2007:

  • Since the start of 2007 the strategy returned 108.9% total, 21.5% CAGR. (NYSE:SPY) returned -10.6% total, -2.9% CAGR.
  • Strategy volatility was 18.5% versus 28% for (NYSE:SPY).
  • Strategy drawdown was -5.7% versus -50.8% for (NYSE:SPY).

When testing the same portfolio and buying the top 3 ETF at the beginning of each month based a combination of 6 month returns, 3 month returns, and 3 month volatility (each weighted 40%/30%/30% and lower volatility receives a higher weighting), the results are below:

  • Since the start of 2007 the strategy returned 135.8% total, 25.5% CAGR. (NYSE:SPY) returned -10.6% total, -2.9% CAGR.
  • Strategy volatility was 20% versus 28% for (NYSE:SPY).
  • Strategy drawdown was -9.8% versus -50.8% for (NYSE:SPY).

Yesterday I also tested a strategy which added (NYSE:SHY) (a close ETF substitute for cash) to the simple 5 ETF Ivy Portfolio.  The rationale was that yesterday’s tests looked for the top 3 ETFs out of only 5 each month based on momentum and thus “forced” the strategy to invest in some ETFs that may be showing poor overall momentum.  When purchasing only 1 ETF there is less need to add cash since bonds (NYSE:BND) and to an extent commodities (NYSE:DBC) generally have low correlations to equities and real estate. Thus, during periods of significant volatility (like 2008), a relative strength strategy which purchases only 1 ETF should avoid “having” to purchase 1 or 2 more ETFs which have no place in an investor’s portfolio (see September/October 2008).

For those of you still interested in the results, in the 5 ETF Ivy Portfolio + (NYSE:SHY), the 3 month returns, 20 day returns, and 20 day volatility strategy returned 96.5% (19.6% CAGR) with 16.7% volatility (-5.7% drawdown). The 6 month returns, 3 month returns, and 3 month volatility strategy returned 117.3% (22.8% CAGR) with 18.7% volatility (-8.2% drawdown).

To summarize, adding the cash option slightly reduced returns and volatility in the 1 ETF strategy.  The top 1 ETF strategy greatly outperformed the top 3 ETF strategy I reviewed yesterday.  The reason is primarily due to the historical volatility of 2008 creating large drawdowns in the 3 ETF strategy. 

Written By Scott’s Investments

 
A site focused on consolidating and tracking free online investment resources for the public with an emphasis on ETFs, stocks, portfolio strategies, technical analysis, and macroeconomics.

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