Tag Archives: cphyx

Summary This article continues the work of my previous article on a tactical asset allocation strategy for Schwab or Fidelity platforms using bond mutual funds with very low volatility. The original basket of funds was modified by exchanging one fund for a less volatile fund, and adding a floating-rate loan fund to enhance the strategy when rates are rising. The backtested results show a CAGR of 12.8%, a MaxDD of -2.9%, and a MAR (defining reward/risk) of 4.4. The worst year from 2000 – 2015 had a +5.6% return. Additional details are presented to help understand the practical implementation of the strategy on Schwab or Fidelity platforms. Funds are traded without costs except for a $50 short-term trading fee. The purpose of this article is to present an enhanced version of the Low Volatility Strategy [LVS] that I presented previously (see here ). Based on comments and further study, I have slightly modified the original LVS-1. The -1 designation means one fund is selected each month from a basket of funds. The original LVS-1 had a basket of four mutual funds coming from four different bond classes. Each fund had very low volatility (i.e. daily standard deviations [DSDs] of 0.35% or less) and the funds were mostly non-correlated to each other. A relative strength approach was used in which the funds were ranked based on their total returns over the previous ten trading days. The top-ranked fund was selected at the end of each month unless it failed a 10-day simple moving average [SMA] test, in which case the money went to a safe harbor. The safe harbor was a money market fund. Further details are explained in the previous article. The original basket of funds for application to the Schwab or Fidelity platforms were: Nuveen High Yield Municipal Bond Fund (MUTF: NHMAX ) Principal High Yield Fund (MUTF: CPHYX ) PIMCO Mortgage-Backed Fund (MUTF: PTMDX ) Dreyfus U.S. Treasury Intermediate Term Fund (MUTF: DRGIX ) Changes to Original Basket and Backtest Results After further study, I have replaced DRGIX with the Loomis Sayles Limited Term Government and Agency Fund (MUTF: NEFLX ) because of its reduced risk (reduced DSD that resulted in lower MaxDD). More importantly, I added a floating rate loan fund to the basket in order to improve performance in a rising rate environment. Since I decided to concentrate on the basket of funds for the Schwab and Fidelity platforms, NHMAX limited how far back I could go in a backtest (2000). Thus, I needed a floating rate loan fund with an inception date in 1999 or before. There were three candidates: Oppenheimer Senior Float-Rate Fund (MUTF: OOSAX ): Annualized Return = 4.66%, DSD = 0.18% Invesco Floating-Rate Fund (MUTF: AFRAX ): Annualized Return = 3.62%, DSD = 0.20% Blackrocks Floating Rate Income Portfolio Fund (MUTF: BFRAX ): Annualized Return = 3.76%, DSD = 0.21% OOSAX was selected because it has the highest annualized return and lowest DSD. Thus, the final basket for use on Schwab or Fidelity platforms is: NHMAX, CPHYX, PTMDX, NEFLX and OOSAX. A correlation matrix is shown below, together with annualized returns and various forms of volatility numbers. It can be seen that all funds are noncorrelated except for PTMDX and NEFLX that have a correlation of 0.81. (click to enlarge) Using these funds, LVS-1 was run on Portfolio Visualizer, a commercially-free software package. The backtest was limited to 2000 – 2015 due to the histories of the selected mutual funds. In this article, I am only going to focus on the LVS-1 using mutual funds we will trade on Schwab and Fidelity. However, it should be noted that, in the previous article, this basic strategy was backtested to 1988 using proxies, and good performance and low risk were demonstrated. The results of LVS-1 are shown below, along with results for a buy & hold, equal weight portfolio. Total Return: 2000 – 2015 (click to enlarge) Annual Return (click to enlarge) Tabulated Annual Return (click to enlarge) Drawdown (click to enlarge) Summary Table (click to enlarge) It can be seen that the Compounded Annualized Growth Rate [CAGR] is 12.8%, the standard deviation [SD] is 5.5%, the worst year is +5.4%, and the maximum drawdown [MaxDD] is -2.9%. There are no losing years, and the monthly win rate is 84%. In terms of reward/risk, the MAR (CAGR/MaxDD) is 4.4. This strategy is appropriate for an investor who wants moderate growth and very low risk. Further Thoughts on Implementing LVS-1 on Schwab and Fidelity Platforms The funds that were selected are no load /no fee funds on Schwab and Fidelity. This means the loads are waived, and there are no commission fees. The only fee you will pay is a short-term trading fee of $49.95 if you sell a fund within 90 calendar days on Schwab or within 60 calendar days on Fidelity. So in some instances, you will hold a fund for multiple months, and avoid the short-term trading fee. But most of the time, there will be a charge when you sell a fund. LVS-1 averages about 8 trades per year. That means it will cost about $400 in short-term trading fees per year. For a $100K account, this will come out to 0.4% per year. But there are no other fees. I also looked at the prospectus of each fund pertaining to trading frequency restrictions. All of the funds warn about excessive trading, but they combat excessive trading in different ways. Round-trips are sometimes used to define excessive trading. A round-trip is the buying and selling of one fund in one account. Excessive trading for the mutual funds of interest are: NHMAX: Limited to two round-trips in a 60-day period. CPHYX: Must hold the fund for 30 days before selling. PTMDX: Nothing specific stated. NEFLX: Limited to two round-trips within a rolling 90-day period. OOSAX: 30-day exchange limit. Fund is blocked for 30 days. Thus, there are no limitations that will stop the trading of the LVS-1 strategy as long as we make our trades 30 days apart. This means if we trade on March 1st, our next trade cannot occur until March 31st at the earliest. Conclusion In conclusion, the LVS-1 shows the potential to achieve 12% net growth on average with maximum drawdown (based on monthly returns) of less than 3%. More realistically, this strategy probably has the potential to earn 10% per year with a maximum drawdown of 5%. The monthly win rate should be higher than 80% according to backtesting. As far as I can tell, this strategy should be viable in Schwab or Fidelity accounts as long as the trades are made 30 calendar days apart. To maintain a spacing of 30 days between trades, a schedule is presented in this article . Recently Herbert Haynes has duplicated this strategy and has looked at the effect of trade day on the results. He has shown that trade day is of paramount importance; the only trade days that produce good results are end-of-the-month [EOM] and first day-of-the-month. It is not clear what causes this seasonality of the strategy. Perhaps it is the effect of using funds with large dividends that occur at EOM, or perhaps it is the effect of a short timing period.