The Top Tactical Portfolios Based On 29 Asset Allocation Approaches

To complement our analysis of strategic asset allocation portfolios, we studied a mix of tactical model ETF portfolios. This analysis looked at tactical models that 1) rebalance monthly according to risk and return metrics and 2) select ETFs each month from a fixed set of asset classes.

Our analysis compared 29 tactical portfolios on a risk vs. return basis. The tactical portfolios use different allocation approaches in the following categories:

  • Risk and volatility portfolios
  • Momentum (trend following) portfolios
  • Blended portfolios using risk and momentum

The Question

Here's the main question we wanted to answer:

Which tactical ETF model portfolios produce the best risk-adjusted return?

Our Approach

We tested the following 29 tactical allocation models over the past 10 years, using monthly data:

  • Adaptive Asset Allocation (4 portfolio variations using ETFs)
  • Mebane Faber's Momentum Portfolios (2 variations)
  • Equal Weight (2 variations)
  • Risk Parity (3 variations)
  • Maximum Diversification
  • Minimum Variance (3 variations)
  • Minimum Correlation
  • Maximum Sharpe Ratio
  • Equal Risk Contribution
  • Target Return 12%
  • Target Risk 10%
  • Maximum Drawdown
  • Minimum Downside Deviation
  • Minimum Mean Absolute Deviation [MAD] (2 variations)
  • Minimum Conditional Value at Risk [CVaR]
  • Minimum Conditional Drawdown at Risk [CDaR]

The algorithms, which determine each portfolio's allocation, use a variety of risk and return metrics. Each portfolio consists of ETFs chosen from a group of 9 asset class ETFs (DBCEEMEFAGLDIWMIYRQQQSPYTLT).

One of the Mebane Faber portfolios adds some additional asset classes (BNDSHYVNQIEFIGOVIWDIWFIWNIWO). As benchmarks, we also included a Balanced Portfolio (60% VTI, 40% BND), Aggregate bonds, S&P 500, and global equities (NASDAQ:ACWI).

For a high-level view comparing 10 of these tactical portfolios to 65 other asset allocations and famous active managers, see VizMetrics Report #vm03. This report contains a risk vs. return scatterplot comparing total return to maximum drawdown over the past seven years.

The Results

Figure 1 (below) plots the 29 portfolios plus the benchmarks on a risk vs. return scatterplot. The time period covered is Feb 2008 to Jan 2014. We believe using this 7-year period is important since it includes the drawdown in 2008-2009.

The risk metric we've chosen is maximum drawdown, which measures the worst peak-to-trough drop in total return over the 7-year period. This provides us a clear picture of how bad things got for each portfolio during the 2008 turbulence.

Here are some findings from Figure 1:

  • One standout allocation (#8 in Figure 1, indicated by the orange arrow) has returned over 17% per year. This portfolio is based on an Adaptive Allocation approach, which combines risk and momentum metrics in its allocation algorithm.
  • 27 of the 29 tactical portfolios have higher return and lower risk than the Balanced Portfolio (#4 in Figure 1, indicated by the purple arrow). These portfolios are shown in the green-bordered region in Figure 1.
  • The Adaptive Portfolios (in the orange rectangle) have returned over 12% per year and offer the best risk-return tradeoff.
  • Several portfolios using risk minimization tactics have returned over 10% annually with drawdown under 15% (#19 through #27 in the blue rectangle below).

For a PDF of this scatterplot with a complete list of all 29 portfolios, download VizMetrics Report #vm22, which is part of the VizMetrics Free subscription. This report also includes 1, 3, 5, and 10-year risk and return metrics.

Conclusion

The best tactical methodology over the past 7 years has been an adaptive portfolio (#8 in Figure 1, above) which produced a compounded annual return of 17.0% with a drawdown of 14.2%. This compares quite favorably to the S&P 500's annual return of 5.3% with 50.8% drawdown over the same period.

Nearly all of the tactical portfolios outperformed a Balanced Portfolio (#4 in Figure 1) and the S&P 500 (#2 in Figure 1). Several of these tactical portfolios produced returns above 10%. Despite the cost and effort to rebalance monthly, these portfolios could be worth a look for active investors and advisers.

Disclosure: I am/we are long EFA, IWM, GLD, TLT, QQQ, SPY, EEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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