Switching portfolio - 3-fund with slight tilt to Larry Porfolio

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zenb
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Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Mon Feb 13, 2017 7:53 pm

[updated to clarify intent of the thread]
Question about whether it is a wise strategy to move to LP portfolio in the interest of reducing risk for similar returns. Are there other portfolio design approaches that achieves goals similar to LP (reducing volatility).
[/updated]

Background:
Discovered this site 9+ years ago. Started of with a 3-fund portfolio initially, and since then evolved into 3-fund with a small tilt towards SCV, Emerging and REIT as a strategy to diversify across different stock fund types. In the 9 year period have gone from 100% stock -> 90/10 -> 80/20 (stock/bond).

I started looking into this topic because:
* In a decade our risk tolerance has changed significantly. Trying to find ways to go to a conservative mix to get to 50% in fixed income.
* Our current savings is roughly 3x our combined household income., and looking at another healthy savings rate for the next 10 years. So probably we can live with lower return on our savings.

LP
I came across discussions on SCV tilts, and 3-factor models., and read few books around it. Came across this article (http://www.etf.com/sections/index-investor-corner/22204-swedroe-factor-tilts-of-larry-portfolio.html) from one of the older posts in this forum. I did some back-testing on my current AA versus a probable LP portfolio (use portfoliovisualizer). Based on simulation results it appears that i can significantly improve diversification (sharpe ratio), reduce risk (50/50 stock/bond), have similar returns and simpler PF. This feels too good to be true.

The caveats being:
* the theory around "size", "vaue" hold into the future.
* backtesting is not far-enough in the past to eliminate single-decade bias. I also read few threads talking about Value tilt was non-factor between '40s-60s.

My current portfolio: (P1)
VIIIX Vanguard Institutional Index Fund Institutional Plus Shares 35.00%
VISVX Vanguard Small-Cap Value Index Fund 10.00%
VGTSX Vanguard Total International Stock Index Fund 20.00%
VEIEX Vanguard Emerging Markets Stock Index Fund 7.00%
VGSIX Vanguard REIT Index Fund 8.00%
VFICX Vanguard Intermediate-Term Investment Grade Fund Shrs 20.00%

LP portfolio: (P2)
VISVX Vanguard Small-Cap Value Index Fund 25.00%
DISVX DFA International Small Cap Value Portfolio 12.50%
DEMSX DFA Emerging Markets Small Cap Portf 12.50%
VUSTX Vanguard Long-Term Treasury Fund 50.00%

For backtesting from '99 - 2016:
# Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio US Mkt Correlation
1 $10,000 $33,601 6.93% 12.77% 30.94% -32.84% -47.16% 0.45 0.65 0.95
2 $10,000 $56,153 10.01% 9.14% 28.07% -8.81% -24.40% 0.90 1.40 0.67

Questions:
1. Though the numbers (sharpe ratio) for P2 says it has better diversification., not having all asset-classes in the portfolio doesnt feel diversified. Is P2 truly less risky than P1?
2. Is there a middle-path between 'diversification in traditional sense' and 'diversification in 3-factor model' -> is that similar to P1 or different?
3. What other factors should i research on before making any big decisions on moving from one model of Portfolio construction to another?
Last edited by zenb on Mon Feb 13, 2017 9:23 pm, edited 1 time in total.

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pezblanco
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by pezblanco » Mon Feb 13, 2017 8:47 pm

I'll let other experts weigh in but a couple of thoughts/questions:

1) Why use Vanguard for the US Small Value component if you have DFA access? The DFA fund gives higher loadings on those factors.

2) Equal weight on EM and International is not market weighting .... it's more like 50 - 37.5 - 12.5 for us-international - em or something like that

3) Are you ready to withstand the tracking error? .... behavioral economics says that you feel the losses (when Total Stock Market beats the LP) more than you enjoy the gains (when the LP beats the Total Stock Market).

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prudent
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by prudent » Mon Feb 13, 2017 9:17 pm

Topic moved to Investing - Help with Personal Investments

zenb
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Mon Feb 13, 2017 9:19 pm

pezblanco wrote:1) Why use Vanguard for the US Small Value component if you have DFA access? The DFA fund gives higher loadings on those factors.


Apologies should have been clear. I dont have DFA in my employer plan (where most of the money is)., and hence lack of DFA in current allocation. For Portfolio#2, used the DFA funds as i was just picking canonical examples for the portfolio. i need to find equivalent vanguard funds, if decide to adopt LP.

pezblanco wrote:2) Equal weight on EM and International is not market weighting .... it's more like 50 - 37.5 - 12.5 for us-international - em or something like that

agree, its not market weighed. i didnt see a huge difference in 'sharp ratio' with different mix. Keep it equal for simplification.

pezblanco wrote:3) Are you ready to withstand the tracking error? .... behavioral economics says that you feel the losses (when Total Stock Market beats the LP) more than you enjoy the gains (when the LP beats the Total Stock Market).

Yes. My current portfolio is relatively high on international developed and EM which under-performed as a segment for the past 2-3 years. That didnt bother me. But a sudden drop of 30+% in 2008 bothered me. That is the motivation for looking for mix that has low correlation to US market and higher sharpe ratio.

Elbowman
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by Elbowman » Mon Feb 13, 2017 9:24 pm

Two points:

1) I disagree with pezblanco and would in fact suggest the opposite. If I was doing the Larry Portfolio I would use:

VBR Vanguard Small-Cap Value
VWO Vanguard FTSE Emerging Markets

Keep costs low first and foremost, whatever other shenanigans you are trying to pull off :D

2) You are proposing 50% long term treasuries and you have only backtested to 1999?! That's like backtesting the S&P 500 starting at 2010. Test out how those bonds would have performed from 1968–1983.

zenb
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Mon Feb 13, 2017 11:11 pm

Came across another discussion around this topic 2 years ago: https://www.bogleheads.org/forum/viewtopic.php?t=145409, that addresses some of the questions i had. Didn't see any concrete ideas on how best to mix the 'asset-class' / 'factor' diversification principles which sufficiently addresses diversification concerns of LP.

Elbowman wrote:Two points:
2) You are proposing 50% long term treasuries and you have only backtested to 1999?! That's like backtesting the S&P 500 starting at 2010. Test out how those bonds would have performed from 1968–1983.

This was one of the concerns came up in the other thread. Large fixed asset on how well it tested for period between 30's-70's. I see it as finding high-quality options for the term-risk portion of the portfolio.

petulant
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by petulant » Mon Feb 13, 2017 11:26 pm

Elbowman wrote:2) You are proposing 50% long term treasuries and you have only backtested to 1999?! That's like backtesting the S&P 500 starting at 2010. Test out how those bonds would have performed from 1968–1983.


This is a major question with OP's proposal. The mantra of the LP is if you're taking risks with the portfolio, take it in the stocks. OP, have you tried visualizer with bond allocations at a 2-5 year duration (somewhere between intermediate and short-term) instead of long-term?

Theoretical
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by Theoretical » Mon Feb 13, 2017 11:30 pm

If you make half of the treasuries 30 year TIPS or I Bonds and do 2:1 DM-EM Small caps, then I'd say you're in better shape. Stagflation would utterly murder long-term treasuries, and there's far fewer places for the interest rates to go than up.

I'd do something like

25% VISVX (I personally prefer IJS/VIOV or Schwab's Fundamental US Small Cap FNDA for this space)
17% PDN or FNDC/SFILX (Powershares RAFI Developed-Ex US Small-Mid Cap or Schwab Fundamental International Small Cap) - .50 or .40 ER
8% PXH or FNDE/SFENX (Powershares RAFI Emerging Large Company or Schwab Fundamental Emerging Large Company) .49 or .40/.39 ERs - or you could do DGS at .64%
25% LLT
25% 30 Year TIPS

if I was going to do the long treasury gamble.

Also, the biggest black swan risk of the Larry Portfolio is the huge bond allocation, so do you really want to have a that massive amount of duration risk on top of that?

heyyou
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by heyyou » Tue Feb 14, 2017 12:52 am

I've chosen to remove this post.

dcabler
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by dcabler » Tue Feb 14, 2017 7:04 am

You can get an idea of further backtesting by using Simba's spreadsheet, available here on bogleheads as there is data that goes quite a bit further back. Be sure to read the first page of the spreadsheet so that you can understand the sources of data in it and, as always, this is only a rough guide.

I don't have the link handy, but you can easily google it within bogleheads and find it.

zenb
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Tue Feb 14, 2017 10:08 am

Theoretical wrote:If you make half of the treasuries 30 year TIPS or I Bonds and do 2:1 DM-EM Small caps, then I'd say you're in better shape. Stagflation would utterly murder long-term treasuries, and there's far fewer places for the interest rates to go than up.

I'd do something like

25% VISVX (I personally prefer IJS/VIOV or Schwab's Fundamental US Small Cap FNDA for this space)
17% PDN or FNDC/SFILX (Powershares RAFI Developed-Ex US Small-Mid Cap or Schwab Fundamental International Small Cap) - .50 or .40 ER
8% PXH or FNDE/SFENX (Powershares RAFI Emerging Large Company or Schwab Fundamental Emerging Large Company) .49 or .40/.39 ERs - or you could do DGS at .64%
25% LLT
25% 30 Year TIPS

Thank you. Very helpful.

Theoretical wrote:if I was going to do the long treasury gamble.

Also, the biggest black swan risk of the Larry Portfolio is the huge bond allocation, so do you really want to have a that massive amount of duration risk on top of that?

acknowledged.

zenb
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Tue Feb 14, 2017 10:08 am

dcabler wrote:You can get an idea of further backtesting by using Simba's spreadsheet, available here on bogleheads as there is data that goes quite a bit further back. Be sure to read the first page of the spreadsheet so that you can understand the sources of data in it and, as always, this is only a rough guide.

I don't have the link handy, but you can easily google it within bogleheads and find it.

Will check it out. Thank you.

dbr
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by dbr » Tue Feb 14, 2017 10:32 am

What is LP?

zenb
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Joined: Mon Nov 09, 2009 11:37 pm

Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Tue Feb 14, 2017 10:42 am

dbr wrote:What is LP?


Larry Portfolio. I found this forum posts explain it succinctlyhttps://www.bogleheads.org/forum/viewtopic.php?t=145409#p2166189. In a nutshell diversification based on factors (beta, size, value)

MikeMak27
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by MikeMak27 » Tue Feb 14, 2017 11:39 am

I'm discussing this same type of strategy in a different post. My idea was to go 45% US small cap value (IJS or VBR), 35% emerging market (VWO or IEMG), and 20% intermediate term treasury FIBAX (I'm at fidelity). With regular 5/25 rebalancing bands, I think this can be an aggressive portfolio that cuts down on the big fat tail risk. That said it's worst year was -30% so use more treasuries if you want to reduce that.

Any reason why you would use long term treasuries over short or intermediate?
Mac 4 fund portfolio: 45% US small cap value (IJS, VBR), 40% Emerging Markets (IEMG, VWO, FPMAX), 10% long term US treasuries (TLT), 5% US REITS (VNQ)

dbr
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Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by dbr » Tue Feb 14, 2017 4:33 pm

zenb wrote:
dbr wrote:What is LP?
Larry Portfolio. I found this forum posts explain it succinctlyviewtopic.php?t=145409#p2166189. In a nutshell diversification based on factors (beta, size, value)
I am very familiar with it but did not recognize the acronym.

zenb
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Joined: Mon Nov 09, 2009 11:37 pm

Re: Switching portfolio - 3-fund with slight tilt to Larry Porfolio

Post by zenb » Sun Feb 26, 2017 5:41 pm

MikeMak27 wrote:I'm discussing this same type of strategy in a different post. My idea was to go 45% US small cap value (IJS or VBR), 35% emerging market (VWO or IEMG), and 20% intermediate term treasury FIBAX (I'm at fidelity). With regular 5/25 rebalancing bands, I think this can be an aggressive portfolio that cuts down on the big fat tail risk. That said it's worst year was -30% so use more treasuries if you want to reduce that.

Any reason why you would use long term treasuries over short or intermediate?
Reference to long-term treasury for fixed portion of the portfolio was a mistake. As others pointed out it needs to be something that has less sensitivity to interest rate movement (currently I hold vanguard interm-term bond fund for 10% of AA).

MikeMak27: Thank you for sharing your strategy.

In my case: After some more research on LP, and other portfolio allocation models., i think i need to spend time to understand the factor model before making any definitive change. a AA with only SCV, EM and Fixed scares me. Even though i understand Larry's argument that need to think of diversification in term of factor model (as opposed to market cap), it still feels uneasy as i dont understand this enough.

For time being going to continue with my current AA which is:
22% Large cap (VIIIX)
22% Small cap (VEMPX, VBR)
20% International (VTPSX)
8% Emerging (VEMAX)
8% reit (VGSNX)
20% bond (VFICX, I-bonds)

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