The system’s parameters are straightforward. An investor chooses or designs a portfolio and decides what percentage of the total value of the portfolio he will devote to each instrument.
He then re-balances the portfolio at regular, predetermined dates to maintain the chosen fixed ratio of instruments within the portfolio.
The HCA Fixed Ratio System can be used to back test such an investment program over historic data and to place orders for the portfolio at the chosen re-balance dates.
After constructing his portfolio, the user can choose whether to re-balance the system daily, weekly, monthly, quarterly, or annually.
The key component of successful investment over the long term, is to spread a portfolio over a wide range of instruments and asset classes. And simply to take what the market gives. Many investors choose index tracking ETFs for this purpose. Others might choose ordinary stocks or mutual funds.
Investors are bombarded with clever sounding investment schemes from a myriad of financial advisors. Those who have studied the market for long enough, will realise that the great majority of products offered by the fund management industry are an expensive waste of time and money. And that a simple, well thought out, balanced portfolio of index trackers will inevitably outperform almost all active fund management in the long term.
An investor might decide (by way of example) to spread his investment 40/60 in favour of bonds, and to include instruments not just from his own country of residence, but from world markets. He might wish to add commodities as an inflation hedge or a safe-haven investment.
Such a portfolio might be made up as follows:
Re-balanced monthly, the HCA Fixed Ratio System shows that such a portfolio would have recorded the following performance since January 2016:
Note that the above statistics and many more are calculated for you by HCA. Additionally, a small sample of the chart output generated by HCA for this back test is shown below:
As can be seen, the trade off with such a portfolio against the benchmark (SPY – the S&P 500 index tracking ETF) is a lower absolute return. But this is compensated (in this back test at least) by greatly increased protection against peak to valley drawdown far less volatility. Lower volatility is usually taken to mean lower risk, and certainly makes for less anxiety during the inevitable periods of market turmoil.
The beauty of HCA is the ability to explore, effortlessly, different portfolios and different re-balancing periods. And then to have the software executes the trades on your live account, should you so choose.
An informed an educated investor is likely to want to explore the historic performance of a proposed portfolio. He will find scant help among the cherry picked information available from the financial services industry, which inevitably suffers from selection bias. Underperforming funds are closed, and the performance data disappears from public view. Fund managers show only their more successful funds which can often hide a string of failures and underperformance.
HCA is the ideal tool to evaluate (at least as regards past performance) investment ideas such as Harry Browne’s Permanent Portfolio.
Harry Browne was an American investment advisor and politician, who wrote 12 books on investing. His Permanent Portfolio was one of the family of “all weather” asset allocations, which seek to invest fixed percentages of a portfolio in different instruments to reflect and benefit from the different investment climates prevailing over time.
Harry’s recommendation was to structure a portfolio as follows, and to re-balance the investments once a year to maintain the fixed ratio between the different assets:
HCA calculates the following statistics for Harry Browne’s Permanent Portfolio since January 2016, re-balanced annually:
Here is a selection of the charts provided by HCA for this back test of Harry Browne’s Permanent Portfolio:
As you can see, in this back-test Harry’s Permanent Portfolio has outperformed the 40/60 portfolio we designed above, in both absolute terms and relative to volatility and draw-down.
How should we interpret this performance?
Well for a start, how diversified is Harry’s Portfolio in reality? The allocation to gold is a big one but historically gold has provided a good investment in a crisis, as capital runs for safe havens. Whether that will continue to be the case is anyone’s guess, but gold has been a staple investment for many thousands of years and remains in demand for industrial purposes.
What of a stock allocation limited to the US market only?Some may look askance at this. The US stock market currently constitutes some 55%of world stock market capitalisation but its outperformance and dominance is unlikely to continue indefinitely. Look what happened to Japan, which in the 1980s represented some 40% of world stock market capitalisation and now accounts for a mere 8%. And as to bonds,again is it entirely appropriate to restrict investment to the US Government?There are other credit worthy governments in the world issuing bonds in a number of different currencies. If true diversification is sought, then how wise is it to restrict the portfolio to the US? Or to the US Dollar?
Ray Dalio is an American billionaire who founded the hedge fund manager Bridgewater Associates in New York in 1975. Bridgewater went on to become the world’s largest hedge fund group in terms of assets under management with $160 billion of investors’money.
The All Weather Portfolio at Bridgewater is designed to weather any storm. Which is of course the object of any diversified and well-balanced portfolio.
In Dalio’s case, he argues that there are four basic factors which affect asset values:
· Rising economic growth.
· Declining economic growth.
He sees four different investment climates:
· Higher than expected inflation.
· Lower than expected inflation.
· Higher than expected economic growth.
· Lower than expected economic growth.
To weather such climates, a portfolio might look something like the following:
Bridgewater’s portfolios will be more complex. Bond holdings will include UK Gilts and bonds of differing maturities from other sovereign issuers, as well as corporates. Leverage will be used to increase the return from bonds, using futures and financing from prime brokers. Commodities may include exposure through the futures market and through physical holdings. Individual stocks will be held. A host of different techniques will be employed but a portfolio like the above perhaps captures the essence of Bridgwater’s “All Weather” gospel.
At the very least, such a portfolio provides another example of diversification, undoubtedly the best way to protect a portfolio from the vagaries of an unknowable future. Wide diversification is the best investment technique we have, and thanks to pioneers like Vanguard and iShares, we have the tools to build portfolios spread widely over asset classes and world markets.
Never has investing been easier or cheaper.
HCA calculates the following statistics for Ray Dalio’s AllWeather Portfolio since January 2016, re-balanced quarterly:
Here is a selection of the charts provided by HCA for this back test of Ray Dalio’s All Weather Portfolio:
Stock picking and active fund management have been shown to underperform their given benchmarks. Furthermore, active funds usually charge considerably more than index trackers. Hedge fund strategies have severely disappointed in recent years and that particular emperor has been shown to have no clothes.
While it is true that a small number of high frequency trading funds have recorded spectacular returns for many years, such a strategy is not available to any but a small handful of traders with the skills and resources to compete in this arena. Even then, given increasing competition and changing markets, such out performance may not continue.
The canny investor has long turned away from active fund managers managed his own investments using index trackers.
An investment in an efficient and well-priced index tracking fund ensures that the investor gets what the market gives. Both in terms of capital growth and dividend payments.
A stock portfolio is an investment in the economy, in human enterprise and ingenuity. A stock index includes up and coming stocks; once those stocks reach their zenith and eventually decline, the stock is dropped from the index. Thus, an investor is always invested in the best instruments within a market segment.
Bonds are the natural and lower volatility counterpart to equities. High quality bonds have historically been negatively correlated to stocks and thus gain in value at a time when such protection is most needed – at times when the equity market is in freefall. 90% of the return from bonds is from the coupon (the interest payment) and thus over time, one cannot expect to benefit from price appreciation or suffer from falling bond prices. In an orderly interest rate environment, falling bond prices are relatively swiftly compensated for by higher interest payments.
Commodities may provide some protection from inflationary environments and precious metals have historically formed a useful safe haven in times of political and economic crisis. Some investors deem commodities an important and often uncorrelated addition to their portfolios.
A widely diversified portfolio of stocks, bonds (and, possibly commodities) can be easily and cheaply constructed using index tracking funds, and over the long term such a portfolio highly probably represents the most efficient and practical way to capture the growth of the world economy.
The HCA Fixed Ratio System allows an investor or his advisor to explore different portfolios and allocations within a portfolio. While a back test can only relate to past performance, it may be combined with financial good sense to hazard a guess as to what the future may hold for a particular combination of assets.
In addition, once a portfolio is chosen, the HCA Fixed Ratio System can be switched to Live Mode and will undertake the necessary trades in an investor’s account.
Note that HCA is a provider of software only and does not give investment advice. The metrics seen in any back test are unlikely to hold good for any future period and a wise practitioner uses back testing for guidance only.
Any decision to invest should be based upon sound economic and financial principals, and appropriate financial advice from a registered investment advisor should be obtained.
Learn about algorithmic trading and strategies, through
zipline backed research, backtest, and live trading.
When live streamng, ask questions...get answers...live!