Computerization is constantly changing the game in many industries. On Wall Street, the rate of change is even faster given the extraordinary sums at stake. Still, many people update their smartphones more often than their investment portfolios.
In recent decades, computerization has helped investors the most through index funds and exchange-traded funds (ETFs). Warren Buffett and David Swensen have both been recommending index funds for years, and Vanguard has surpassed Fidelity in assets under management. In fact, the world’s largest asset managers are the leading ETF and index fund providers.
Since investment results are mainly determined by “asset allocation,” investors need to use index funds strategically. In the book, “Unconventional Success,” David Swensen explains his prescription for a core growth portfolio using six top ETFs from Vanguard and iShares.
Swensen is the ideal architect for a core portfolio. He has a leading institutional track record managing Yale’s multi-billion dollar endowment fund and his book bashes Wall Street for overcharging investors on inferior solutions. And if that is not enough, a large portion of Wall Street is openly following his lead.
At ETF Portfolio Management (ETF PM), we track Swensen’s prescription through the “eMAC,” an efficient multi-asset class portfolio. Over the past decade, the eMAC compounded by 9.9% per year while the S&P 500 delivered 7.0% annually. This equates to a total return of 157% versus 97% for the S&P. See the historical performance at www.InvestableBenchmarks.com.
Once you have a strong core portfolio in place, you can measure absolute return strategies far more effectively. In the hedge fund marketplace, computerization has aided investors the most through a strategy called “Trend Following.” Trend following has delivered gains during market crashes repeatedly and has also produced a competitive return long term.
Still, many investors have either never heard of trend following, or they refer to it as “managed futures” or “CTAs.” In many respects, indexing is actually a passive form of trend following. Both strategies react to market trends but they operate at different speeds, and with different levels of diversification. Historically, investors that combined these two rules-based approaches reduced their risk significantly.
Over the past 26 years, combining 60% trend following, via the Systematic Index, with 40% indexing, via the S&P 500 (INDEXSP:.INX), would have reduced the worst three-year total return to -2%, from -38% for the S&P 500 alone. Similarly, the worst 10 year total return would have improved to a 44% gain, from a 13% loss for the S&P 500 alone.
Investors that combined indexing with trend following received important diversification by asset class, and by investment process. In recent decades, this approach delivered an attractive “escalator-like” return stream.
At ETF PM, our 50/50 Portfolio works to simulate and to improve upon this dynamic mix with an all-ETF solution. We use an equal combination with the eMAC instead of the S&P 500 for indexing, and our tactical ETF portfolios instead of the Systematic Index for trend following.
The Bottom Line
Nobody can predict which asset class or investment process will deliver the most in the future and the right mix is certain to change over time with new technology. Investors should closely monitor the evolution of leading investment trends on Wall Street and look for financial advisors who are passionate about innovation that maximizes client value.
David S. Kreinces is the Founder & Portfolio Manager of ETF Portfolio Management (ETF PM), a revolutionary financial advisory firm that specializes in rules-based investing and risk control. He has over 20 years of professional investment experience in multiple asset classes and investment processes. He is an expert in ETF trend following and has successfully delivered gains in the market crash of 2008. ETF PM also gives back to the community through a pledge to donate a portion of each client’s annual advisory fee. See etfpm.