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Portfolio Construction: The Trader’s Portfolio Patrick Berch Portfolio Manager/Registered Investment Advisor Representative 1
PURPOSE OF THIS PRESENTATION To present one method of portfolio construction and things to consider when doing so Discuss the use and value of multiple asset classes Things to consider in portfolio construction: • Low correlation • Diversification in strategy • Diversification in periodicity • Position sizing assumptions • Long/short/cash 2
PHILOSOPHICAL TENETS First, ask yourself, “Do I have any? ” If so, then how do they effect the way I trade? Beliefs…what are they? Extreme Diversification – Most investors are too heavily allocated to stocks/bonds and US-centric Long/Cash/Short – One needs the ability to make money in down markets Market Timing – There's a time to be long (bullish), short (bearish), and cash (neutral) as many asset classes as possible Active, Not Passive – You cannot control investment risk by doing nothing 3
CONVENTIONAL DIVERSIFICATION Most investors have stock mutual funds, maybe a little exposure to bond and developed country international mutual funds 4
EXTREME DIVERSIFICATION v [typical portfolio in financial crisis] 5
EXTREME DIVERSIFICATION Previous chart shows "diversified" portfolio is not as diversified as one may think Correlations of 0 are ideal, but non-existent; between -70% and +70% are acceptable. High correlations <-0. 70; >+0. 70 Bottom line: we need to choose asset classes much less correlated with each other 7
RISK-ADJUSTED RETURNS Maximizing risk-adjusted returns is the objective of the All. Asset Portfolio. What are your objectives? Maybe you don’t need to maximize but hit a minimum of X%. We define risk-adjusted return as annual return divided by risk, where risk is defined as maximum drawdown Drawdown is the loss in portfolio value from peak to trough, ex. October 2007 to March 2009, the S&P 500 had a drawdown of 55. 25% 8
EXTREME DIVERSIFICATION v [typical portfolio in financial crisis] 9
LONG/CASH/SHORT VS. LONG ONLY Long/Cash is better than buy-and-hold Long/Cash/Short is ideal Each of our systems have the ability to be Long/Cash/Short depending on market conditions. 11
EXTREME DIVERSIFICATION v [typical portfolio in financial crisis] 12
MARKET TIMING Because the global economy is cyclical, so are the prices of different asset classes Also, because the global economy is cyclical, there's a time to be bullish, a time to be bearish, and a time to be neutral each and every asset class Market timing is not picking tops and bottoms to the exact tick; it's simply putting odds in your favor Are the odds in your favor being long (bullish) bond prices when interest rates are going up? Hint: No. So why be in bonds when rates trend up? Do not hold an asset class simply because it adds "diversification" - only if it adds value – i. e. , long if bullish; short if bearish 13
ALL-ASSET PORTFOLIO A combination of 6 market-timing systems. And they’re not even that great! Systems applied to 6 disparately correlated asset classes. The systems employ multiple timeframes improving diversification. Each systems is Long/Cash/Short. 15
WHAT DOES THIS LOOK LIKE? 16
The gold system outperforms buy-and-hold gold by over 4% annually with over 14% less drawdown. 17
EMERGING MARKETS The REIT system outperforms buy-and-hold REITs by 7. 5% annually with over 41% less 18 drawdown.
US DOLLAR The US dollar system outperforms buy-and-hold US dollar by over 2% annually with 19 over 18% less drawdown.
S&P 500 The S&P 500 system outperforms buy-and-hold S&P 500 by almost 15. 72% annually with over 43% less drawdown. 20
COMMODITIES The High Yield system outperforms buy-and-hold High Yield by 0. 6% annually and 21 has a 11. 78% less drawdown giving it a much better risk adjusted return.
BONDS The bond system has underperformed buy-and-hold bonds by 0. 10% annually with 1. 78% greater drawdown – note bonds have only been in a bull market during the 22 test period.
RELATIVE PERFORMANCE SUMMARY Five of the six systems had higher annual returns than their buy-and-hold counterpart. Note that bonds were only in a bull market during the test period. All six systems have a lower drawdown than their buyand-hold counterpart. Therefore, all six systems have a better risk-adjusted return than their buy-and-hold counterpart. What happens when you combine these systems into one portfolio? 23
FINAL PORTFOLIO PERFORMANCE 24
PUTTING IT ALL TOGETHER The worst drawdown of any individual system is 32. 22%; for the total portfolio, though, it's only -9. 95% Because of this, weighted average risk-adjusted return of individual systems is 46. 98; but for the total portfolio, it's 130. Why? Each system experiences its worst drawdown at different times. 25
PORTFOLIO METRICS Average number completed trades per year = 34. 5; that's 69 buys and sells per year, or roughly 5 actions per month on average; we're active; average $37. 68 in commissions per year. Winning % = 64. 5%; it’s not always right! Average win is 15. 07% - but this is both longer-term and shorter-term systems. Average loss is 3. 50% - again, an average of both longerand shorter-term systems. When we're right, it's usually a decent gain; losses are controlled. 28
SUMMARY All-Asset Portfolio (AAP) is a trend following system – usually a few (or more) asset classes are trending at any given period of time. Relative Strength is a key component to overall return. Each of 6 disparately correlated asset classes are timed so that we are Long/Cash/Short in each. In other words, extreme diversification, Long/Cash/Short investing, market-timing and active management are all employed in the AAP. 29
SUMMARY – AAP BENEFITS Extreme diversification allows for a more robust portfolio – helps reduce drawdowns Long/short and long/cash systems allow the portfolio to adapt to changing trends – helps increase returns and reduce drawdown AAP is not dependent on any one type of market environment – can thrive in any environment; helps produces consistent gains over time AAP gives the investor exposure to asset classes they may not otherwise have exposure to – a higher likelihood of finding "what's hot" End result is opportunity with double-digit annual gains, limited drawdowns, and higher level of consistency of returns than typical investment portfolios 30
DISCLOSURE 1 The All-Asset Portfolio (AAP) is a portfolio of model systems developed by Patrick Berch with Butler, Lanz and Wagler. The model performance presented has been back-tested and is strictly hypothetical. The performance was gathered using historical data obtained from yahoo finance, Reuters Data. Link, and Trade. Station. The information received from these third party sources, as well as the calculations made in constructing model performance, is believed to be reliable, but we cannot guarantee its accuracy or completeness. The AAP is an actively managed strategy and consists of the following asset classes: US and emerging market stocks, high yield bonds, US Treasury securities, REITs, the US dollar, commodities and gold. Each of the markets systems are part of a long-short -cash model. The following securities were used to execute trades in the portfolio's historic performance construction and are currently used in the portfolio's trading activity: Rydex Commodities (RYMBX), Rydex Banking (RYBKX), Rydex Biotechnology (RYBOX), Rydex Electronics (RYELX), Rydex Energy (RYENX), Rydex Financial Services (RYFNX), Rydex Healthcare (RYHEX), Rydex Internet (RYINX), Rydex Leisure (RYLSX), Rydex Precious Metals (RYMNX), Rydex Technology (RYTHX), Rydex Telecommunications (RYTLX), Rydex Transportation (RYTSX), Rydex Utilities (RYUTX), Rydex High Yield (RYHGX), Rydex Inverse High Yield (RYIHX), Rydex Real Estate (RYHRX), Pro. Funds Short Real Estate (SRPIX), i. Shares MSCI Emerging Markets Index ETF (EEM), SPDR Gold Trust ETF (GLD), Deutsche Bank AG DB Gold Short ETN (DGZ), Rydex Series Trust Inverse S&P 500 Strategy (RYARX), i. Shares Barclays 20+ Year Treasury Bond ETF (TLT), Pro. Funds Rising Rates Opportunity Fund Inverse (RRPIX), Pro. Funds Rising U. S. Dollar Fund (RDPIX) and Pro. Funds Falling U. S. Dollar Fund (FDPIX). Where system trading signals were generated prior to the above funds' inception dates, proxies were used - either comparable securities or the underlying index itself. Securities held at any given time are completely a function of the timing system for each asset class. The portfolio is rebalanced on an annual basis. Asset classes are added to the model as they became available. Not all asset classes were available in 1989. The AAP was developed by retroactive application and is used solely to illustrate what performance would have been had the portfolio been created on May 31, 1989. The AAP performance results take into account expected time-weighted rates of return, the reinvestment of dividends and other account earnings. AAP's performance results take into account, and are therefore net of investment management fees, commissions charged on trades, and the fees assessed directly by each unaffiliated mutual fund and/or exchange-traded fund holding that comprises the AAP. An investment management fee of 2% has been used to show the net-of-fees performance. The reinvestment of dividends and other earnings may have a material impact on overall returns. 31
DISCLOSURE 2 Because the model results are hypothetical they have inherent limitations due to the fact that they do not reflect actual trading and may not reflect the impact that material economic and market factors might have had on decision-making if actual clients had been invested in the model strategy. No matter how positive the model returns have been over any time period, the potential for loss is always present due to factors which may not be accounted for in the model. The nature of a back-tested model creates the potential for a financial professional to select superior performance results in order to get the desired model results. All economic and performance information is historical and not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made referenced to directly or indirectly, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from BLW or any other investment professional. Further, the charts and graphs contained herein should not serve as the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation consult your investment advisor. All performance results have been compiled solely by Patrick Berch, are unaudited, and have not been independently verified. Use the information provided in this presentation at your own risk. I or any organization that I affiliate with are not responsible for any losses incurred. Do your own due diligence. I would be glad to discuss the methods presented here with anyone. 32