Strategy Blends

Our strategy blends are what brings the three strategies from the previous chapters to life. By combining the three strategies in a core-satellite fashion, we create a family of portfolios. The members of this family all behave very similar to each other, but with different levels of risk. Among these blends, investors should easily be able to find a portfolio, that suits their needs.

Capital Preservation Portfolio

This portfolio marks the low-risk end of our strategy blends. This portfolio is suitable when Investing Toward a Goal, when Investing for Income, or when the investment is only held for a short period of time.

There is no construction involved here: the Capital Preservation Portfolio invests 100% of its capital in the Safeguard strategy. Therefore, all claims and observations made in the strategy discussion apply here.

The cumulative return chart shows how the Capital Preservation Portfolio produces strong returns with a downside that is much reduced, when compared to the aggregate bond benchmark.

This is especially true in times of rising interest rates, as seen in the 2022/23 period.

The rolling returns and tracking chart show that, for the most part the Capital Preservation Portfolio will keep up with the aggregate bond market. Any upside the portfolio has over its benchmark stems from either avoiding drawdowns, or from taking higher risks. After all, the Capital Preservation Portfolio will at times invest in longer maturities, or lower-quality bonds than the aggregate bond market benchmark.

The Monte Carlo simulation shows that the Capital Preservation Portfolio beats its passive benchmark in every dimension. Not only does it offer higher average returns, it also offersdependable returns that are higher across all time horizons, shorter break-even time, and faster recovery after deep drawdowns.

The portfolio metrics confirm these statements. On average, the Capital Preservation Portfolio offers about 1.5% higher returns, with less deep maximum drawdowns, and faster recovery. However, it is worth noting that the standard deviation of returns is slightly higher, due to the longer durations and/ or lower-quality bonds included in the portfolio.

Conservative Growth Portfolio

The Conservative Growth Portfolio aims to produce steady returns, while at the same time appealing to a risk-averse clientele. While it is slightly riskier than the Capital Preservation Portfolio, it is still very suitable for the Investing for Income and Investing Toward a Goal investment scenarios. Further, the portfolio is still very well-suited for short investment horizons of five years or even less

The portfolio construction involves all three of our strategies, but holds more than half of its capital in the Safeguard managed bond strategy. The inclusion of the Commitment and Opportunity strategies adds to the overall portfolio diversification and not only supports the returns, but also dampens overall volatility.

The cumulative returns show how the strategy offers very steady returns over a wide range of economic situations. Most importantly, the Conservative Growth Portfolio has been doing great in the 2001 and 2008 recession periods, and through the 2022 period of rising interest rates.

We benchmark the tactical portfolio against a buy-and-hold portfolio of 30% stocks and 70% bonds. Compared to this benchmark, the Conservative Growth Portfolio is about on par throughout bullish periods, while at the same time doing significantly better in recession periods.

The Monte Carlo simulation shows how the tactical portfolio beats its passive benchmark in all dimensions. Average returns and dependable returns are about 2% higher across all time horizons. Typical recession drawdowns are significantly lower, and recovery from such drawdowns is notably shorter.

The portfolio’s key metrics support the qualitative statements made above. Especially the risk-adjusted metrics and the low beta confirm the high quality of the investment.

Balanced Growth Portfolio

The Balanced Growth Portfolio balances decent returns with docile behavior. Its characteristics are close to the ubiquitous 60/40 portfolio; the baseline many investment advisors suggest for building long-term wealth. Expanding on this scheme, our Balanced Growth Portfolio is suitable for the long-term accumulation of wealth, e.g., in retirement accounts. In my opinion, it marks the goldilocks standard for the Investing Toward a Goal and Investing for Income scenarios.

The portfolio construction is shown above. This allocation makes sure that:

• we have a healthy allocation to Commitment as the centerpiece strategy
• bull-market returns are roughly on-par with the 60/40

With this construction, the Balanced Growth Portfolio fares significantly better than its strategic counterpart during major recessions, mostly thanks to its reduced downside. The cumulative return chart shows that investors get significantly more value out of their tactical investment, than they would with the strategic 60/40.

The rolling returns visualize how the Balanced Growth Portfolio gains against its passive benchmark during major downturns. Outside of such turbulent periods, the portfolio’s performance closely matches that of a passive investment.

The Monte Carlo simulation details how Balanced Growth Portfolio‘s lower end of expected outcomes is across the board higher than the 60/40‘s. In other words, this portfolio significantly increases the probability of successfully reaching critical financial goals.

The portfolio metrics quantify these effects. Notably, the portfolio’s average return is about 2.5% above its benchmark, while standard deviation, maximum drawdown, and maximum flat days all indicate a reduced downside risk. Together, these factors lead to significantly improved risk-adjusted returns.

Moderate Growth Portfolio

Within our family of portfolio blends, the Moderate Growth Portfolio marks the second riskiest place. While the returns are certainly higher those of the more docile portfolios, the risk increases slightly faster, effectively lowering risk-adjusted returns.

The portfolio construction shows how the Moderate Growth Portfolio is centered around Opportunity as its centerpiece. However, this aggressive trend-following strategy is tamed down through a sizeable allocation to Commitment, plus a smallish allocation to Safeguard. Overall, this composition allows for returns in striking distance of stock market returns, without sacrificing diversification.

With these properties, the Moderate Growth Portfolio is on the high end of risk for the Investing Toward a Goal scenario, and on the lower end of risk for the Investing Excess Funds scenario.

The cumulative returns show very docile behavior throughout the simulation period. The dot-com crash and the burst of the housing bubble are handled exceptionally well. But even short-lived crises, like the COVID epidemic, and periods of all assets dropping in unison like in the 2022 period of rising rates are all managed in superior fashion.

The rolling returns and tracking chart confirms these statements. While the Moderate Growth Portfolio performs mostly on par with its benchmark during bullish periods, it is outperforming its benchmark throughout major recessions.

The Monte Carlo simulation again shows advantageous properties in all dimensions. Average returns, dependable returns, volatility, expected recession drawdowns, and recovery time are all improved, when compared to the passive 80/20 benchmark.

The portfolio’s key metrics show average returns close to long-term stock-market returns. At the same time, the volatility is only about 60% of a pure stock-market investment. Especially the risk-adjusted metrics show a huge improvement over the passive benchmark, making this a high-quality investment with a wide range of applications.

Aggressive Growth Portfolio

This portfolio marks the high-performance end of our strategy blends. This portfolio is suitable when Investing Excess Funds, and for investors that don’t mind taking on full market risk. It is important to understand that this type of aggressive investment is only sensible for investment periods of 10 years or more.

Similar to the Capital Preservation Portfolio, there is no construction involved here: The Aggressive Growth Portfolio invests 100% of its capital in the Opportunity strategy. All statements made in the Opportunity chapter also apply here.

The cumulative return chart shows how the Aggressive Growth Portfolio is able to capture almost all of the stock-market upside, while doing a fantastic job on avoiding the downside. Nonetheless, this strategy is not meant to be used for investment scenarios that require hitting critical financial goals. Especially due to the tail risks involved with investing up to 100% of the available capital in the stock market, this strategy is better suited for Investing Excess Funds on a long time horizon.

The rolling returns and tracking chart show the quality of Opportunity‘s novel trend-following detector. With the exception of the dot-com bubble in the late 1990s, the Aggressive Growth Portfolio keeps up with the stock market across the decades. At the same time, it handles deep recessions, quick market meltdowns, and the fast recoveries exceptionally well.

The Monte Carlo simulation shows how the Aggressive Growth Portfolio adds tremendous value for investors. It improves average returns by ~2%, while at the same time reducing volatility, and raising dependable returns by up to ~4%. The break-even period is reduced to about 2.5 years, while recession drawdowns and recovery periods are cut in half.

The portfolio’s key metrics confirm the statements made above. Especially the improvements in risk-adjusted metrics, and the reduced recovery period make this an investment that is much preferred over buy-and-hold.

Comparison

Now having five investment portfolios in our arsenal, it is time to compare them.

The cumulative returns show what we expected: the portfolios differ in their risk and return, just the way we expected them to.

However, the difference between the various portfolios is much smaller than one might assume, especially when looking at the ex-ante Monte Carlo simulation.

With ourBalanced Growth Portfolio marking the goldilocks compromise, we note significantly lower expected recession drawdowns for the Capital Preservation Portfolio and the Conservative Growth Portfolio. And at least the Capital Preservation Portfolio also offers faster recovery after such drawdowns.

However, when we look at the dependable returns at the lower edge of the expected returns, we notice that only the Capital Preservation Portfolio offers us a slightly shorter break-even time. The Conservative Growth Portfolio‘s break-even time is almost exactly the same as that of the Balanced Growth Portfolio.

We can therefore conclude that the Capital Preservation Portfolio and the Conservative Growth Portfolio only offer a real advantage, when the investment horizon is very short, maybe shorter than five years, or when avoiding drawdowns as much as possible is a priority. But in all applications with longer investment periods, and a risk-attitude that can tolerate its investment risks, the Balanced Growth Portfolio will be the better choice.

On the higher performance end, the situation is similar. The Monte Carlo simulation shows that the Moderate Growth Portfolio and the Aggressive Growth Portfolio likely have deeper recession drawdowns, slower recovery from such drawdowns, and slightly longer break-even periods than the Balanced Growth Portfolio.

In investment scenarios that require meeting critical financial goals, the dependable returns are key. Here, both the Moderate Growth Portfolio and the Aggressive Growth portfolio trail the Balanced Growth Portfolio, at least for the first ten to fifteen years. And even after twenty-five years, the dependable returns of these riskier portfolios don’t surpass the Balanced Growth Portfolio.

However, when Investing Excess Funds, we are more interested in the average returns, than the dependable returns. Here, the situation is different. Both the Moderate Growth Portfolio, and the Aggressive Growth Portfolio offer higher average returns than the Balanced Growth Portfolio.

We can therefore conclude, that the Moderate Growth Portfolio and the Aggressive Growth Portfolio both have no place in Investing for Income and Investing Toward a Goal scenarios; their only sensible use is for Investing Excess Funds. Here, the choice mostly depends on the investor’s willingness to take risks, and the available investment horizon.

For investment horizons beyond twenty-five years, the Aggressive Growth Portfolio is probably a reasonable choice. This is especially true, when we consider the portfolio’s lack of diversification, and the tail risk associated with investing in a portfolio that potentially has 100% exposure to stocks.

For shorter investment periods, prudent investors should likely gravitate towards the Moderate Growth Portfolio, which at all times maintains at least a minimal level of diversification.