It´s time to dig a bit deeper into the current asset allocation of my portfolio. You can read more here about my process of structuring the portfolio in general and how I think about adapting it to different market conditions.
Let´s start with the most important foundation of my portfolio: a global asset allocation adapted to the current market environment.
I allocate between 30% to 70% of my capital (depending on current market regime) to this basic building block, but it can be a great solution for a standalone portfolio just as well.
To determine my allocation, I look at the overall state of different asset classes. I don´t want to predict anything, but use fundamentals and technical indicators to provide me with an idea where to invest how much of my capital. It does not matter, if that is not very exact. What matters is to be diversified in general and to get out when an area is breaking down below its long term moving average to protect the downside.
My philosophy is that the market tends to stay in the state it is, until it actually changes. Bad fundamentals can get more extreme for a long time before they influence market direction. Therefore I prefer to be a bit late to the party and wait until technical indicators tell me a change is happening instead of trying to predict when it will happen.
Let´s move from the top down:
The broadest basic asset classes to allocate to globally are:
- fixed income
- real assets
The allocation spectrum used in many globally diversified buy and hold portfolios with periodic rebalancing commonly falls somewhere between these weightings:
My basic allocation falls into the middle and through adapting to market conditions moves between the left and right extremes over time, overweighting and underweighting different assets cyclically. When things look grim in the majority of assets I gradually raise the cash allocation.
Basically this can be done with about six ETF (basic allocation = equal weight):
- 33% VT: world equities
- 33% BND, BNDX: fixed income US and international
- 33% VNQ, VNQI: real estate US and international and PDBC: commodities
Because I like to overweight sub- assets, that look most promising within the broad asset classes and add some factor tilts (like value and momentum), I use more specific ETF. I try to strike a balance between being flexible and avoiding too many choices, which has led to a universe of about 20 to 30 low fee ETF. It splits equities into major regions and international sectors; fixed income into treasuries, TIPs, corporate, municipal and sovereign bonds; for real assets I add gold, timber and global natural resource companies.
Keep in mind that exposure to many real assets in practice includes equity exposure as well. For example VNQ consists of companies that invest in real estate, which is different from owning the real asset itself, but has the advantage of being easily accessible and liquid.
My asset allocation in mid 2017
What am I actually doing at the moment? Where is my money invested?
The first thing I do, is select a minimum weight for global assets, that I want to hold through bull & bear markets and put that into separate vehicles that manage themselves, so I can forget about them. This is about 12% of my capital in: GAA (a global asset ETF which rebalances itself and adds some factor tilts), GVAL and GMOM (value and momentum ETF) and a german robo advisor with a good allocation concept (scalable capital).
Next, I analyze the markets, taking my first clue from the GAA ETF: It´s strongly trending above it´s long term moving average, so I want to be in the upper range (55% – 65% of capital – including the fixed 12% from above) of my allocation to global assets. Because of the length of the current bull market, I don´t invest the maximum and am slowly raising my allocation to trend following managed futures (allocations to trend-following and short volatility strategies will be in a separate post).
I evaluate each asset class separately and deploy my money accordingly (for each positive technical and fundamental indication, I add a couple of percentage points, when negative I subtract points – technicals count stronger):
- technical: very strong overall trend (VT) and in each world region and most sectors, volatility is low: very calm. All positive.
- fundamental: Cape ratio is very high in the US, average in developed markets, low to average in emerging markets, economic indications are positive, debt is on the rise. Overweight pockets that show more value.
- sentiment: optimistic and rising, not crazy yet.
- I overweight equities in general (to about 55% of the global asset allocation), underweight US, overweight other developed markets (all regions about the same) and overweight emerging markets.
- technical: uninspiring, but recovering from outright bad technical indications. Quite bad.
- fundamental: expected future returns can be estimated by current yield and that is very low. Very sensitive to rising interest rates – we might be at a turning point and face serious headwinds after thirty years of rising bond prices. Very bad.
- I strongly underweight bonds (less than 15%) and specifically hold more high yielding international sovereign bonds (SOVB) as they show pockets of value.
Real assets (this is a more diverse field):
- technical: REITs are solid, commodities overall are bad (but due for mean reversion after multiple down years), natural resource companies are already showing signs of a comeback, gold is recovering weakly, timber is very strong.
- fundamental: rising interest rates might be a headwind for real estate, inflation shows a sign of stirring and commodities can provide protection. commodity prices are quite low compared to their averages across the board.
- I weight real assets normally (about 20% to 30%: actually is a bit lower, but I will add to it), distributing it into the areas, that are strongest: overweight timber (WOOD); normal weight: international REITs, gold for inflation protection. Natural resource companies (GNR) are on buy list; ready to add commodities if they show improvement.
- very low allocation at the moment, but prepared to pull money out of the equity markets, when ETF break their moving averages.
What do you think?
Here are some good, free tools that I use:
https://www.portfoliovisualizer.com for backtesting different asset allocations including the possibility to add a trend following overlay with moving averages.
www.etfscreen.com to screen a list of ETF for momentum including technical and fundamental filters
http://www.starcapital.de/research/stockmarketvaluation for an overview of the valuation of world equity markets including the cape ratio
A good place to start and a quick read is the book „Global Asset Allocation“ by Meb Faber.