Tag Archives: tranche

Tranche Model Applied To The ‘Swensen Six’ Portfolio

Diversify globally using six ETFs. Reduce portfolio risk through the use of a tranching model. Minimize the “luck-of-review-day.”. Rebalancing a portfolio, whether it is done monthly, quarterly, or annually, inserts a variable known as the “luck-of-review-day.” This problem is examined in a recent white paper readers can find at the end of this introductory blog post . The paper is titled, Minimizing Timing Luck with Portfolio Tranching . What is portfolio tranching and how can it be applied to the ” Swensen Six ” portfolio? While the “Swensen Six” is an example portfolio, the Tranche Model can be used with any group of securities. There is an advantage to including low correlated securities and the “Swensen Six” meets this requirement. The spreadsheet used for the following tranche analysis includes four critical worksheets. 1) A main menu where assumptions are set up for the analysis. 2) A portfolio worksheet for listing securities and number of shares held in each security. Available cash is also included. 3) Data worksheet for automatically downloading data. 4) Tranche recommendations based on the assumptions and securities used for portfolio construction. A few of the assumptions include the following. The Number of Offset Portfolios can be set from one (1) through twelve (12). I generally use eight (8) as this takes into account eight different portfolios ranging over the past sixteen (16) trading days. The second variable is to determine the Periods between Offsets and I generally use two (2). If the portfolio is updated after the market closes on a Friday, the data for the first portfolio offset is Friday, the second portfolio offset is the prior Wednesday and the third portfolio offset is the prior Monday. If one selects three (3) for the offset periods we jump back by three-day intervals. Look-back periods of 60 and 100 trading days are based on extensive research. Weights of 50% for the shorter look-back period and 30% for the longer look-back period are applied to ROC1 and ROC2 respectively. See the following screen-shot. For this example, two (2) ETFs are the maximum permitted for any offset portfolio. (click to enlarge) After the assumptions or variables are set in the Main Menu and the latest data is downloaded, we move to the Tranche Recommendations as shown in the following screen-shot. Based on the recommendations from the 10/23/2015 portfolio, 50% is invested in VNQ and 50% in TLT. The same was true two days prior of 10/21/2015. However, the recommendation ten trading days ago was to invest 50% in SHY and 50% in TLT. The seventh offset portfolio recommended investing 50% in TLT and 50% in TIP. Based on the eight portfolio offsets, the required number of shares is listed in the Required column. What these different offset portfolios are telling us is that we would have come up with different recommendations had the portfolio review come up on a different day or what is known as “luck-of-review-day.” (click to enlarge) For a $100,000 portfolio an investor, using this tranche model, would invest 75 shares in SHY, 450 shares in VNQ, 400 shares in TLT, and 50 shares in TIP. Rounding the number of shares is a personal judgment. Back-testing research shows tranching reduces portfolio volatility. There is a penalty to be paid for lowering risk as the return is also reduced. Portfolio turnover is another issue. I prefer to review portfolios every 33 days and depending on how one rounds the number of shares held in the various ETFs, one has some control over the portfolio turn over. All the ETFs using in the “Swensen Six” are commission free through certain discount brokers so commissions are not an issue. Note to readers: This tranche model differs from the model explained in the white paper referenced above.

Dividend Oriented Retirement Portfolio Using Only 9 Commission Free ETFs

Asset allocation is set to generate approximately 3.0% yield. Dual momentum option is designed to enhance return while reducing risk. Three portfolio management styles are: Passive, Dual Momentum, and Tranche. A Tranche Model will reduce “luck” of rebalancing. Dividend yield closely matches that provided by a portfolio of Dividend Aristocrats. Retirement goals drive investors to save and invest. The following three models use eight ETFs for investing and one ETF, the iShares 1-3 Year Treasury Bond ETF ( SHY), as a cutoff or “circuit breaker” security. When set up using the following asset allocations, the portfolio will generate approximately 3.0% annually or not far off a portfolio built around Dividend Aristocrats. The nine ETFs are as follows. Vanguard Total Stock Market ETF ( VTI) Vanguard FTSE Developed Markets ETF ( VEA) Vanguard FTSE Emerging Markets ETF ( VWO) Vanguard REIT Index ETF ( VNQ) SPDR Dow Jones International Real Estate ETF ( RWX) PowerShares Emerging Markets Sovereign Debt Portfolio ETF ( PCY) iShares 20+ Year Treasury Bond ETF ( TLT) Vanguard Intermediate-Term Bond ETF ( BIV) iShares 1-3 Year Treasury Bond ETF (( SHY)) Passive Portfolio Model: The next major decision focuses on what percentage to invest in each ETF if one is constructing a portfolio to be passively managed. The percentage allocations follow the ” Swensen Six ” recommendations with a few modifications. RWX and PCY are new additions and BIV replaces TIP. SHY is the ninth ETF and is used strictly as a cutoff ETF in the momentum and tranche models – to be described below. VTI = 30% with a 1.96% yield VEA = 10% with a 3.07% yield VWO = 10% with a 3.1% yield VNQ = 15% with a 4.11% yield RWX = 5% with a 3.2% yield PCY = 10% with a 5.07% yield TLT = 10% with a 2.66% yield BIV = 10% with a 2.7% yield Using the above asset allocations, all one needs to do is keep the various asset classes in balance or close to the suggested targets. All ETFs pay a nice dividend, an advantage for retirees, while providing an equity emphasis for future return. The portfolio also meets the diversification requirement as there are hundreds of stocks and bonds spread out all over the globe. Dual Momentum Model: The dual momentum model is slightly more complicated compared to the passive model in that it requires a bit more time to manage. The basic concepts behind this model can be found in Antonacci’s Dual Momentum book or a condensed version in this Seeking Alpha article . The major advantage of this investing model is keep one out of deep bear markets as we experienced in the early part of this century and again in 2008 and early 2009. Using the same eight commission free ETFs, three metrics are used to rank the securities and compare performance with SHY. 1. Return of Capital (ROC1 and ROC2) are assigned weights of 50% and 30%. 2. Look-back periods are 91 and 182 calendar days. 3. A 20% weight is assigned to volatility where a mean-variance calculation is used and low volatility is rewarded. When a portfolio is reviewed, the securities are ranked as shown below. The recommendation is to only invest in the top two ranked ETFs, and then only if they are outperforming SHY. Based on current data (10/2/2015) only BIV and TLT meet this standard so 50% of the portfolio is invested in BIV and 50% in TLT. If there is a tie, then the investments are split evenly three ways. (click to enlarge) Tranche Model: The Tranche Model may be new to many investors and therefore requires a little explanation. The logic behind this model is to mitigate the “luck-of-review-day” problem. I review portfolios every 33 days so the reviews come at different times of the month. This also avoids wash sale issues and short-term trading fees that are accessed by brokers offering commission free ETFs. When a specific review days is selected, the dual momentum recommendations can vary from day to day. We might be lucky and find recommended buys on a day when the market down, or we could be unlucky and end up with a pair of ETFs that were not ranked so high on trading days on either side of the review day. What the Tranche Model (TM) does is permit the user to select multiple portfolios using different days of separation. The TM answers the question, what was the dual momentum recommendation two days ago, or four days ago? While the Tranche Model reduces risk, it also tends to reduce return. In the following screen-shot the number of Offset Portfolios is set to eight (8). The software permits as many as 12 portfolio options. The period (trading days) between offsets is set to 2. Otherwise, the settings are similar to the above dual momentum screen-shot. Recommendations from the Tranche Model, if rounding to the nearest 50 shares, are as follows. For a $100,000 portfolio, buy 200 shares of SHY or leave in cash. Purchase 400 shares of PCY, 250 shares of TLT, and 450 shares of BIV. Once the portfolio is positioned based on these recommendations, do nothing until the next portfolio review. (click to enlarge) The passive portfolio is the easiest to manage and there are tax advantages as shares are held for long periods of time. The dual momentum and tranche models require more attention, but will prevent major losses when major bear markets strike.