Download KCR-Presentation-Final_a

Portfolio Construction:
The Trader’s Portfolio
Patrick Berch
Portfolio Manager/Registered Investment
Advisor Representative
1
To present one method of portfolio construction and things to
consider when doing so
Discuss the use and value of multiple asset classes
Things to consider in portfolio construction:
•
Low correlation
•
Diversification in strategy
•
Diversification in periodicity
•
Position sizing assumptions
•
Long/short/cash
2
First, ask yourself, “Do I have any?” If so, then how do they
effect the way I trade? Beliefs…what are they?
Extreme Diversification – Most investors are too heavily
allocated to stocks/bonds and US-centric
Long/Cash/Short – One needs the ability to make money in
down markets
Market Timing – There's a time to be long (bullish), short
(bearish), and cash (neutral) as many asset classes as possible
Active, Not Passive – You cannot control investment risk by
doing nothing
3
Most investors have stock mutual funds, maybe
a little exposure to bond and developed country
international mutual funds
4
 [typical portfolio in financial crisis]
5
6
Previous chart shows "diversified" portfolio is not as diversified as one may
think
Correlations of 0 are ideal, but non-existent; between -70% and +70% are
acceptable. High correlations <-0.70; >+0.70
Bottom line: we need to choose asset classes much less correlated with
each other
7
Maximizing risk-adjusted returns is the objective of the AllAsset Portfolio. What are your objectives? Maybe you don’t
need to maximize but hit a minimum of X%.
We define risk-adjusted return as annual return divided by
risk, where risk is defined as maximum drawdown
Drawdown is the loss in portfolio value from peak to trough,
ex. October 2007 to March 2009, the S&P 500 had a
drawdown of 55.25%
8
 [typical portfolio in financial crisis]
9
10
Long/Cash is better than buy-and-hold
Long/Cash/Short is ideal
Each of our systems have the ability to be
Long/Cash/Short depending on market conditions.
11
 [typical portfolio in financial crisis]
12
Because the global economy is cyclical, so are the
prices of different asset classes
Also, because the global economy is cyclical, there's a
time to be bullish, a time to be bearish, and a time to
be neutral each and every asset class
Market timing is not picking tops and bottoms to the
exact tick; it's simply putting odds in your favor
Are the odds in your favor being long (bullish) bond
prices when interest rates are going up? Hint: No. So
why be in bonds when rates trend up?
Do not hold an asset class simply because it adds
"diversification" - only if it adds value – i.e., long if
bullish; short if bearish
13
14
A combination of 6 market-timing systems. And
they’re not even that great!
Systems applied to 6 disparately correlated asset
classes.
The systems employ multiple timeframes improving
diversification.
Each systems is Long/Cash/Short.
15
16
The gold system outperforms buy-and-hold gold by over 4% annually with over 14% less
drawdown.
17
The REIT system outperforms buy-and-hold REITs by 7.5% annually with over 41% less
18
drawdown.
The US dollar system outperforms buy-and-hold US dollar by over 2% annually with
19
over 18% less drawdown.
The S&P 500 system outperforms buy-and-hold S&P 500 by almost 15.72%
annually with over 43% less drawdown.
20
The High Yield system outperforms buy-and-hold High Yield by 0.6% annually and
21
has a 11.78% less drawdown giving it a much better risk adjusted return.
The bond system has underperformed buy-and-hold bonds by 0.10% annually with
1.78% greater drawdown – note bonds have only been in a bull market during the
22
test period.
Five of the six systems had higher annual returns than
their buy-and-hold counterpart. Note that bonds were
only in a bull market during the test period.
All six systems have a lower drawdown than their buyand-hold counterpart.
Therefore, all six systems have a better risk-adjusted
return than their buy-and-hold counterpart.
What happens when you combine these systems into
one portfolio?
23
24
The worst drawdown of any individual system is 32.22%; for the total portfolio, though, it's only -9.95%
Because of this, weighted average risk-adjusted return
of individual systems is 46.98; but for the total
portfolio, it's 130.
Why? Each system experiences its worst drawdown at
different times.
25
26
27
Average number completed trades per year = 34.5;
that's 69 buys and sells per year, or roughly 5 actions
per month on average; we're active; average $37.68 in
commissions per year.
Winning % = 64.5%; it’s not always right!
Average win is 15.07% - but this is both longer-term and
shorter-term systems.
Average loss is 3.50% - again, an average of both longerand shorter-term systems.
When we're right, it's usually a decent gain; losses are
controlled.
28
All-Asset Portfolio (AAP) is a trend following system –
usually a few (or more) asset classes are trending at any
given period of time. Relative Strength is a key
component to overall return.
Each of 6 disparately correlated asset classes are timed
so that we are Long/Cash/Short in each.
In other words, extreme diversification, Long/Cash/Short
investing, market-timing and active management are all
employed in the AAP.
29
Extreme diversification allows for a more robust portfolio – helps
reduce drawdowns
Long/short and long/cash systems allow the portfolio to adapt to
changing trends – helps increase returns and reduce drawdown
AAP is not dependent on any one type of market environment –
can thrive in any environment; helps produces consistent gains
over time
AAP gives the investor exposure to asset classes they may not
otherwise have exposure to – a higher likelihood of finding
"what's hot"
End result is opportunity with double-digit annual gains, limited
drawdowns, and higher level of consistency of returns than
typical investment portfolios
30
The All-Asset Portfolio (AAP) is a portfolio of model systems developed by Patrick Berch with Butler, Lanz and Wagler. The
model performance presented has been back-tested and is strictly hypothetical. The performance was gathered using
historical data obtained from yahoo finance, Reuters DataLink, and TradeStation. The information received from these third
party sources, as well as the calculations made in constructing model performance, is believed to be reliable, but we cannot
guarantee its accuracy or completeness.
The AAP is an actively managed strategy and consists of the following asset classes: US and emerging market stocks, high yield
bonds, US Treasury securities, REITs, the US dollar, commodities and gold. Each of the markets systems are part of a longshort-cash model. The following securities were used to execute trades in the portfolio's historic performance construction
and are currently used in the portfolio's trading activity: Rydex Commodities (RYMBX), Rydex Banking (RYBKX), Rydex
Biotechnology (RYBOX), Rydex Electronics (RYELX), Rydex Energy (RYENX), Rydex Financial Services (RYFNX), Rydex Healthcare
(RYHEX), Rydex Internet (RYINX), Rydex Leisure (RYLSX), Rydex Precious Metals (RYMNX), Rydex Technology (RYTHX), Rydex
Telecommunications (RYTLX), Rydex Transportation (RYTSX), Rydex Utilities (RYUTX), Rydex High Yield (RYHGX), Rydex Inverse
High Yield (RYIHX), Rydex Real Estate (RYHRX), ProFunds Short Real Estate (SRPIX), iShares MSCI Emerging Markets Index ETF
(EEM), SPDR Gold Trust ETF (GLD), Deutsche Bank AG DB Gold Short ETN (DGZ), Rydex Series Trust Inverse S&P 500 Strategy
(RYARX), iShares Barclays 20+ Year Treasury Bond ETF (TLT), ProFunds Rising Rates Opportunity Fund Inverse (RRPIX), ProFunds
Rising U.S. Dollar Fund (RDPIX) and ProFunds Falling U.S. Dollar Fund (FDPIX). Where system trading signals were generated
prior to the above funds' inception dates, proxies were used - either comparable securities or the underlying index itself.
Securities held at any given time are completely a function of the timing system for each asset class. The portfolio is
rebalanced on an annual basis. Asset classes are added to the model as they became available. Not all asset classes were
available in 1989.
The AAP was developed by retroactive application and is used solely to illustrate what performance would have been had the
portfolio been created on May 31, 1989. The AAP performance results take into account expected time-weighted rates of
return, the reinvestment of dividends and other account earnings. AAP's performance results take into account, and are
therefore net of investment management fees, commissions charged on trades, and the fees assessed directly by each
unaffiliated mutual fund and/or exchange-traded fund holding that comprises the AAP. An investment management fee of 2%
has been used to show the net-of-fees performance. The reinvestment of dividends and other earnings may have a material
impact on overall returns.
31
Because the model results are hypothetical they have inherent limitations due to the fact that they do not reflect actual trading and may
not reflect the impact that material economic and market factors might have had on decision-making if actual clients had been invested
in the model strategy. No matter how positive the model returns have been over any time period, the potential for loss is always present
due to factors which may not be accounted for in the model. The nature of a back-tested model creates the potential for a financial
professional to select superior performance results in order to get the desired model results. All economic and performance information
is historical and not indicative of future results.
Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific
investment, investment strategy, or product made referenced to directly or indirectly, will be profitable, equal any corresponding
indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or
information provided here serves as the receipt of, or as a substitute for, personalized investment advice from BLW or any other
investment professional. Further, the charts and graphs contained herein should not serve as the sole determining factor for making
investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your
individual situation consult your investment advisor.
All performance results have been compiled solely by Patrick Berch, are unaudited, and have not been independently verified.
Use the information provided in this presentation at your own risk. I or any organization that I affiliate with are not responsible for any
losses incurred. Do your own due diligence. I would be glad to discuss the methods presented here with anyone.
32