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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. Scalper1 News
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