Tag: 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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2020 Mid-year Review by ETFMathGuy

The coronavirus pandemic has made for an interesting year so far in the financial markets. So, we chose to focus this post on a 2020 mid-year review of market volatility and returns.

Let’s begin by looking at the stock (equity) and bond (debt) markets. The time series below shows the significant volatility in both markets. The green line is the total return of the iShares Core S&P 500 ETF (ticker: IVV). The blue line is the total return of the iShares Core U.S. Aggregate Bond ETF (ticker: AGG). Notable, for the second quarter of the year, the S&P 500 had its biggest return since 1998. Unfortunately, the S&P 500 total return (including dividends) is still down for the year.

Year-to-Date Returns

The year-to-date total returns for the stock and bond market appear in the next figure. Alongside them, you can see the total returns of the ETFMathGuy Moderate and Aggressive portfolios. We found these portfolio returns by reviewing my account balances, so they represent returns that include portfolio turnover and the bid-ask spread from actual trades. However, they do not include the effect of taxes. Like many individual investors, I won’t file my 2020 returns until early next year.

Both portfolios continued to outperform the total return of the S&P 500. Premium subscribers can now access the July 2020 portfolios. Free subscribers are invited to review previous month portfolios. We also encourage free subscribers to upgrade their subscriptions to enable access to the portfolios built from the latest market dynamics.

Year-to-date returns through June 2020 for the stock market, bond market and ETFMathGuy Portfolios

Market Volatility

Stock market volatility continues to trend down, but is still higher than historical norms. Current volatility is 27.7% using our market volatility calculator that updates daily. Thus, over the last month, the volatility has come down from the 96th percentile to the 90th percentile, based on historical norms.

Stock market volatility continues to trend down, but still higher than historical norms.

We interpret this lower volatility as the markets reaction to less uncertainty about future economic growth. But, as the chart shows, we are still in a time of elevated uncertainty.

We hope you find this 2020 mid-year review educational as your consider your investments in the second-half of 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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Market Volatility Continues to Decline

Declining market volatility continued in the month of May. Also, the S&P 500 had a very good month, returning 4.8%. However, the broad-based index is still down 5.0% for the year, including dividends. The chart below updates the returns from last month for returns through May 29, 2020. As these results show, the ETFMathGuy Moderate and Aggressive portfolios continued to outperform the S&P 500. The premium portfolios for April and May 2020 are now available to all subscribers. The latest premium portfolios for June 2020 are available to paid subscribers.

Year-to-date returns through May 2020 for the stock market, bond market and ETFMathGuy Portfolios
Year-to-date returns through May 2020 for the stock market, bond market and ETFMathGuy Portfolios

Markets returning to normal?

The declining market volatility suggests that the fear in the markets continued to subside in May. However, they are still elevated above their long-term historical average. The image below shows the volatility from our daily monitor that tracks the S&P 500 ETF (ticker: IVV). We determine the standard deviation of daily returns over one, two and three month periods, and report an average to find a daily value. As of Friday, May 29th, volatility was 37.8%, as shown below.

Stock market volatility is still high, be is now well below its recent peak over 70%.
Stock market volatility is still high, be is now well below its recent peak over 70%.

Market Volatility Still Higher than Normal

Analyzing over 5,000 trading days since mid-June 2000, we can see how “out of the norm” current volatility really is. The table below shows the distribution of volatility over this nearly 20-year time period. As this table shows, we are still in the 96 percentile of volatility, meaning only 4% of the days since mid-June 2000 exhibited higher volatility then on May 29th, 2020.

Stock market volatility is still very high, by historical standards.

Stock markets returning to “normal” can be very subjective. The table above can provide a more objective perspective to such an assessment. However, if the downward trend continues, it may not take much longer before volatility returns to its long term historical norm.

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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S&P 500 down about 20% in the First Quarter of 2020

It was a difficult year so far for many investors. The total return of the iShares Core S&P 500 ETF (ticker: IVV) was -12.1% for the month of March. The total return of IVV in the first quarter 2020 was -19.6%. Such large losses often shake investor confidence. Also, the math is against you now. To recover from the 20% loss, a investor needs a 25% gain. If losses hit 40%, then an investor needs a 67% return to get back to where they started. And, if losses reach 50%, an investor needs a 100% return, or double their money, to recover all their losses. This is the unfortunate math behind compounded gains and losses.

The recovering from a large market loss can be challenging due to the effect of compounding
Recovering from a large market loss can be challenging due to the effect of compounding

How did the ETFMathGuy portfolios do in First Quarter 2020?

Using my account balances at the end of March, I measured my investment returns for the first quarter. For the Moderate Portfolio in my taxable account, my first quarter return was -5.0%. My Roth IRA used the Aggressive Portfolio and had a first quarter return of -2.1%. These returns far exceeded the S&P 500 in this first quarter. So, we are pleased with these results, which were supported by the backtesting we used to tune our optimization methodology.

Total Returns for the First Quarter Using Taxable and IRA Accounts
Total Returns for the First Quarter Using Taxable and IRA Accounts

Why is there such a large difference between the moderate and aggressive portfolios? The biggest driver was the moderate portfolio’s exposure to the municipal bond market. The aggressive portfolio did not include municipal bond ETFs, since it operated within an IRA. Please, look for yourself at the premium portfolios that produced these returns, which are now available to all free subscribers.

Measuring Volatility

We’ve added a new feature to the ETFMathGuy site to track the daily stock market volatility. Using the first ETF ever created, the SPDR S&P 500 ETF Trust, we developed an average of one, two and three month annualized volatility. At the end of this week, volatility was 70.6%, which is well above its median value of about 13% over the last 20 years.

Current stock market volatility hasn't been seen since the financial crisis of 2008.
Current stock market volatility hasn’t been seen since the financial crisis of 2008. Click this image to see the latest volatility, updated daily.

The last time volatility reached this level was the 2008 financial crisis. Then, volatility peaked at 77.8% on November 24, 2008.

In our next post, we will discuss using volatility to potentially detect market trends. Before then, you may want to read this article on on tips for investors in volatile markets.

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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Diversification and February 2020 returns

The stock market experienced a significant drop in the month of February 2020. But, the bond market had a positive total return for the month. In this post, we discuss the benefits of a diversified portfolio during times of market stress, like seen in the February 2020 returns.

A big economic shock

Market returns for the the month of February 2020 were significantly impacted by the corona virus outbreak affecting the global economy. The S&P 500 index ETF (ticker: IVV) lost 8.5% in the month, but the iShares Core U.S. Aggregate Bond ETF (ticker: AGG) gained 1.6%. The stock market appears to be pricing in reduced earnings growth, due to the virus outbreak. Consequently, stock market sellers have rotated their investments into the bond market. Increased demand for bonds is driving up prices, and consequently returns, from bond investments.

The graphic below shows the total returns for the stock market, bond market, and two other portfolios for February, 2020.

Stock, bond and other portfolio returns in February 2020

Using a diversified portfolio and February 2020 returns

In hindsight, the bond market offered a higher return in February 2020. But, exclusively investing in bonds eliminates the possibility of the significant upside potential of the stock market, such as the 31.3% of the stock market in 2019.

One approach to managing risk while realizing some additional return is to invest in a 50% stock and 50% bond portfolio. For February 2020, this would have led to a 3.4% loss. However, wider diversification beyond the mainstream stock and bond markets offered a more substantial benefit. Specifically, the ETFMathGuy’s moderate risk portfolio (shown in a previous post) appears below. It returned 0.1% in February 2020, and was designed to match the volatility of the 50% stock and 50% bond portfolio.

The January ETFMathGuy moderate risk portfolio for taxable accounts.

The additional return comes from our optimal portfolio construction. ETFMathGuy portfolios diversify across other asset and sub-asset classes beyond stocks and bonds using a quantitative methodology. For instance, the portfolio above contains municipal bonds, commodity and tech sector exposure, among others. This diversified exposure has been very favorable to returns so far in 2020. But, market conditions are very dynamic. So, if you are looking for ideas on how to improve your portfolio’s diversification, please check out our current free and premium portfolios, constructed using the latest market data.

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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.