The AssetBuilder investment strategy is represented by our nine Model Portfolios.  We match client investment goals for risk, expected return and investment horizon with these portfolios.

We are not market timers. We believe deeply in our index investing strategy.  However, we want to inoculate our investment strategy with a “tilt” that assumes future inflation.  The inflation tilt we are going to give our Model Portfolios is a weighting in commodities.  This will add an additional asset class to our already highly diversified Model Portfolios.

In a recent article (http://assetbuilder.com/blogs/scott_burns/archive/2007/12/14/the-art-and-benefit-of-the-steady-eddy-portfolio.aspx), Scott outlined some of our thoughts about the value of commodities in an investment strategy.  We have been intrigued by the increased diversification. More important, we like the reduction in volatility commodities offer the Model Portfolios.

Why No Treasury Inflation Protection Securities (TIPS)

We use mean variance optimization to construct our Model Portfolios.   Under the simple construction of the Couch Potato Portfolios, TIPS act as a hedge against expected future inflation. But when you are developing optimized portfolios there are good reasons to exclude TIPS.

In our optimized portfolio construction our "glue" -- the stuff that influences how we put portfolios together -- is the level of risk in any given asset class. Because of the long average maturity of the TIPS indexes (including DFA), they provide relatively little return for the amount of risk taken. The risk factor argues for short fixed income maturities, not long maturities. That’s why our portfolios tend to hold one, two and five-year fixed income funds.

Putting our fixed income dollars at that maturity level allows us to "buy" more portfolio return by holding a variety of equity asset classes that have higher standard deviations--- but disproportionately higher expected returns.

This works to benefit portfolios in rising markets. But it looks rather lame in this particular down market. Since the equity markets rise more than they fall, holding short-term fixed income so we can own more equity will continue to be a better long term strategy.

Why No Energy Sector

Energy is an equity sector. It is not an asset class.  When you start making “sector bets”, over and underweighting them in a portfolio, you are stepping on a slippery slope.  This action will reverse the level of engineering that went into the construction of our Model Portfolios. 

Scott introduced energy in his Six Ways from Sunday couch potato portfolio as a currency and inflation hedge.  Without dredging up the long history, he realizes, in order to apply the "rocket science" to the modeling process we had to engineer the portfolios with asset classes and exclude sector indexes.

Because energy has been such a hot sector recently, the Six Ways from Sunday portfolio has done very well.  However, the better way to get at the advantages of energy without investing in companies is to use commodities.

Commodity as a New Asset Class

There are three major indexes which track the commodities market.  The S&P Goldman Sachs commodity index (S&P GSCI), the Dow Jones-AIG commodity index (Dow Jones - AIG) and the Deutsche Bank Liquid Commodity Index (DBLCI).  In our analysis, DBLCI was the most effective index. It has the following characteristics;

  • Comprised of six commodities: West Texas Intermediate (WTI) crude oil, heating oil, aluminum, gold, corn and wheat.
  • Constant weighting which reflect world production and inventory, providing a diverse and balanced commodity exposure.
  • A rule-based and transparent calculation methodology. Energy contracts are rolled monthly, metal and grain contracts annually.
  • Historically measured from December 1, 1988.

The security which tracks this benchmark is the Powershares DB Commodity Index Tracking Fund (DBC). The downside is the lack of history associated with this exchange-traded-fund -- started in March 2006.  However, with the history of DBLCI, we can garner the necessary data to make prudent inclusion of the asset in the Model Portfolios.

An in-depth discussion of commodity indices can be found on the Deutsche Bank website - http://dbfunds.db.com/Pdfs/dbindexguide2007.pdf.

How Do Commodities Help our Investment Strategy/Model Portfolios?

We don’t want to time the market. We don’t want to take a “the sky is falling” approach.  But our investment strategy will assume higher inflation in the future--- higher than we are living with today.  Because commodity prices usually rise when inflation is accelerating, commodities offer protection from the effects of inflation.  

Adding commodities--- particular DBLCI--- increased diversification. More important, it reduced volatility in the Model Portfolios.The diversification comes from another asset class.  It avoids overweighting an equity sector.  The reduction in portfolio volatility is the result of the low correlation of commodities to equity.  Commodities tend to move in the opposite direction as equity.

New vs. Old Model Portfolios

One of the key modeling principles we apply in our portfolios is based on the incremental return benefits of small cap and value, per the Fama/French research.  In 2007, the subprime shakeout negatively affected the value and REIT market, which ultimately affected our investment strategy.

New Model Portfolios

As of Dec 2007: Last 3 Months (period) Return Last 1 Year (annual) Return Last 3 Years (annual) Return Last 5 Years (annual) Return Y-T-D (period) Return
AB Model Portfolio 06 0.42 7.24 8.40 10.42 7.24
AB Model Portfolio 07 0.08 7.80 9.70 12.50 7.80
AB Model Portfolio 08 (0.41) 8.13 10.93 14.49 8.13
AB Model Portfolio 09 (0.90) 8.50 12.20 16.58 8.50
AB Model Portfolio 10 (0.95) 9.80 13.98 19.21 9.80
AB Model Portfolio 11 (1.23) 9.81 14.50 20.13 9.81
AB Model Portfolio 12 (1.26) 11.16 16.31 22.71 11.16
AB Model Portfolio 13 (1.51) 11.23 16.87 23.59 11.23
AB Model Portfolio 14 (1.76) 11.76 17.86 25.03 11.76

 

Old Model Portfolios

As of Dec 2007: Last 3 Months (period) Return Last 1 Year (annual) Return Last 3 Years (annual) Return Last 5 Years (annual) Return Y-T-D (period) Return
AB BB 06 (0.77) 5.20 7.94 10.20 5.20
AB BB 07 (1.05) 5.74 9.21 12.34 5.74
AB BB 08 (2.05) 5.22 10.13 14.10 5.22
AB BB 09 (2.87) 4.98 11.23 16.09 4.98
AB BB 10 (3.14) 5.44 12.19 17.53 5.44
AB BB 11 (3.69) 5.39 13.22 19.27 5.39
AB BB 12 (4.12) 5.65 14.24 21.11 5.65
AB BB 13 (4.43) 5.92 15.16 22.60 5.92
AB BB 14 (4.66) 6.39 16.04 24.08 6.39

 

Individual Security Performance

As of Dec 2007: Last 3 Months (period) Return Last 1 Year (annual) Return Last 3 Years (annual) Return Last 5 Years (annual) Return Y-T-D (period) Return
DFA One-Year Fixed-Income I 1.26 5.19 4.08 2.94 5.19
DFA Five-Year Government I 1.18 4.95 3.39 3.12 4.95
DFA Intermediate Govt Fixed-Income I 4.36 9.53 4.87 4.26 9.53
DFA Two-Year Global Fixed-Income I 1.38 5.25 3.86 2.84 5.25
DFA U.S. Large Company I (3.35) 5.44 8.55 12.72 5.44
DFA U.S. Large Cap Value I (5.39) (2.76) 8.81 15.41 (2.76)
DFA U.S. Small Cap Value I (8.81) (10.75) 5.35 18.51 (10.75)
DFA U.S. Micro Cap I (6.91) (5.22) 5.18 17.23 (5.22)
DFA U.S. Targeted Value I (7.95) (8.19) 6.29 18.19 (8.19)
DFA Real Estate Securities I (14.50) (18.67) 7.57 17.39 (18.67)
DBC new (fictional security) 15.78 31.35 20.11 21.94 31.35
DFA Intl Value I (3.69) 10.24 19.46 26.91 10.24
DFA Intl Small Cap Value I (7.49) 2.95 17.66 29.59 2.95
DFA Emerging Markets Value I 2.71 45.64 37.99 45.23 45.64
DFA Emerging Markets Small Cap I 0.06 38.02 33.57 39.63 38.02
Our new Model Portfolios can be accessed by the following links;

Model Portfolio 06
Model Portfolio 07
Model Portfolio 08
Model Portfolio 09
Model Portfolio 10
Model Portfolio 11
Model Portfolio 12
Model Portfolio 13
Model Portfolio 14