Investing is emotionally charged, thanks to the “power of now” in our lives and our news cycles. This emotional charge leads to poorly rationalized actions with our investments.
Successful Investing, happens when you are noticing what you are noticing. It’s recognizes the polarity between order and chaos; emotional and rational thinking; simple and complex; more and enough. Changing a portfolio without purpose, feels like changing pitchers in a baseball game - it’s the illusion of activity based on a “gut feeling”. Many don’t recognize how similar change rationale in your portfolio may lead to things falling faster than a Jenga skyscraper.
Investing can be like balancing your daughter’s wedding cake while flying cross-country on a commercial airliner. Most of the time, it’s fine - the pilot turns off the fasten seat belt light and you have an on time arrival. But get bounced in any direction by a turn or unexpected turbulence, or hit by the drink cart, or another clueless passenger, and you are screwed. Plus, there are times when there are expected inconveniences - boarding, connections, crowded restaurants, short layovers. Investing has the same complexity and same type of problems - some in our control, and others where we need to be prepared. There are a lot of moving parts that you have to hit perfectly.
The Moving Targets of Investing
How can you expect to be a successful investor when you are aiming at multiple moving targets?
Moving Target 1 - Life happens and goals change or require a new means to achieve them. Job changes, college funding, family size, aging parents are some that we will all face at some time. There are others that are less common, but still may significantly impact your plan.
Moving Target 2 - Markets misbehave - it is what they do. Unfortunately, our human nature results in us handling this behavior quite poorly. It is another change to let our emotions take over, and frankly, we suck at it. We tell our kids all the time that bad behavior doesn’t justify bad behavior - why do we allow ourselves to misbehave with our money.
Moving Target 3 - Your risk profile. The important aspects of risk are (1) what risk is required to enable your goals, and (2) what is the maximum risk you can afford to take without putting your goals in jeopardy, (3) what is your desired risk tolerance - hopefully this falls between the risk required and maximum risk, and (4) what is your risk composure in turbulent markets - this is a sliding scale.
If your risk composure falls between your risk required and maximum risk (some call this risk capacity) you are in a good place. Anything above your risk required is unnecessary risk. Recognize that contributions to your account make you more risk agnostic and distributions makes your account more risk dependent.
How do we confront moving targets in investing?
I use a rules-based, Relative Trend investment strategy that switches the holding within an asset class based on relative price performance. The trend is based on relative price strength between an “offense” and “defense” position. The “offense” position is for when the markets has a more constructive stance. Conversely, the “defense” position is when the markets have risk off tendencies. This relative approach doesn’t necessarily change the asset allocation, just the risk allocation within the asset class. We switch between the two holdings based on market behavior, rather than when the earth orbits the sun. Below is a chart of our strategy in motion with our Domestic Large Cap position.
Here is the difference in each position’s risk profile, courtesy of Riskalyze.
Here is MTUM…
Here is USMV…
Changing between offense and defense has five distinct features over a buy-and-hold approach: (1) Your current 401k is not capable of diversifying like this. Diversification isn’t just about asset classes, but extends to the management of those asset classes, (2) you not only have dynamic asset allocation, you also have dynamic risk allocation - your risk profile isn’t a snapshot of a risk tolerance questionnaire you took three years ago, it includes a risk required, risk desired, and your risk composure which changes when your situation or the markets change. This space defines your full risk spectrum range. Relative Trend can slide in that range based on current market behavior and capitalize on your full risk profile, (3) you already have a plan for when to sell and what to buy in its place, no need to wonder if now is the time to buy back in or when to sell (4) you remain invested in the asset class in case the market continues on a constructive path; while this dynamic risk management technique provides an intriguing risk-adjusted return, it is vulnerable to whipsaw markets that generate false positives. Relative Trend Portfolios should be viewed as a short-term insurance policy that may not be needed, but serve as an emotional backstop to possible bad behavior, and (5) knowing this approach, how it works, and understanding its triggers, makes you more likely to stick to your financial plan.
Much like a balance bike allows kids to focus on what attributes of learning to ride at a time (balance), our rules-based, Relative Trend Portfolio approach converts three moving targets into one and allows us to focus on our life goals. The Relative Trend Portfolio serves as a control for market and personal bad behavior within our personal risk profile, so we only have to do one thing at a time.
What is a Relative Trend Portfolio?
According to Corey Hoffstein…
Performance tends to persist in the short-run. The theory behind trend equity is that behavioral biases exhibited by investors leads to the emergence of trends. Trend equity strategies seek to capture this potential inefficiency.
Using Relative Trend Portfolios with smart beta indexes create unique opportunities. Smart beta indexes are concentrated subsets or reallocated equity within an index with a specific strategy.
Relative Trend attempts to identify behavioral inflection points that are (a) indicative enough to say a trend has shifted, (b) provide an opportunity through this switch to outperform either index on its own, and (c) prevent oversteering leading to excessive trading or excessive opportunity cost on the upside where an “all in” or “all out” is more vulnerable to false positives.
Relative Trend Portfolios attempt to further diversify your portfolio while capturing market inefficiencies created by market behavior. The intent behind this approach is to enhance client adherence to sticking to their financial plan and improving investing success by isolating all the moving targets.
Most people have unreasonable expectations when it comes to investing - mainly outcome based (big returns) and time (fast). Investing should be about a successful process than enable the life you want to live - what you want to do and when you want to do it with your money. We focus on process with an emphasis on reducing risk, reducing expenses, reducing taxes while hoping to improve returns in a market we have no control over so that you can live the life you want. We believe our Relative Trend tactics are a critical ingredient to increasing the probability to achieving your goals.
Current Relative Trend Portfolio Holdings
Asset Class Offense Defense Current Change Date Index
US Large Cap MTUM USMV Defense 10/1/2018 SPY/ITOT
US Small Cap EES SMMV Defense 9/14/2018 IJR/ITOT
Global VT ACWV Defense 8/20/2018 VT
International IMTM EFAV Offense 6/13/2019 SCHF
Emerging Mkts FNDE EEMV Offense 4/15/2019 SCHE
EM Bonds VWOB SCHZ Offense 2/6/2019 SCHZ
Hi Yield Bonds ANGL SCHZ Offense 4/30/2019 SCHZ
Bank Loans SRLN SCHZ Defense 1/15/2019SCHZ
Strategic Inc RIGS SCHZ Defense 2/5/2019 SCHZ