Bill Sharpe's preferred portfolio

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

I’ve got a basic question which may put the previous timing/rebalancing question in regard to WBS in context.

When the equity market collapses, bonds end up representing a greater percentage of the WBS. However, my understanding is that the combined market value of the WBS is lower. Right?

So rather then looking to market time by adjusting AA within WBS a better approach is to have enough safe assets and income outside of the WBS in which to make new purchases of the WBS at whatever AA is present at the time. This could be either spare savings from monthly income or any liquid funds above a basic emergency fund. This way you don’t have to make a decision as to whether stocks or bonds are over/under valued, the decision is only how much extra human capital and liquid reserves can you put into the WBS, perhaps by shifting short term priorities. Admittedly there are limits to this but it scratches the itch we all seem to have to want to buy something on sale.


(I’ve been reading thru Roth’s Depression Diary and the reoccurring theme seems to be to have enough safe assets (non WBS) to get thru the crisis and to have cash available to continue buying. The number of false bottoms and rallies during the Depression should convince anybody otherwise. )
rcmoormt
Posts: 4
Joined: Thu Jul 01, 2021 6:02 am

Re: Bill Sharpe's preferred portfolio

Post by rcmoormt »

Thank you for the replies, that makes sense. It was always my assumption that investors buy more equity when lower, I was wrong with that. It makes sense that the free fall could continue.

I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??

I think I explained it pretty well.... example:
Global market is 60/40. I put $60 in VT, $40 in BNDW. I leave it alone. Market eventually falls to 50/50. Will I look in my account and see a 50/50 split in vt/bndw?

Thank you so much everyone.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

rcmoormt wrote: Thu Jul 01, 2021 5:10 pm I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??
Yes, the allocation floats so it will vary over time by itself. You make contributions and withdrawals at the same proportion of whatever the current WBS AA shows. I agree, this at first feels counter to what a lot of others might advocate, but you're just owning the market and letting the market be the market.

The only time you might need to rebalance is when market cap values are updated on the spreadsheet. This is not due to valuation or timing, its because of things like share creation, etc etc. Its pretty minor but keeps everything tuned up.

:sharebeer
Gup
djm2001
Posts: 82
Joined: Fri May 29, 2020 6:23 am

Re: Bill Sharpe's preferred portfolio

Post by djm2001 »

Hi guppyguy,

Part of what you're saying is consistent with classic Modern Portfolio Theory (MPT) -- that, given a bunch of (admittedly unrealistic) assumptions, every portfolio should be on the efficient frontier located on the Capital Market Line (CML), which consists of all linear combinations of the risk-free asset and the market portfolio of risky assets. I.e., according to classic MPT, all investors would hold just two components -- some amount of the risky market portfolio and some amount (perhaps negative, i.e., borrowing) of the risk-free asset. As Sharpe suggests, WBS is our proxy for the risky market portfolio, and TIPS is our proxy for a risk-free asset or what you called the "safe asset". It's very important to note that what Sharpe does not explicitly state (or maybe I didn't read RISMAT 7 closely enough) is that in order to be truly risk-free, particularly w.r.t. reinvestment / interest-rate risk, the TIPS need to be duration-matched to a predictable schedule of the investor's expenses/liabilities.

In the MPT framework, the typical narrative is that investors consciously pick a risk-vs-return tradeoff, which implicitly selects a point on the CML -- i.e., what combo of risk-free asset and risky market portfolio to hold. And this is where your proposal deviates from the usual MPT story. You're proposing to move around on the CML line, based on whether the total market cap of the market portfolio is "expensive" or "on sale" (in inflation-adjusted terms, I guess?).

Here are a couple of thoughts / questions about your approach:
  • How would you decide when WBS is "on sale"? Compare it to yesterday? Last year? Note that the market cap of the global market portfolio is generally increasing over the long run as we turn natural resources and innovation into future profit. So perhaps we could say that WBS is on sale when its market cap is below its all time high. This is similar to ERN's "active strategy" glidepath approach. But note that ERN also found that the active strategy (buy when "underwater", i.e., less than all-time high) doesn't make a big difference over the long run (60-year period). It's also tricky because we're measuring the market cap in terms of a currency that may be inflated or deflated relative to past measurements.
  • As mentioned above, in order for TIPS to be truly "risk-free" (e.g., safe from reinvestment/interest-rate risk), you'd need to know when you're going to use the money upfront, and buy an appropriate amount of duration-matched TIPS. This would require you to predict when you are going to sell the TIPS to buy WBS. Thus, we can't really use this "risk-free asset" to take advantage of unexpected opportunities that arise (even if we could recognize them).
  • Is it even possible to find a risk-free asset / safe asset that is safe from inflation risk and reinvestment/interest-rate risk and can be opportunistically consumed on an unpredictable schedule?
Northern Flicker
Posts: 8031
Joined: Fri Apr 10, 2015 12:29 am

Re: Bill Sharpe's preferred portfolio

Post by Northern Flicker »

If your asset allocation is to hold stocks and bonds at market weight, once the allocation was implemented, you would never rebalance. This is the problem I have with using market cap to drive allocation weights across asset classes. Doing so gives up control over portfolio risk, and that risk varies with movements in the asset classes.

I believe the reason for saying TIPS to taste is that the a market cap allocation to TIPS would be a weighting of (I believe) about 2.5%, not enough to matter with respect to inflation protection. Once you say that an asset class can be over- or under-weighted to manage risk, you don't have a market cap portfolio. I could just as easily say I want to under-weight nominal bonds for inflation protection, and over-weighting TIPS would in fact just be the same thing if the TIPS allocation cannibalizes the nominal bond allocation. Thus, I don't even think that Dr. Sharpe is fully on board with the model.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

djm2001 wrote: Thu Jul 01, 2021 6:21 pm Hi guppyguy,

Part of what you're saying is consistent with classic Modern Portfolio Theory (MPT) -- that, given a bunch of (admittedly unrealistic) assumptions, every portfolio should be on the efficient frontier located on the Capital Market Line (CML), which consists of all linear combinations of the risk-free asset and the market portfolio of risky assets. I.e., according to classic MPT, all investors would hold just two components -- some amount of the risky market portfolio and some amount (perhaps negative, i.e., borrowing) of the risk-free asset. As Sharpe suggests, WBS is our proxy for the risky market portfolio, and TIPS is our proxy for a risk-free asset or what you called the "safe asset". It's very important to note that what Sharpe does not explicitly state (or maybe I didn't read RISMAT 7 closely enough) is that in order to be truly risk-free, particularly w.r.t. reinvestment / interest-rate risk, the TIPS need to be duration-matched to a predictable schedule of the investor's expenses/liabilities.

In the MPT framework, the typical narrative is that investors consciously pick a risk-vs-return tradeoff, which implicitly selects a point on the CML -- i.e., what combo of risk-free asset and risky market portfolio to hold. And this is where your proposal deviates from the usual MPT story. You're proposing to move around on the CML line, based on whether the total market cap of the market portfolio is "expensive" or "on sale" (in inflation-adjusted terms, I guess?).

Here are a couple of thoughts / questions about your approach:
  • How would you decide when WBS is "on sale"? Compare it to yesterday? Last year? Note that the market cap of the global market portfolio is generally increasing over the long run as we turn natural resources and innovation into future profit. So perhaps we could say that WBS is on sale when its market cap is below its all time high. This is similar to ERN's "active strategy" glidepath approach. But note that ERN also found that the active strategy (buy when "underwater", i.e., less than all-time high) doesn't make a big difference over the long run (60-year period). It's also tricky because we're measuring the market cap in terms of a currency that may be inflated or deflated relative to past measurements.
  • As mentioned above, in order for TIPS to be truly "risk-free" (e.g., safe from reinvestment/interest-rate risk), you'd need to know when you're going to use the money upfront, and buy an appropriate amount of duration-matched TIPS. This would require you to predict when you are going to sell the TIPS to buy WBS. Thus, we can't really use this "risk-free asset" to take advantage of unexpected opportunities that arise (even if we could recognize them).
  • Is it even possible to find a risk-free asset / safe asset that is safe from inflation risk and reinvestment/interest-rate risk and can be opportunistically consumed on an unpredictable schedule?
Hi djm2001-
I really wasn't thinking of it strictly from a MPT perspective. It's more personal finance and behavioral. Take spring of 2020 for example. If one has extra slack in their budget they could allocate cash or sell I-Bonds (no duration risk) or increase their paycheck withholdings, etc etc. (TIPS is also possibility but you bring up good objections). Discretionary spending can be converted as well as savings from lower prices of goods and services. We did all of this (minus the I-bond sale) during COVID. Of course the risk is in the adequacy of remaining liquidity to possible fund expenses unsupported by normal income ESPECIALLY over an unknown horizon, but I contend that if one has a healthy EF and high natural savings rate it isn't hard to individually quantify.

**What doesn't have to be done is to change the AA of stocks and bonds against WBS or to make specific bets away from MCW. **

The timing of WBS being categorized as on sale should be obvious, I hope. I'm not talking about minor corrections or pullbacks, but obvious cataclysmic world events that has everybody glued to a television. My personal willingness to do all of the above in 2000/2001 was a lot different than 2008 which was still different than last year. The main difference was more assets, much higher savings rate, much higher EF, and also older and much more secure in our human capital and willingness to put a little more into the overall market.

Gup
djm2001
Posts: 82
Joined: Fri May 29, 2020 6:23 am

Re: Bill Sharpe's preferred portfolio

Post by djm2001 »

Hi Northern Flicker,

Sharpe says, "allocate by market weight, and adjust for personal circumstance". In other words, an investor should start with market portfolio (which is the right choice for the average investor), and then make departures from that based on their personal risk exposures that makes them different from average. Or more accurately, an investor should start with their own individual risks, and then try to attain the efficient risk allocation picked out by the market portfolio by buying the market portfolio as well as other hedges to zero out their individual / atypical / idiosyncratic risks.

When framed this way, the reason for "overweighting" TIPS is clear. In theory, an investor would use a TIPS ladder (over and above holding the market portfolio) to neutralize some of their predicted expenses (e.g., as watchnerd does) in order to bring them back to average (or some guess at what average looks like). These future expenses thus neutralized (with duration-matched TIPS), the investor then holds their remaining money in the market portfolio.

But of course, this is all theory. In practice, it's hard for an individual investor to maintain an accurately duration-matched TIPS ladder, it's hard to predict future expenses and earning power, it's hard to know what the average investor's risks look like, let alone quantify how one differs from that. In practice, what I personally do is use a rough heuristic to pick a stock / bond ratio appropriate to my life situation (e.g., if I expect to have lots of high-earning years remaining, I reduce my bond allocation) and to hold no extra TIPS beyond market caps -- I just hold enough cash for near-term (3-6 month) expenses in a savings account.

That said, I don't buy the need to control portfolio risks (by playing with the knobs of asset class weights) for any reason other than to neutralize one's own atypical / idiosyncratic risks to bring oneself back to the (hopefully) somewhat efficient risk allocation picked out by market portfolio. Not unless an investor can pick a more efficient allocation that the market can... Maybe some investors can; I can't.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

Northern Flicker wrote: Thu Jul 01, 2021 6:30 pm If your asset allocation is to hold stocks and bonds at market weight, once the allocation was implemented, you would never rebalance. This is the problem I have with using market cap to drive allocation weights across asset classes. Doing so gives up control over portfolio risk, and that risk varies with movements in the asset classes.

I believe the reason for saying TIPS to taste is that the a market cap allocation to TIPS would be a weighting of (I believe) about 2.5%, not enough to matter with respect to inflation protection. Once you say that an asset class can be over- or under-weighted to manage risk, you don't have a market cap portfolio. I could just as easily say I want to under-weight nominal bonds for inflation protection, and over-weighting TIPS would in fact just be the same thing if the TIPS allocation cannibalizes the nominal bond allocation. Thus, I don't even think that Dr. Sharpe is fully on board with the model.
Think of WBS as an AA within your overall household AA. WBS is strictly as set forth earlier and your household AA is really, anything that can ever be converted to value. Moving assets into/out of WBS IS what controls portfolio risk, not arbitrarily changing the average market portfolio twice (away then back to WBS). So if the AA of WBS goes from 60/40 to 50/50, the overall market value of both probably decreased which makes your additional household funded capital purchases that much more valuable.

Some might say this is just semantics or mental accounting but I think it is actually how we really act as humans. I'd love to make every penny fit in our household fit into a model but its just far simpler this way.
djm2001
Posts: 82
Joined: Fri May 29, 2020 6:23 am

Re: Bill Sharpe's preferred portfolio

Post by djm2001 »

guppyguy wrote: Thu Jul 01, 2021 7:19 pm Hi djm2001-
I really wasn't thinking of it strictly from a MPT perspective. It's more personal finance and behavioral. Take spring of 2020 for example. If one has extra slack in their budget they could allocate cash or sell I-Bonds (no duration risk) or increase their paycheck withholdings, etc etc. (TIPS is also possibility but you bring up good objections). Discretionary spending can be converted as well as savings from lower prices of goods and services. We did all of this (minus the I-bond sale) during COVID. Of course the risk is in the adequacy of remaining liquidity to possible fund expenses unsupported by normal income ESPECIALLY over an unknown horizon, but I contend that if one has a healthy EF and high natural savings rate it isn't hard to individually quantify.

**What doesn't have to be done is to change the AA of stocks and bonds against WBS or to make specific bets away from MCW. **

The timing of WBS being categorized as on sale should be obvious, I hope. I'm not talking about minor corrections or pullbacks, but obvious cataclysmic world events that has everybody glued to a television. My personal willingness to do all of the above in 2000/2001 was a lot different than 2008 which was still different than last year. The main difference was more assets, much higher savings rate, much higher EF, and also older and much more secure in our human capital and willingness to put a little more into the overall market.

Gup
"On sale" would mean that the market is inefficient for whatever reason (e.g., behavioral), right? I certainly would never claim that the market is perfectly efficient. I wonder though... is it more inefficient at the macro level or at the individual stock level? If you decided to market time at all... then would it be better to market time WBS as a whole? Or would it be better to time targeted stocks / sectors? In other words, if one believes in market inefficiency enough to exploit it as an investment strategy, why not specifically target the weak spots rather than targeting both the efficient and inefficient parts together?

Personally, during big drops I would (and twice have -- once successfully and once unsuccessfully) employ tax-loss harvesting (sell fund X and buy similar-but-not-identical fund Y) to maintain my WBS allocation while saving on taxes.
HootingSloth
Posts: 596
Joined: Mon Jan 28, 2019 3:38 pm

Re: Bill Sharpe's preferred portfolio

Post by HootingSloth »

guppyguy wrote: Thu Jul 01, 2021 5:49 pm
rcmoormt wrote: Thu Jul 01, 2021 5:10 pm I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??
Yes, the allocation floats so it will vary over time by itself. You make contributions and withdrawals at the same proportion of whatever the current WBS AA shows. I agree, this at first feels counter to what a lot of others might advocate, but you're just owning the market and letting the market be the market.

The only time you might need to rebalance is when market cap values are updated on the spreadsheet. This is not due to valuation or timing, its because of things like share creation, etc etc. Its pretty minor but keeps everything tuned up.

:sharebeer
Gup
I could be wrong, but I believe this story is complicated somewhat by the different amount of (net) issuances of new stocks and bonds that happen over time. This explains why the WBS allocation can still be at 60/40 despite the fact that stocks have dramatically outperformed bonds over the last many decades. For this reason, I think maintaining the allocation would require rebalancing.
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
rcmoormt
Posts: 4
Joined: Thu Jul 01, 2021 6:02 am

Re: Bill Sharpe's preferred portfolio

Post by rcmoormt »

HootingSloth wrote: Thu Jul 01, 2021 8:02 pm
guppyguy wrote: Thu Jul 01, 2021 5:49 pm
rcmoormt wrote: Thu Jul 01, 2021 5:10 pm I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??
Yes, the allocation floats so it will vary over time by itself. You make contributions and withdrawals at the same proportion of whatever the current WBS AA shows. I agree, this at first feels counter to what a lot of others might advocate, but you're just owning the market and letting the market be the market.

The only time you might need to rebalance is when market cap values are updated on the spreadsheet. This is not due to valuation or timing, its because of things like share creation, etc etc. Its pretty minor but keeps everything tuned up.

:sharebeer
Gup
I could be wrong, but I believe this story is complicated somewhat by the different amount of (net) issuances of new stocks and bonds that happen over time. This explains why the WBS allocation can still be at 60/40 despite the fact that stocks have dramatically outperformed bonds over the last many decades. For this reason, I think maintaining the allocation would require rebalancing.

This is exactly why I asked the question. I can't grasp how the allocation could remain as stable in a portfolio as it is in the market with stocks performing vastly better.

Guppyguy, do you have any insight?
HootingSloth
Posts: 596
Joined: Mon Jan 28, 2019 3:38 pm

Re: Bill Sharpe's preferred portfolio

Post by HootingSloth »

rcmoormt wrote: Thu Jul 01, 2021 8:19 pm
HootingSloth wrote: Thu Jul 01, 2021 8:02 pm
guppyguy wrote: Thu Jul 01, 2021 5:49 pm
rcmoormt wrote: Thu Jul 01, 2021 5:10 pm I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??
Yes, the allocation floats so it will vary over time by itself. You make contributions and withdrawals at the same proportion of whatever the current WBS AA shows. I agree, this at first feels counter to what a lot of others might advocate, but you're just owning the market and letting the market be the market.

The only time you might need to rebalance is when market cap values are updated on the spreadsheet. This is not due to valuation or timing, its because of things like share creation, etc etc. Its pretty minor but keeps everything tuned up.

:sharebeer
Gup
I could be wrong, but I believe this story is complicated somewhat by the different amount of (net) issuances of new stocks and bonds that happen over time. This explains why the WBS allocation can still be at 60/40 despite the fact that stocks have dramatically outperformed bonds over the last many decades. For this reason, I think maintaining the allocation would require rebalancing.

This is exactly why I asked the question. I can't grasp how the allocation could remain as stable in a portfolio as it is in the market with stocks performing vastly better.

Guppyguy, do you have any insight?
It turns out Yardeni tracks this information, and it appears to be quite a significant effect: https://www.yardeni.com/pub/fofisspurstbnd.pdf. As you can see, net issuances of stock have often been negative over the past twenty years and have never been more than about $400bn in a single quarter (or maybe the figures are annualized, I can't quite tell). In contrast, net issuances of bonds are consistently positive, and have hit over $6trn.

Edited to add: Thinking about it, a rough and long-term stability would seem to make sense. As equities grow, aggregate enterprise value grows at a similar rate, and so the aggregate capacity of corporations to issue new debt grows at a similar rate. At the same time, stock-market-cap-to-gdp and public-debt-to-gdp both seem to stay within a (fairly wide) range over time (although both are unusually high in the US right at the moment), and so the amount of outstanding public debt should roughly keep pace with stock market capitalization through new issuances of government debt. Obviously there is room for fluctuation, but it shouldn't be surprising that bonds don't get diluted away in the WBS allocation.
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
Northern Flicker
Posts: 8031
Joined: Fri Apr 10, 2015 12:29 am

Re: Bill Sharpe's preferred portfolio

Post by Northern Flicker »

djm2001 wrote: Thu Jul 01, 2021 7:26 pm Hi Northern Flicker,

Sharpe says, "allocate by market weight, and adjust for personal circumstance". In other words, an investor should start with market portfolio (which is the right choice for the average investor), and then make departures from that based on their personal risk exposures that makes them different from average. Or more accurately, an investor should start with their own individual risks, and then try to attain the efficient risk allocation picked out by the market portfolio by buying the market portfolio as well as other hedges to zero out their individual / atypical / idiosyncratic risks.

When framed this way, the reason for "overweighting" TIPS is clear. In theory, an investor would use a TIPS ladder (over and above holding the market portfolio) to neutralize some of their predicted expenses (e.g., as watchnerd does) in order to bring them back to average (or some guess at what average looks like). These future expenses thus neutralized (with duration-matched TIPS), the investor then holds their remaining money in the market portfolio.

But of course, this is all theory. In practice, it's hard for an individual investor to maintain an accurately duration-matched TIPS ladder, it's hard to predict future expenses and earning power, it's hard to know what the average investor's risks look like, let alone quantify how one differs from that. In practice, what I personally do is use a rough heuristic to pick a stock / bond ratio appropriate to my life situation (e.g., if I expect to have lots of high-earning years remaining, I reduce my bond allocation) and to hold no extra TIPS beyond market caps -- I just hold enough cash for near-term (3-6 month) expenses in a savings account.

That said, I don't buy the need to control portfolio risks (by playing with the knobs of asset class weights) for any reason other than to neutralize one's own atypical / idiosyncratic risks to bring oneself back to the (hopefully) somewhat efficient risk allocation picked out by market portfolio. Not unless an investor can pick a more efficient allocation that the market can... Maybe some investors can; I can't.
Although the tone of your article suggests a different position from mine, after a careful reading, I realize we are saying the same thing in different ways. I would point out that whether or not you start from the market portfolio doesn't really matter. I could just as easily start with 60% total US stocks, 20% treasuries, and 20% TIPS, and modify to accommodate personal circumstance and risk. Where the portfolio lands ultimately is what matters.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
Posts: 8031
Joined: Fri Apr 10, 2015 12:29 am

Re: Bill Sharpe's preferred portfolio

Post by Northern Flicker »

djm2001 wrote: Thu Jul 01, 2021 7:26 pm Hi Northern Flicker,

Sharpe says, "allocate by market weight, and adjust for personal circumstance". In other words, an investor should start with market portfolio (which is the right choice for the average investor), and then make departures from that based on their personal risk exposures that makes them different from average. Or more accurately, an investor should start with their own individual risks, and then try to attain the efficient risk allocation picked out by the market portfolio by buying the market portfolio as well as other hedges to zero out their individual / atypical / idiosyncratic risks.

When framed this way, the reason for "overweighting" TIPS is clear. In theory, an investor would use a TIPS ladder (over and above holding the market portfolio) to neutralize some of their predicted expenses (e.g., as watchnerd does) in order to bring them back to average (or some guess at what average looks like). These future expenses thus neutralized (with duration-matched TIPS), the investor then holds their remaining money in the market portfolio.

But of course, this is all theory. In practice, it's hard for an individual investor to maintain an accurately duration-matched TIPS ladder, it's hard to predict future expenses and earning power, it's hard to know what the average investor's risks look like, let alone quantify how one differs from that. In practice, what I personally do is use a rough heuristic to pick a stock / bond ratio appropriate to my life situation (e.g., if I expect to have lots of high-earning years remaining, I reduce my bond allocation) and to hold no extra TIPS beyond market caps -- I just hold enough cash for near-term (3-6 month) expenses in a savings account.

That said, I don't buy the need to control portfolio risks (by playing with the knobs of asset class weights) for any reason other than to neutralize one's own atypical / idiosyncratic risks to bring oneself back to the (hopefully) somewhat efficient risk allocation picked out by market portfolio. Not unless an investor can pick a more efficient allocation that the market can... Maybe some investors can; I can't.
But the market does not fully control the allocation of the global market portfolio. Public policy has a much bigger influence on the market cap of sovereign bonds than the market.

I believe allocation weights for asset classes should be decided by risk management. Cap-weighted market portfolios are excellent implementations of asset classes. Once you adjust from the global market weightings of individual asset classes to adjust for personal circumstance, it amounts to the same thing. The fact that global market weight of asset classes was the starting point is not relevant. It is where you end up that matters.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

djm2001 wrote: Thu Jul 01, 2021 7:45 pm
"On sale" would mean that the market is inefficient for whatever reason (e.g., behavioral), right? I certainly would never claim that the market is perfectly efficient. I wonder though... is it more inefficient at the macro level or at the individual stock level? If you decided to market time at all... then would it be better to market time WBS as a whole? Or would it be better to time targeted stocks / sectors? In other words, if one believes in market inefficiency enough to exploit it as an investment strategy, why not specifically target the weak spots rather than targeting both the efficient and inefficient parts together?

Personally, during big drops I would (and twice have -- once successfully and once unsuccessfully) employ tax-loss harvesting (sell fund X and buy similar-but-not-identical fund Y) to maintain my WBS allocation while saving on taxes.
You are placing two bets with that approach, first in allocating opposite of what macro forces are valuing the overall market and then second in trying to overweight a section of equities that you believe will mean revert. You would then need to place two more bets to return to WBS. Are you that different from the average investor? You may be or have individual circumstances that warrant this deviation but make no mistake you are deviating from the market and at some point, if desired, reconcile back. Furthermore, how do you know whether this behavior will actually be beneficial in the long run? Most of us do zero post trade analysis (at least I rarely did), we just act as though we are improving our position as compared to the market.
guppyguy
Posts: 174
Joined: Tue Jan 30, 2018 4:24 pm

Re: Bill Sharpe's preferred portfolio

Post by guppyguy »

rcmoormt wrote: Thu Jul 01, 2021 8:19 pm
HootingSloth wrote: Thu Jul 01, 2021 8:02 pm
guppyguy wrote: Thu Jul 01, 2021 5:49 pm
rcmoormt wrote: Thu Jul 01, 2021 5:10 pm I stated in my initial question that the preexisting investments will roll with the global market. Am I correct about this? Let's say the global market is exactly 60/40 (vt/bndw) currently and I reallocate my 401k exactly to that. If in time stocks lower and it is a 50/50 split globally, will my current allocations also have moved to that same split with the market (given i didn't touch a thing in my portfolio)??
Yes, the allocation floats so it will vary over time by itself. You make contributions and withdrawals at the same proportion of whatever the current WBS AA shows. I agree, this at first feels counter to what a lot of others might advocate, but you're just owning the market and letting the market be the market.

The only time you might need to rebalance is when market cap values are updated on the spreadsheet. This is not due to valuation or timing, its because of things like share creation, etc etc. Its pretty minor but keeps everything tuned up.

:sharebeer
Gup
I could be wrong, but I believe this story is complicated somewhat by the different amount of (net) issuances of new stocks and bonds that happen over time. This explains why the WBS allocation can still be at 60/40 despite the fact that stocks have dramatically outperformed bonds over the last many decades. For this reason, I think maintaining the allocation would require rebalancing.

This is exactly why I asked the question. I can't grasp how the allocation could remain as stable in a portfolio as it is in the market with stocks performing vastly better.

Guppyguy, do you have any insight?
The ratio of global stocks to bonds is just comparing two pools of capital, valued by number units available in the public market times what the average investors thinks each unit is worth. These two pools can increase/decrease for many reasons but rebalancing as Sharpe puts forth is only meant to capture the overall capitalization of each pool, not the valuation of each unit within that pool (at least not directly).
So it's true, it's possible for the AA to remain the same because price and supply move in opposite directions. Yet the average investor doesn't care about supply, so long as the market can function - which is also why he only focuses on the largest, meatiest parts of the economy and not things such as real estate and private equity of which market efficiency might not always as apparent.

The average investor is only trying to decide whether they want to be a contrarian investor as compared to all of the other investors in the world. 50/50 may be the new 60/40, for reasons completely unrelated to valuation, since the world is off the gold standard, who know. WBS isn't perfect but I can't think of anything as close.

(I'm probably off on some of the details as I have little formal economic training, but I did stay in a Holiday Inn once :happy )
buyer
Posts: 2
Joined: Tue Jul 20, 2021 1:25 am

Re: Bill Sharpe's preferred portfolio

Post by buyer »

I've been experimenting recently to determine the precise world ratio specific to ITOT and IXUS, instead of VTI/VXUS. I think I've got it, but I wanted to run it by you all to make sure I'm doing it right.

Per the wiki article, I need to get the market caps of the indexes tracked by ITOT and IXUS. As of 2021-06-30 they are:

ITOT: S&P Total Market Index (TMI) = 47,829,435.70
IXUS: MSCI ACWI ex USA IMI Index = 32,093,118.55

Then I need the most recent prices and the prices from 2021-06-30 to get the price ratio:

Price Ratio = Ending Price / Starting Price
ITOT: 97.33 / 98.76 = ~0.9855
IXUS: 70.98 / 73.30 = ~0.9683

Then I do the following to get the current adjusted percentage:

Adjusted % = (Market Cap) x (Price Ratio) / ( Sum ( (Market Cap) x (Price Ratio) ) )

ITOT: (47,829,435.70) x (~0.9855) / 78,214,234.43
IXUS: (32,093,118.55) x (~0.9683) / 78,214,234.43

My final results (as of 2021-07-19) are:

ITOT: 60.27%
IXUS: 39.73%


I was surprised to find these percentages are off by 1.68% from the currently calculated VTI/VXUS ratio (58.59% / 41.41% as of 07-19), a larger difference than I would have expected.

Do my results seem right? Does the nearly 2% discrepancy make sense given the different indexes used by ITOT/IXUS versus VTI/VXUS? Or did my math go wrong somewhere? Thanks!
Last edited by buyer on Tue Jul 20, 2021 4:53 am, edited 1 time in total.
djm2001
Posts: 82
Joined: Fri May 29, 2020 6:23 am

Re: Bill Sharpe's preferred portfolio

Post by djm2001 »

I checked your sources (factsheet data and ETF prices) and your math, and it is correct. And you're doing the right thing by calculating your allocation based on the indexes that are tracked by the funds that you actually own.

I don't know the cause of the 1.68% discrepancy between the two sets of indexes, but it's definitely an interesting puzzle to dig into. Perhaps it has to do with how the different companies adjust for "free float" or set some other threshold.

That said, a 1.68% discrepancy in US vs ex-US stock allocations when computed from two different index sources is not a total shocker. I recently compared US vs ex-US bonds from Bloomberg Barclays indexes against FTSE indexes, and found a ~5% difference between Bloomberg-Barclay-based allocations vs FTSE-based allocations.
buyer
Posts: 2
Joined: Tue Jul 20, 2021 1:25 am

Re: Bill Sharpe's preferred portfolio

Post by buyer »

djm2001, thank you for double-checking my work, much appreciated. Also thanks for your GMP sheet, a very handy reference.

Yes, I just spent some time reading the BH wiki article on indexing, and realize now that there are a lot different methodologies between the various index providers, so it makes sense that they'll produce different ratios.

Anyway, I'm looking forward to achieving the proper ITOT/IXUS world ratio in my portfolio with my next contribution.
Joey Jo Jo Jr
Posts: 33
Joined: Mon Jun 21, 2021 11:38 pm

Re: Bill Sharpe's preferred portfolio

Post by Joey Jo Jo Jr »

I find market weights intriguing, but does the issuance of massive amounts of public debt, a good bit of which is not actually owned by the public (such as the Fed) distort the picture? Would buying sovereign debt just because it’s issued encourage fiscal irresponsibility?

I like treasuries for the negative correlation to equities and the resulting better risk adjusted return, but I can’t get my head around owning them just because they are out there.
djm2001
Posts: 82
Joined: Fri May 29, 2020 6:23 am

Re: Bill Sharpe's preferred portfolio

Post by djm2001 »

If the Federal Reserve is distorting the market in a way that is detrimental to your own financial goals, you could always do your own additional float adjustment (over and above the bond index's float adjustment) by subtracting out the portion of market cap owned by the Fed.

In an ideal world, float adjustment would personalized. It would go beyond limiting to "publicly available" portion of assets, and focus more narrowly on the market cap of assets owned by individuals who are similar to you (same country, similar life situation, similar job, similar expenses). This would give a more personalized asset allocation that better fits your own circumstances An index's public float adjustment is a one-size-fits-all adjustment. You can either be lazy and use it, or you can customize it further with additional effort.
HootingSloth
Posts: 596
Joined: Mon Jan 28, 2019 3:38 pm

Re: Bill Sharpe's preferred portfolio

Post by HootingSloth »

I believe that the Bloomberg Barclays index (which is used, e.g., by BND) already takes out Treasurys that are purchased by the Federal Reserve at auction. From their methodology document:
Float Adjustments to Amount Outstanding

US Treasuries

Federal Reserve purchases and sales of nominal and inflation-linked US Treasuries in open market operations are adjusted in the Bloomberg Barclays flagship US Aggregate, Global Treasury and Series-L US TIPS Indices using data made publicly available on the Federal Reserve Bank of New York website. These reports are released weekly by the Fed, usually Thursdays around 4:30pm New York time.

Adjustments to each security’s amount outstanding are made in the Projected Universe for government purchases and sales for the Federal Reserve SOMA (System Open Market Account) on a weekly basis, typically on Fridays. When US Treasury nominal or inflation-linked bonds are issued or reopened, the initial par amount outstanding that enters the Projected Universe is reduced for any issuance bought by the Federal Reserve at auction.
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
longinvest
Posts: 4701
Joined: Sat Aug 11, 2012 8:44 am

Re: Bill Sharpe's preferred portfolio

Post by longinvest »

This post documents the monthly return and asset class weights as of June 30, 2021 of the Global Stock-and-Bond Portfolio or, if you prefer, William Sharpe's Market Portfolio. Here's a link to the previous entry.

The June 2021 return was:
  • Global Stock-and-Bond Portfolio: ((60.54% X 1.19% (global stocks)) + (39.46% X 0.61% (global bonds))) = 0.96% (USD)
    • Global stocks: Vanguard Total World Stock ETF (VT) NAV return
    • Global bonds: Vanguard Total World Bond ETF (BNDW) NAV return
As of June 30, 2021 the weights were:
  • Global stocks: $75,163,286 million USD Market cap -- 60.92%
    • FTSE Global All Cap Index (GEISLMS) -- Net MCap
  • Global bonds: $48,217,210 million USD Market cap -- 39.08%
    • FTSE World Broad Investment-Grade Bond Index (WBIG) -- Market Value
For practical investing purpose I think that the Vanguard LifeStrategy Moderate Growth Fund (VSMGX) is a close-enough approximation of the Global Stock-and-Bond Portfolio with a moderate home bias justified by the slightly higher risks (political, etc.) and costs of foreign investing. Conveniently, it can be used as a One-Fund Portfolio. Its June 2021 return was 1.07%.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW
Post Reply