Posted By admin on Aug 20, 2013

I have been browsing some excellent websites recently and I came across a post from a blog that is listed in blog roll that talked about asset allocation. I thought that it would be fun to do a series of individual posts where I would profile an asset allocation investment style called, the Lazy Portfolio, to see how it has done over the past years.

I’m going to take the approach that people looking at these blog posts are just starting to invest. If you’re not a novice investor just skip all this below and head straight to the graphs on page 2.

A portfolio is a grouping of financial assets such as stocks, bonds and cash. It will often consist of various mutual funds, which are an investment vehicle that made up of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments etc. I’ll generally compare the portfolio to either the S&P 500 or Dow Jones. The S&P 500 is an index of 500 stocks chosen based on market size, liquidity and industry category, among other factors. The Dow Jones Industrial Average is made up of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

This portfolio (the Lazy Portfolio) will be equally weighted where 25% goes to Gold, 25% goes to long term government bonds, 25% goes to REIT, and the remaining 25% goes to the S&P 500. The back test will test for the ** nominal return** which is the rate of return on an investment without adjustment for inflation and the

*real return rate**of an investment, which adjusts for inflation. Inflation is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.*

The risk metrics, or units of measurement used to evaluate the portfolio are the Sharpe Ratio and the Sortinto Ratio. Even though I generally don’t use the Sharpe Ratio to evaluate funds or portfolios, it is an industry standard, so we will use it for this back test. The Sharpe Ratio is a ratio that is designed to tell us whether a portfolio’s returns are due to smart investment decisions or the result of excess risk. The Sortino ratio is similar to the Sharpe ratio, except, it uses downside deviation (A measure of downside or negative volatility that focuses on returns that fall below a minimum threshold or minimum acceptable return – **MAR**) for the denominator instead of standard deviation, the use of which doesn’t discriminate between up and down volatility.

In this series we will also test for the drawdown in the portfolio which is the peak-to-trough (top to bottom) decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted as the percentage between the peak and the trough.This series will also look at the correlation between the US markets and the International markets. Correlation is a statistical measure of how two securities move in relation to each other. Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1. Perfect positive correlation (a correlation co-efficient of +1) implies that as one security moves, either up or down, the other security will move in lockstep in the same direction. Alternatively, perfect negative correlation means that if one security moves in either direction the security that is perfectly negatively correlated will move in the opposite direction.

The portfolio will also be unbalanced and re-balanced; Rebalancing the portfolio is the process of realigning the weightings of the portfolio of assets.

As one can see from the backtest the Equal Weighted Portfolio outperforms the S&P 500 in Compound Annual Growth Rate – CAGR which is the year-over-year growth rate of an investment over a specified period of time. The re-balanced equal weighted portfolio has less volatility and lower drawdowns. Page two has the graphs for the S&P 500 and the Equal weighted portfolios.

Chad O. Grant

**Portfolio Growth Nominal – Equal weighted Assest Allocation**

**Portfolio Growth Real – Equal weighted Asset Allocation**

**DrawDown – Equal weighted Asset Allocation**

**Portfolio Growth Nominal – S&P 500**

**Portfolio Growth Real – S&P 500**

**DrawDown – S&P 500**

Chad O. Grant

You must log in to post a comment.