Tag: efficient portfolio

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Market uncertainty prior to next week’s election

The stock market, measured by the S&P 500, lost about 2.5% in October. But, earlier in the month, the stock market was up over 5%. The chart below shows the roller coaster ride for two ETFs that track the stock and bond markets: iShares Core S&P 500 ETF (ticker IVV), Vanguard Total Bond Market ETF (ticker: BND) So, what’s going on with this market volatility?

Stock and bond returns in October, 2020. Source: finance.yahoo.com

Markets don’t like uncertainty

There are many opinions to describe what caused the financial markets to move like they did in October 2020. We think that the combination of the upcoming election and spike in coronavirus cases is adding to uncertainty. But, this uncertainty, as measured by stock market volatility, is still well below where it was earlier in the year. We used our daily volatility monitor in the plot below.

Stock market volatility as of October 30, 2020. Source: ETFMathGuy.com
Stock market volatility as of October 30, 2020. Source: ETFMathGuy.com

As this chart shows, volatility has crept a little higher in October. But, based on the long-term historical norm, this volatility is still slightly elevated in the 75% percentile. Of course, if you are a believer in efficient markets, then you simply don’t know what the future of the market will hold. In more positive news, the WSJ recently reported that the U.S. economy recovered significantly in the 3rd quarter of 2020. Consumer spending for online retail items continue to stay strong, while the travel sector still lags.

How about the ETFMathGuy portfolios and market uncertainty?

Thanks to wide diversification from over 2,000 ETFs we analyze each month, our portfolios continue to perform well. Consequently, the moderate risk portfolio lost 0.6% and the aggressive risk portfolio lost 0.5% in October. The year to date cumulative return of the ETFMathGuy aggressive risk portfolio appears below, along with the S&P 500 and Aggregate Bond Market total return.

ETFMathGuy year to date cumulative returns, versus the S&P 500 and Aggregate Bond Market returns.

Premium subscribers can now access the backtested portfolios for November 2020. Not a premium subscriber yet? Then, just visit the bottom of our “Join Us” page to upgrade your subscription and get immediate access!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Market Volatility is Back?

Market volatility returned in September 2020. In this post, we discuss this recent surge in the context of long-term historical volatility. We also show how our ETFMathGuy portfolio performed, and elaborate on a source of that performance.

Market Volatility returned, but will it persist?

Earlier this year, we developed an app to automatically measure stock market volatility. This app updates daily, and the figure below shows the latest result.

Stock Market Volatility was 19.7% on Friday, slightly above its long-term historical norm.
Stock Market Volatility was 19.7% on Friday, slightly above its long-term historical norm.

We also provided a table showing the distribution of long-term historical volatility, as observed over more than 20 years. Current volatility is 19.7% as of October 2nd, which corresponds to the upper limit of the third-quartile. So, while market volatility returned, it is still well below the volatility seen in early 2020.

Market Performance through the 3rd Quarter

The higher volatility occurring in September did indeed correspond to a loss in the stock and bond markets. The stock market lost 3.7% and the bond market lost 0.1%, based on the ETFs with ticker symbols IVV and AGG. The year to date return of these stock and bond index ETFs were 5.5% and 6.7%, respectively, including dividends. The year to date return of the ETFMathGuy Aggressive Risk Portfolio was 20.8%. This return is the result of trades conducted in a brokerage account at Fidelity Investments, and so includes the bid-ask spread.

Stock and Bond Market YTD Returns compared to the ETFMathGuy Aggressive Risk Portfolio
Stock and Bond Market YTD Returns compared to the ETFMathGuy Aggressive Risk Portfolio

Premium subscribers now have access to the October 2020 premium portfolios, as well as a handy rebalancing calculator. Free subscribers are welcome to log in to review older premium portfolios through May 2020, or upgrade their account to enable premium access.

Sources of Excess Performance

One ETF that our portfolios have consistently included throughout this year is the Aberdeen Standard Physical Palladium Shares ETF (ticker: PALL). Its 12 month return and volatility appear below next to the S&P 500 ETF (ticker IVV).

The Palladium ETF has higher volatility than the S&P 500, but also has a higher return over the last 12 months. Source: www.ETFreplay.com
The Palladium ETF has higher volatility than the S&P 500, but also has a higher return over the last 12 months. Source: www.ETFreplay.com

Examining these results for PALL confirms the expectation that higher risk can lead to a higher return. Our optimal portfolio construction process creates a portfolio that, along with PALL, finds other ETFs that maximize expected return. This process also keeps the portfolio’s expected risk between the stock and bond markets. Additionally, we backtested this process over a full market cycle. We hope you will consider upgrading your subscription to gain insights into a wider variety of ETFs that appear in our efficient portfolios.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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Can minimum volatility ETFs consistently perform well?

Last weekend, there was a fascinating article about minimum volatility ETFs. It was written by one of my favorite Wall Street Journal columnists, Jason Zweig. In this article, he shared a lot of wisdom, which I will highlight more here.

What is a minimum volatility ETF?

One of the most common ways to measure risk in an ETF is to track its volatility. So, investing in a minimum volatility ETF may make sense for investors seeking to reduce risk. One of the largest low volatility ETFs is the iShares MSCI USA Min Vol Factor ETF (ticker: USMV), with over $30B in assets. The chart below shows it performance since its inception in October 2011, which generally lagged the S&P 500 (ticker: IVV). However, its volatility was noticably lower.

Risk and Return of a large minimum volatility ETF compared to the S&P 500 . Source: www.ETFReplay.com
Risk and Return of a large minimum volatility ETF compared to the S&P 500 . Source: www.ETFReplay.com

Why did this ETF produce lower risk and lower return?

This ETF is able to lower risk through the use of optimization, much like the ETFMathGuy portfolios. However, we don’t limit our optimal portfolios to equities like minimum volatility ETFs. We consider bonds, commodities and other alternative investments too. ETFMathGuy also uses backtesting that includes transaction costs to build portfolios to maximize returns.

The fund’s index uses an optimization algorithm to build a “minimum variance” portfolio—one that considers correlation between stocks—rather than simply holding a basket of low-vol stocks…

USMV Factset Analytics Insight (https://www.etf.com/USMV)

So, this ETF consists of stocks which typically emphasize lower volatility sectors like financial, utilities and real estate. These sectors are often termed “value”, rather than “growth” investments, in part due their issuance of dividends. Consequently, optimization to produce a minimum volatility ETF removes some market risk, generating a beta of 0.87. But, as we can see in the economic cycle from 2011 – 2020, the return also lagged the market.

Recent performance of minimum volatility

This year’s pandemic has certainly affected the stock market in significant ways. Investments favored by minimum volatility ETFs (financials, utilities, and real estate) have been significantly impacted by coronavirus lockdowns. However, technology has done very well, as remote work has increased the demand for technology systems and services. Unfortunately, technology is typically more of a “growth” investment. So, minimum volatility ETFs often limit their exposure to growth stocks to reduce volatility. In the ETFMathGuy portfolios, technology has been a noticeable portion this year, and has led to encouraging year-to-date returns and performance statistics.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Alpha and Beta Portfolio Statistics

In this post, we will be diving deeper into two commonly used portfolio statistics. These terms are Alpha and Beta, are based on a statistical method called “Regression“, and are used in the Capital Asset Pricing Model (CAPM). They are calculated by fitting a “line” to a set of points.

“…alpha is the return on an investment that is not a result of general movement in the greater market”.

Description of “Alpha” from the Capital Asset Pricing Model (CAPM). Source: Investopedia

“Beta effectively describes the activity of a security’s returns as it responds to swings in the market”

Description of “Beta” from the Capital Asset Pricing Model (CAPM). Source: Investopedia

If we define the market as the S&P 500, then Beta is an indication on how sensitive a portfolio is to S&P 500 returns. Alpha indicates how returns occur independent of the S&P 500. The term Alpha is so important, that it has even spawned its own website. And, why not? It represents the return obtained without exposing an investor to (stock) market risk.

An Example of CAPM

To better illustrate how Alpha and Beta are determined, consider the last 8 months of returns for the the following data sets:

  1. ETFMathGuy Aggressive Portfolio Returns
  2. S&P 500 total returns (ticker: IVV) to represent the market
  3. Short-term U.S. Treasury bill returns (ticker: SHV) to represent the risk free rate

Since CAPM is based on the concept of “excess returns”, which are returns above the risk-free rate, we can visualize this relationship in a scatterplot. The horizontal axis is the “Market Returns – Risk Free Rate”, and the vertical axis is the return of our “ETFMathGuy Aggressive Risk Portfolio Returns – Risk Free Rate”.

The Capital Asset Pricing Model (CAPM) applied to 8 months of returns of ETFMathGuy Portfolios
The Capital Asset Pricing Model (CAPM) applied to 8 months of returns of ETFMathGuy Portfolios

These results look promising, with a value of Beta = 0.37 and Alpha = 2.1%. However, 8 observations are small, so analysts typically look to see if these values are “significantly different” than 0. Or, put another way, what is the chance that these value were obtained by skill, rather than luck?

Assessing Luck vs. Skill

More data or evidence is always helpful in supporting any claim using statistics. For the example we show above, we are claiming that Alpha and Beta are non-zero values. Using some fundamentals from statistics, we can determine p-values for our Alpha and Beta calculation above as 29% and 15%, respectively. (Yes, p-value is another statistical term.) These p-values are fairly easy to interpret. In this case, 29% is the probability that Alpha = 2.1% is due to random chance, and the 15% is the probability that Beta= 0.37 is due to random chance. Put another way, we can say that Alpha = 2.1% and Beta = 0.37, but there is a chance (29% and 15%) that, in fact, we are wrong and that these value should be zero. So, the smaller the p-values, the greater confidence we have that these are the correct values and have minimal estimation error.

So What?

These results show that the ETFMathGuy Aggressive Portfolio is generating positive Alpha, and isn’t overly sensitive to the market. However, more data is needed to provide stronger evidence that these results are not simply due to luck. We hope you will continue to check back to see how the ETFMathGuy portfolios perform for the rest of 2020. And, for those who are premium subscribers, the September portfolios are now available, which includes a new calculator at the bottom of the page to further aid in portfolio re-balancing decisions.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Will this stock market rally continue?

As recently discussed in this Wall Street Journal article, there is a deep suspicion on the future of this current stock market rally. In this article, we discuss what this rally looks like in various market segments. We will close on how our ETFMathGuy portfolios have performed so far this year.

The state of our economy

Most investors would agree that the economy is not doing well. Unemployment is high and our GDP (Gross Domestic Product) is shrinking at record levels. However, the Federal reserve has acted quickly and significantly. Also, congress has provided significant economic stimulus. Consequently, we have a stock market, as measured by the S&P 500 total return, up 3.5% year to date. But, not all segments of the market are behaving the same.

Below is a chart similar to the one we wrote about previously, where real estate was lagging the overall market. In that post, we also highlighted that the top 5 companies in the S&P 500 were focused on technology, helping the performance of the S&P 500.

Stock market total returns, year to date. Source: www.ETFreplay.com
Stock market total returns, year to date. Source: www.ETFreplay.com

As this chart shows, real estate is still down about 10% year to date, as measured by the iShares Dow Jones Real Estate REIT ETF. (ticker: IYR). However, the energy sector, as measured by U.S. Energy Sector SPDR ETF (ticker: XLE) is down nearly 38% for the year. Given few people are travelling much these days, we shouldn’t be surprised to see the energy sector prices behaving this way. Alternatively, the technology sector, as measured by the U.S. technology sector SPDR ETF (ticker: XLK) is doing very well, with a 21% total return year to date. Again, this is not surprising to many investors. The demand for many forms of technology is high in order to support workers in our economy working remotely.

ETFMathGuy Portfolios

We build ETFMathGuy portfolios to respond to market dynamics by analyzing daily price returns, variance and covariance over a historical period chosen from our backtesting. We build these portfolios from segments of the market not typically considered, but also exclude ETFs that are not sufficiently liquid. Our cumulative year to date total returns appear below.

Year to Date Total returns of ETFMathGuy Portfolios Through July 31, 2020.

As this chart shows total returns each month for this year, the ETFMathGuy portfolios are succeeding in reducing risk. These portfolios are also continuing to outperform the stock market. If you would like to see how this performance was possible, remember that we analyze over 2,000 ETFs to find assets that maximize returns for the levels of risk chosen. We encourage free subscribers to review the portfolios published earlier in the year, including April and May. Premium subscribers can now view the latest portfolios, based on market data through July 31, 2020.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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S&P 500 had a great month but market volatility remains

The S&P 500 had its best month since January 1987, returning 13%. However, investors in this stock index still have a long way to go before posting a gain for 2020 due to market volatility. Through the end of April, the year-to-date total return of the iShares Core S&P 500 ETF (ticker: IVV) is -9.4%. The portfolios from ETFMathGuy continued to outperform this index, as shown below. Free subscribers can now view both the April portfolios and the January through March portfolios. At this time, we only restrict current month portfolios to paid subscribers.

ETFMathGuy Moderate and Aggressive Portfolios continue to outperform total returns of the S&P 500
ETFMathGuy Moderate and Aggressive Portfolios continue to outperform total returns of the S&P 500

How is volatility doing?

This large return of the S&P 500 in April could be perceived as an indication of a new bull market. After all, the S&P 500 is up well over 20% from its lows in March. The chart below shows how a $100,000 investment in the S&P 500 would have performed since the beginning of the year. This chart clearly shows a “bounce”. But, it is not clear if this trend will lead to a recovery or more market volatility.

Year-to-date price changes of $100,000 investment in iShares Core S&P 500 ETF (ticker: IVV)
Year-to-date price changes of $100,000 investment in iShares Core S&P 500 ETF (ticker: IVV)

Updated Market Volatility

In a previous post, we discussed how market volatility is common during big market corrections, like the one we experienced this year. About a month ago, volatility was over 70%, and today it is 55.6%. You can keep track of volatility using our new market volatility monitor, which updates daily. Notice that while volatility is going down, it is still far from its long-term historical average of about 13%.

Market volatility remains high, relative to the long-term historical norm of 13%
Market volatility remains high, relative to the long-term historical norm of 13%

When will markets be “back to normal”?

What does this all this mean? We interpret this current high volatility, relative to historical norms, as an indication that markets are still struggling with the price discovery process. Consequently, we suspect it will take the markets more time to properly price the uncertainty of the economy recovering from the coronavirus. Ideally, we would like to see volatility below about the 95th percentile of those seen historically since 2001, which means a volatility below 40%. However, when that will occur is anyone’s best guess.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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January 2020 portfolios had a strong start

With the first month of the year now passed, we reflect in this post on the returns of our January premium portfolios. With over 2,000 ETFs analyzed, we expected greater opportunity for growth from a diversified portfolio. This past month of January 2020, we realized this opportunity.

The premium portfolios

At the close of Monday, January 6th, we purchased two optimal portfolios. The first used a taxable account at a moderate risk level. Then, the second used a Roth IRA using an aggressive risk level. We describe moderate and aggressive risk portfolios in our portfolio construction process.

These portfolios, published on ETFMathGuy on Sunday, January 5th, appear below.

The January ETFMathGuy moderate risk portfolio for taxable accounts.
The January ETFMathGuy moderate risk portfolio for taxable accounts.
The January ETFMathGuy aggressive risk portfolio for IRA accounts.
The January ETFMathGuy aggressive risk portfolio for IRA accounts.

The returns from the premium portfolios

Thus, there were 19 daily returns, from January 7th through January 31st. Over that time, the moderate portfolio returned 4.6% and the aggressive portfolio returned 5.72%. Over that same time period, stocks (measured by the S&P 500 ETF, ticker IVV) returned -0.6% and bonds (measured by the Barclay’s Aggregate Bond ETF, ticker AGG) returned 1.5%. Therefore, these results are consistent with previous academic research.

“The conclusion of the research clearly advances the case of ETFs. Individual investors cannot afford to ignore these potential portfolio enhancing instruments. This is in part because of the fact that some of the ETF-only strategies are made possible by providing exposure to asset classes previously virtually unavailable…”

DiLellio and Stanley (2011), “ETF trading strategies to enhance client wealth maximization”, Financial Services Review. Vol 20, pp. 145-163.

In conclusion, the January 2020 returns from the premium portfolios exceeded their benchmarks. But, will this excess return persist? Please watch for future posts which will continue tracking the performance of the ETFMathGuy premium portfolios in 2020.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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2019 ETF Returns

Where will the global economy take us in 2020? To consider this question, we thought it would be helpful to review 2019 ETF returns. So, we devoted this post to highlight the 2019 returns among the major ETF categories.

So many ETFs to pick from…

In 2019, there were over 2,000 ETFs available to investors. Unfortunately, thinly traded and limited return history ETFs represented many of these. Thus, to focus on only the most major asset classes represented by ETFs, we chose to only review the 59 ETFs currently managed by Vanguard. Then, we broke the list into two obvious groups.

  1. Equity or stock-based ETFs
  2. Fixed income or bond-based ETFs

Equity ETF Returns

Vanguard offered 41 equity-based ETFs in 2019. Including dividends, the image below sorts their total returns for 2019.

Total Returns of Vanguard's Equity ETFs in 2019
Total Returns of Vanguard’s Equity ETFs in 2019

As this image clearly shows, our benchmark S&P 500 index ETF had a total return of 31.4%, making for an excellent year. In fact, it was the best annual return for this ETF since its inception in 2010.

But, there were other broad-based equity ETFs that did even better. The best performing one was focused on information technology. Other top performers included growth ETFs distributed across, small-cap, mid-cap and mega cap indices. And, a newer investment trend we’ve written about before also emerged as a leader: Environmental, Social and Corporate Governance (ESG) in the U.S.

Returns from Information Technology Firms led the markets in 2019
Returns from Information Technology Firms led the markets in 2019

On the other end of the return spectrum, the energy sector lagged the S&P 500 by the greatest amount. Other noteworthy groups of ETFs tracked by Vanguard that also lagged the S&P 500 were as follows.

  1. Value and dividend-oriented ETFs
  2. International, both developed countries and emerging markets
  3. Many industry sectors (real estate, industrials, consumer discretionary and staples, utilities, materials health care)

Fixed Income ETF Returns

Fixed income ETFs also had a very good year in 2019. Using the total bond market ETF as a benchmark, fixed income ETFs returned 8.8%

Total Returns of Vanguard's Fixed Income ETFs in 2019
Total Returns of Vanguard’s Fixed Income ETFs in 2019

The leaders in the bond market in 2019 were those that held riskier bonds, like those from corporations vs. the U.S. government. Fixed income ETFs with longer maturities also led the bond markets in 2019.

Conclusions on 2019 ETF returns

We hope you found this review of stock and bond ETF returns from 2019 helpful. Interested in using the Vanguard ETFs in a 2020 diversified portfolio? If so, please check out our Free Optimal Portfolios for 2020 for some ideas. Or, if you are seeking a diversified portfolio that analyzes over 2,000 ETFs (including those from Vanguard), please review our Premium Optimal Portfolios for 2020.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Happy New Year from ETFMathGuy!

Happy New Year! To start this year, we made some significant updates to our services. Hopefully, you will find these updates useful as you evaluate your ETF investments.

New Menu Options To Access Optimal Portfolios for 2020

We have reorganized the menu at the top of ETFMathGuy.com to provide access to the 2019 and 2020 portfolios. You can still find them under the heading “Current Portfolios“.

We have also created two options for the 2020 portfolios. The first option is labeled “Free Optimal Portfolios for 2020”, and is accessible to all free subscribers of ETFMathGuy. It provides optimal portfolios generated each month using only Vanguard ETFs. So, please check out the January portfolios posted earlier today, and also now available to download for offline review. These portfolios are an excellent way to minimize expense ratios associated with ETFs, while keeping the number of ETFs in a portfolio to a minimum.

New menu options to access the 2019 and 2020 Optimal Portfolios
New menu options to access the 2019 and 2020 Optimal Portfolios

The other option is the “Premium Optimal Portfolios for 2020“. This option takes advantage of other parts of the financial market that Vanguard ETFs don’t reach, and analyzes over 2,000 commission-free ETFs. As a result, these portfolios are only accessible to premium subscribers. Like the free portfolios, they are also available for download.

All 2020 portfolios are available to download as PDF files.
All 2020 portfolios are now available to download as PDF files.

New Subscription Options

If you are interested in accessing the premium portfolios, we provide two payment options. As shown on the “Join Us” page, you can select either monthly or annual billing. Also, we accept credit card payments through our payment processor Stripe.

Price: $9.95 / month

Want to save over 30% on your monthly subscription each year? Then, consider paying once per year!

Price: $79.95 / year

Don’t want to upgrade your subscription? Well, that is not a problem. You can continue receiving our periodic commentary, access the free portfolios, and continue to test out our new interactive retirement income calculator.

Wishing you a wonderful 2020!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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More ETFs trading commission-free

The year of 2019 has seen a dramatic shift in the costs to trade ETFs. There are now four discount brokers who offer nearly all ETFs commission-free, including Ameritrade, Fidelity, Schwab and Vanguard. But, as we’ve discussed previously, investment returns depend on another cost too. We discuss this other cost here, and suggest alternatives to help minimize it.

How many commission-free ETFs are there now?

There are many ETFs available today covering broad and narrow aspects of the market. According to my favorite screener at ETF.com, and excluding leveraged and inverse ETFs, there are 2,052. That is a lot of choices for any investor to consider. Here at ETFMathGuy, we prefer optimal portfolio construction. That is, selecting ETFs that compliment one another in a diversified portfolio. Prior to this construction, we also screen ETFs to ensure each portfolio avoids ETFs with (i) low volumes and (ii) short track records.

The other cost: the bid-ask spread

The hidden cost of buying and selling an ETF is the bid-ask spread. So, investors should conduct some due diligence to reduce this cost whenever possible. Based on the latest data from ETF.com, we constructed the chart below. As it shows, thinly traded ETFs or ETFs that have less-liquid underlying securities still persist in about 10% of ETFs available today. Fortunately, a little more than half of ETFs have a bid-ask spread under 0.15%.

Number of ETFs and their bid-ask spreads, as of November 2019.
Source: ETF.com’s ETF Screener & Database

Conclusions

Commission-free ETFs are good news, as they reduce the cost of investing in ETFs. However, care should be taken to avoid other costs, like the bid-ask spread. To help avoid this cost, investors should seek more liquid ETFs with lower bid-ask spreads, or find ways to trade less frequently. In any case, commission-free doesn’t mean there are no transaction costs, and investors would be wise to choose their ETFs with care.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.