Last year I started writing more and shared my strategy for the first time. In the spirit of increased transparency, I thought it would be useful to show how Movement’s managed accounts performed in 2019.
Each account uses a strategy that blends together active and passive models. All models are implemented with low-cost index funds. The active models protect against extreme stock downside while the passive models provide buy-and-hold exposure.
The starting point for every account is a risk glidepath based on someone’s time horizon.
“The most important portfolio decision of all is how much of your capital to put at risk.“Source: William Bernstein’s The Four Pillars of Investing, page 109
Here’s a section of my glidepath for accounts with between 15 and 5 years until withdrawals start:
There’s flexibility if someone’s risk tolerance is unusually low, but in general most accounts stick to this glidepath.
Next, an account’s stock exposure is grouped into the three stock models. They’re equal weighted, so if an account has a baseline stock exposure of 60% it will have 20% in each stock model:
Later I’ll analyze how each model changed in 2019, but let’s cut to the chase and look at the net performance of one account. The account below is a taxable brokerage that’s eight years away from withdrawals starting. The return statistic is net of all management fees and transaction costs:
More risky accounts (with longer time horizons) earned higher returns and less risky accounts earned lower returns.
Here’s how each model contributed to the overall performance:
This model invests in either a U.S. or international stock index fund, but can shift to bonds if price momentum is negative for both stock funds. Here’s a post with an in-depth walkthrough.
The trend model spent most of 2019 in U.S. stocks. In hindsight this positioning was correct since stocks had a solid year and U.S. stocks outperformed international.
Relative price momentum between U.S. and international stocks is the main input to this model. This calculation measures performance over multiple periods – not just a single period like twelve months. Here’s a look at price momentum for each stock fund in 2019:
Until February the trend model was in bonds since momentum for both stock funds was negative.
This model is similar in nature to an insurance policy. A significant amount of academic evidence shows that trend following has been an effective way to reduce the downside risk of stocks. But no strategy is perfect, and expecting both outperformance in an up market and protection in a down market is like not paying for home insurance but still expecting a payoff when disaster strikes.
This model reduces stock exposure when there’s a high probability of recession. It has the same downside protection goal as the trend model, but it does so by analyzing economic data rather than price momentum.
The macro model was fully invested in stocks throughout 2019. In hindsight this was correct as economies grew and stocks rose.
The model is based on three indicators:
- Retail sales measure the dollar value of merchandise sold by retailers. Increasing retail sales indicates strong consumer spending and this indicator is considered healthy if retail sales have increased over the prior year.
- Industrial production tracks business activity and measures the output of manufacturing companies. Like retail sales, this indicator is considered healthy if it’s increased over the prior year.
- The unemployment rate tracks the labor market. Recessions have typically occurred when the unemployment rate quickly rises. This indicator is considered healthy if the unemployment rate is less than its average level over the past year.
I use these indicators because they cover three broad economic sectors and there’s historical data to 1950 for all three. Here’s how the indicators have changed over time (recessions in grey):
The macro model equally invests in U.S. and international stocks if at least two of the three indicators are healthy. If this isn’t the case, the model rotates to a bond fund.
The trend and macro models diversify each other because they’re driven by different types of data. They tend to take different stances at different times, and 2019 was an example of this.
Passive Stock Model
This model equally invests in U.S. and international stocks and follows a buy-and-hold approach.
A 50/50 split between U.S. and international aligns with the passive composition of global stock market:
I use a passive model because an Achilles heel for some portfolios is that they’re too reliant on the future looking like the past. If someone goes all-in on active strategies they’ve introduced a portfolio vulnerability if their approach stops working.
“You need to invest in a way so that the consequences of being wrong are tolerable.”Source: William Bernstein
This model guarantees participation in long-term market growth, but it does come with the volatility inherent in passive exposure.
Passive Bond Model
This model invests in regular and inflation-protected bonds. For tax-deferred accounts the regular bond fund is VGIT (Treasury bonds) and for taxable accounts the fund is VTEB (muni bonds). The same inflation-protected bond fund, VTIP, is used in both account types.
High inflation can result in traditional bonds experiencing stock-like drawdowns. For example, Treasury bonds lost 60% after inflation from 1940 to 1981. Inflation-protected bonds hedge against this.
Duration of the three bond funds averages 4.3. That means this model takes a medium amount of interest rate risk, compared to shorter or longer-term bond funds that result in a bet on the future path of interest rates. I avoid betting on rates since forecasters of the 10-year Treasury (dashed lines) have shown that nobody truly knows where interest rates are headed:
Here’s how target positioning of the 60/40 example account changed in 2019:
2019 was a low frequency year since there was only one model change (the trend model in February). Doing more isn’t synonymous with adding value, and I would much rather trade less than trade more.
Here’s how each model’s positioning sums up to the current allocation for a baseline 60/40 taxable account:
Four ETFs might look like a concentrated portfolio, but more holdings doesn’t equal more diversification. The four funds own over 15,000 individual stocks and bonds.
2019 was a good year and I’m proud Movement Capital clients earned solid returns. Two final thoughts:
Appropriately sizing active strategies is really important. Rather than take a binary stance on stock exposure based on one model, blending a variety of approaches ensures you’ll never be totally caught offside.
Portfolios are only one part of the financial puzzle. We focus on portfolios because they’re easy to measure. But a tax-efficient withdrawal strategy or well-timed Roth conversion will likely make more of an impact than correctly anticipating the next downturn.