The Gold Conundrum And The Thing About Portfolios

After my piece on gold silver ratio was published, one of my acquaintances read it and asked me this question: is gold (or commodities in general) really necessary for The Bedokian Portfolio?

As usual, my response is: it depends.

Elaborating on my answer, I shall use the Portfolio Visualizer (seems obvious that this place is becoming my go-to site) to carry out a simple back test, with three versions of the US Bedokian Portfolio and benchmarked to the Vanguard 500 Index Investor, representing the US equity market.

• Bedokian Portfolio 1 (Portfolio 1): The balanced Bedokian Portfolio; 35% equities, 35% REITs, 20% bonds, 5% commodities (gold) and 5% cash.

• Bedokian Portfolio 2 (Portfolio 2): We shift the 5% component from gold to equities, hence 40% equities, 35% REITs, 20% bonds and 5% cash.

• Bedokian Portfolio 3 (Portfolio 3): We shift the 5% component from gold to REITs, hence 35% equities, 40% REITs, 20% bonds and 5% cash.

The period covered is from 1994 to 2018, as 1994 is the earliest year that REITs data is available on the Portfolio Visualizer site.

Fig. 1a – Portfolio returns, table view, 1994-2018. Inflation is not factored in.

Fig. 1b - Portfolio returns, graphical view, 1994-2018. Inflation is not factored in.

From Figures 1a and 1b, in terms of returns, the balanced Bedokian Portfolio lost out to the other two alternatives, which in turn trail badly against an all-equities portfolio. Risk-return (Sharpe and Sortino ratios) and volatility wise (standard deviation), the balanced portfolio had a slight edge over the rest.

So can we say do not add gold? Not so fast.

What if we use the period between 2001 and 2010? This decade covered the aftermath of the dot-com bust, the subsequent super bull, the Global Financial Crisis (GFC) and the follow-up recovery.

Fig. 2a – Portfolio returns, table view, 2001-2010. Inflation is not factored in.

Fig. 2b - Portfolio returns, graphical view, 2001-2010. Inflation is not factored in.

Interestingly, the balanced Bedokian Portfolio gave the most returns, yet still scored well in risk-return and lower volatility than the rest.

By now you may be wondering: these numbers are just hindsight statistical play, and I could just find a favourable period to prove my point. Yes, in a way that is correct, but what if in real life there was really a person who had a 10-year investment plan starting from Jan 2001; the gold allocation would had given additional returns (and lower volatility and better risk-return ratio) if he/she decided to withdraw all at Dec 2010 as compared to the rest. 

In my ebook I had stated that commodities are a form of insurance against market volatility¹. Though in the examples of Figures 2a and 2b, the difference of protection was not much, but at least it proved its insurance role.

Now The Thing About Portfolios…

Bringing in a related point, in my opinion there is no best strategic asset allocation-based investment portfolio around (and yes The Bedokian Portfolio is no exception). Each one of them has its own strengths, weaknesses, best and worst performance at different points in time and differing duration. So in summary, there could be one portfolio that is good at some moments, but not all of the time.

Yet I would like to emphasize that having a diversified portfolio of various asset classes still trumps a one-asset-class-only portfolio, especially in managing returns and risks at the same time.

And I shall end off with this disclaimer: past performance is not an indication of future results.

1 – The Bedokian Portfolio, p37

Assumptions on Portfolio Visualizer Data

Asset class representations used in the data: Equities = U.S. Stock Market; Bonds = Total U.S. Bond Market; REITs = REIT, Commodities = Gold; Cash = 1-month Treasury Bills. All dividends are reinvested and transaction costs (e.g. commissions) are not included.

Results

To see the results (Figures 1a and 1b) in its entirety for the 1994-2018 period in Portfolio Visualizer, click here.

To see the results (Figures 2a and 2b) in its entirety for the 2001-2010 period in Portfolio Visualizer, click here.

References

Standard Deviation – https://www.investopedia.com/terms/s/standarddeviation.asp

Sharpe Ratio – https://www.investopedia.com/terms/s/sharperatio.asp

Sortino Ratio – https://www.investopedia.com/terms/s/sortinoratio.asp

What Star Wars Can Teach Us About Investing

Today is Star Wars Day.

For this post, I will pull out nine famous quotes from the science fiction movie franchise and relate them to our real-life investment experiences.

#1: “Do or do not. There is no try.”

Yoda uttered this line while training the protagonist Luke Skywalker in The Empire Strikes Back. 

The key gist here is commitment. When learning about investing, or conducting your fundamental analysis, have determination and focus while carrying out the tasks. Do not do things half-heartedly.

#2: “You must unlearn what you have learned.”

Again from Yoda while teaching Luke in the same movie. 

It is refreshing to re-read some of the investment basics that we had gone through. Who knows, putting on that newbie hat again might spark some other points of view that we may have overlooked back then. Also, after a period of investing, most of us are quite into our own style and methodology, but it is good that if we could look at other alternatives and try to incorporate some of their pluses to ours to make it better.

#3: “Fear is the path to the Dark Side.”

And again, from Yoda, but this time from The Phantom Menace, while speaking to Anakin Skywalker.

Fear is one of the powerful emotions felt by humans, as it is the instinct to trigger the “fight or flight” response. While this is useful in physically dangerous situations, in the world of investing, this is a big no-no. The important thing is to stay calm and take stock of what is going on, before deciding on your next move. Engulfed by fear, and chances are your portfolio will go to the dark side, of losses.

#4: “Great, kid. Don’t get cocky.”

Han Solo told this to Luke in A New Hope, after the latter had shot down an enemy spacecraft.

It is common for new investors to feel euphoric and confident after getting their first positive returns. However, if this “high” continues, overconfidence will set in, and this could be detrimental in subsequent investment analysis and decisions. Be happy, yes, but everyday is not a Sunday, so stay focused and resume your everyday routine.

#5: “Now, be brave and don’t look back.”

This was said to Anakin by his mother, Shmi Skywalker, just before the former left home to train to be a Jedi, in The Phantom Menace.

It is natural that we do look back at our decisions and wonder if they are good or bad. Whatever it is, it was over and we have to make do with it. Lamenting on past investment decisions, such as ‘I should have sold it at a higher price’ or ‘I was following this counter but did not go in. Now it went up above my valuation’, is not healthy. Leave this baggage behind and focus on the present.

#6: “Who is the more foolish? The fool, or the fool who follows him?”

Obi-Wan Kenobi quipped this in A New Hope.

This is akin to herd mentality, or some might say “jumping on the bandwagon” or “fear of missing out”. Be it an asset class, a sector, a region/country or even an individual share/bond, there are times when it becomes hot, everybody will want to have a piece of it. Sometimes it is better to take a breather and find out what is it all about before making that jump. To quote another phrase from a song: “Wise men say only fools rush in”.

#7: “Stay on target.”

A pilot muttered this while flying towards the attack target in A New Hope.

There are aims and objectives when starting off an investment portfolio, such as to have an $X amount of portfolio generating Y% of yield when I reach age Z. Investing is a long journey, at least 10 years in my definition, so please do not stray from your course unless absolutely necessary.

#8: “Difficult to see. Always in motion is the future.”

And we are finally back to Yoda, who said this to Luke in The Empire Strikes Back.

As I have always mentioned countless times, we really do not know what the future holds. We may have past and present data (i.e. the Force in our context), but these provide at most a guesstimate. In my opinion a guesstimate is still better (and more prepared) than a wild stab in the dark wearing a blindfold.

#9: “The greatest teacher, failure is.”

This last one is from Yoda (who is full of sensible quotes if you know by now) to Luke in the latest Star Wars movie The Last Jedi.

Failure is one of the biggest bugbears one could face in life, but it is also a good lesson to learn from. Pick up the pieces, learn from them and move on. Do not let just a few bad experiences put you totally off from investing. Strength is not from winning all the time, but also from climbing up when you are down.

Unfortunately, there is no lesson to be shared from the most famous quote of all: “No, I am your father”.

May the Fourth be with you.

The Gold Silver Ratio

The gold silver ratio (GSR for short) is the number of ounces (oz) of silver required to buy one ounce of gold (i.e. price of 1 oz silver / price of 1 oz gold). It is used by gold and silver traders to determine when to buy or sell the two precious metals. 

Unlike most other ratios where there is a generally accepted number or a range of numbers, the GSR has none. One oft-quoted number is 17.5, which is the amount of silver to gold in the Earth’s surface. However, based on the last 30 years or so, the ratio did not even hit that number, and the lowest was back in 2011 where the GSR was slightly above 30¹.

Though these two are precious metals and have a high positive correlation with each other (0.79 between 2007 and 2018²), the GSR swung wildly between the 30s and 80s during the said period, and as of now it is about 80-plus³.

Gold and silver are two of the three assets for the commodities component in The Bedokian Portfolio⁴. If your portfolio has only gold or silver, then you can take this article as knowledge. If you have both, then read on.

Gold And Silver Are The Same, Yet Different

Chemically, gold and silver belongs to group 11 in the periodic table of elements, along with copper, meaning they have similar properties such as good electrical conductivity and are used for coinage. Their current usage, however, differs with each other. Silver is used more in industrial applications, such as electronics and photography, while gold, though there are some industrial uses for it, is mostly used for jewellery and for investment purposes.

From a portfolio viewpoint, looking at both, you can say that they are akin to sectors within the equities asset class. Just like financials and consumer staples, they could be positively correlated but both can be up and down separately for certain periods of time.

GSR As A Rebalancing Tool

We know that rebalancing involves selling the overpriced and buying the underpriced to balance our portfolio back to its asset class allocation. Likewise, we can make use of GSR as a rebalancing tool for gold and silver within the commodities portion. The tricky part is what would be the “magic number”, which unfortunately there isn’t any.

If you have some trading background, you could employ technical charting such as trends and signals. However, for the not-so technically inclined (like myself), you could use a moving annual average of past GSRs, something like how I would do it for the indices in my 10-30 Rule in my ebook⁵.

Let’s say I want to use a 3-year moving annual average, so I would take the GSR at the beginning and ending of 2016, and get an average value for that year. I repeat for the years 2017 and 2018, and then I will average these three numbers to get the final average number, and that will be my “magic GSR number” for 2019. When 2020 comes, I will get the 2019 figure and average it together with 2017’s and 2018’s, and I have another new “magic GSR number”. 

This is just one method. You can choose any number of years for your moving annual average, and/or you can choose to obtain the GSR from different points within a year instead of twice, like three times for the case of half-yearly (1 Jan, 30 Jun and 31 Dec) or five times for quarterly (1 Jan, 31 Mar, 30 Jun, 30 Sep and 31 Dec). Furthermore, instead of one number, you can have a tolerance range (e.g. plus 10, minus 10).

You may be wondering, “I already have a 50-50 allocation of gold and silver in my commodities. I could just rebalance according to these fixed percentages. Do I still need GSR to guide me?”

And my answer is: it is up to you.

Cheers!

1, 3 – Goldprice. Gold/Silver. https://goldprice.org/gold-silver-ratio.html  (accessed 20 Apr 2019)

2 – Portfolio Visualizer. Annual returns correlation between GLD and SLV ETFs, 1 Jan 2007 to 31 Dec 2018. https://www.portfoliovisualizer.com/asset-correlations?s=y&symbols=GLD%2C+SLV&endDate=04%2F20%2F2019&timePeriod=4&numTradingDays=60 (accessed 20 Apr 2019)

4 – The Bedokian Portfolio, p36

5 – ibid, p119-120

It’s That Season Again

SPH REIT had just declared their 2Q2019 results and dividends. For REIT investors, SPH REIT’s announcement marks the beginning of the so-called REIT CD (cum dividend) season, where in the next few weeks, we will see most of the S-REITs publish their finances and distributions for their quarter.

For dividend investors like myself, this period is “full-of-win” as you will know how much you are getting from your REIT portfolio. If you are carrying out the Bedokian Portfolio investment approach, the distributions received will be parked at the cash portion, ready for deployment into whichever asset class in the next rebalancing moment.

At the same time however, you will also need to review the REITs’ results for the quarter and comparing them with past performances. 

The numbers that you used months or years ago in selecting a REIT to invest may have changed today, such as the net asset value (NAV), weighted average lease expiry, gearing, etc. For SPH REIT’s case¹, between 31 Aug 2018 and 28 Feb 2019, the NAV had changed from SGD 0.95 to SGD 0.94, and the gearing had increased from 26.3% to 30.1%.

Then again, numbers do not form the whole picture, and a holistic approach is required when conducting fundamental analysis. If you are vested in this REIT and if time permits, you can have a relook and then decide if you want to hold, sell or add more of it.

In the meantime, keep calm and collect dividends.

1 – SPH REIT. Financial Statements And Related Announcement: Half Yearly Results. 5 Apr 2019. http://sphreit.listedcompany.com/news.html/id/711266 (accessed 6 Apr 2019).

The SIA 3.03% Bond: The Bedokian’s Take

Another corporate bond is coming to town, and yes, it is the Singapore Airlines (SIA) 3.03% bonds. A few financial blogs had articles on it, so I shall just concentrate my post from a Bedokian Portfolio investor’s point of view.

Let us run through this bond using my conservative selection guidelines stated in my ebook¹:

• Bond is priced at par or discount: If you are applying for the bond at this stage and got it, it is considered as getting it at par (well almost. There is this $2 application fee which makes it slightly above par, but we will just let it be).
• At least five years to bond maturity date: Pass, since the bond tenure is exactly five years.
• Credit rating of “investment grade”: This is the gripe. According to the product highlights sheet², it was stated that the issuer (i.e. SIA) and the bonds are not rated by any credit agency. We shall look at this later.

In conjunction with the selection guidelines, we still need to conduct a full fundamental analysis (FA), using the Bedokian Portfolio’s three-level FA approach, on SIA. However, we shall only highlight some of the important points from our own analysis as well as from other sources.

Company Level

First up we will look at SIA from an equity investor’s perspective. Key indicators pertaining to bonds (a.k.a. debts) will be the debt-to-equity (D/E) and current ratios, which are (from Yahoo Finance)³ is 40.03 and 0.5 respectively. Going by The Bedokian Portfolio’s equity selection guidelines⁴, that is not so good.

SIA, being in the airline industry, having a high D/E is the norm due to the capital-intensive nature (in fact, the issuance of these bonds are meant for the purchase of aircraft and aircraft related payments⁵). In the case of having high leverage, a strong cash flow is very important for the company.

Kyith from Investment Moats had detailed SIA’s financial information and cash flow, and concluded: “Their financial position looks strong enough to pay the coupon payment”. He also highlighted that the non-current liabilities were mostly past bond issues and very little bank loans⁶.

Environmental Factors Level

The airline industry is very competitive and price-sensitive, period. A rise in air ticket prices will send customers to another airline that offers lower ones, ceteris paribus. This means for an airline that is not so cheap, it has to offer some other value-added services or experiences, which in other words, qualitative advantages.

SIA got the world’s best airline title, as well as best first class, best first class airline seat and best airline in Asia, as ranked by research firm Skytrax in the priod Aug 2017 to May 2018⁷. Such awards are important as SIA can be seen as a premium in terms of quality, thus it may appeal to customers who does not only see price in choosing an airline. 

Still, SIA has an answer to price-only customers, in the form of their subsidiary Scoot.

Economic Conditions Level

Air travel has become part and parcel of travellers wanting to go overseas, or to go from one part to another part in a large country efficiently.  The same goes to air freight and the transportation of cargo and goods.

During an economic downturn, demand for discretionary travel and goods tend to fall as consumers would want to ride out the storm and save, thus there is some positive correlation between airlines and the state of the economy. To prove this point, the annual growth rate in global air traffic passenger fell from 7.9% to 2.4%, and then to -1.2%, in the years 2007, 2008 and 2009 respectively, the latter two being the Global Financial Crisis years⁸.

No Ratings and Not Secured

I guessed I may have got carried away with my FA. Now back to the bond. Remember that this bond is not rated? Then there is only one other thing that you have to rely on, and that is faith.

On another related note, the product highlights sheet mentioned that the bonds are not secured⁹, meaning the bonds are not tied to any collateral except for the good faith of the company. Hence in the event of SIA’s winding up before the bonds mature:

“…the Bondholders will not have recourse to any specific assets of the Issuer and its subsidiaries and/or associated companies (if any) as security for outstanding payment or other obligations under the Bonds and/or Coupons owed to the Bondholders and there can be no assurance that there would be sufficient value in the assets of the Issuer after meeting all claims ranking ahead of the Bonds, to discharge all outstanding payment and other obligations under the Bonds and/or Coupons owed to the Bondholders.” 

Sounds morbid? Well in any investment, we have to consider all risks, and this will depend on how you view those risks. It is up to you how to judge the probability of those risks.

Judging from the past performance (though it is not an indicator of future returns), SIA had returned positive net profits and good cash flow, so in my opinion, the “no-ratings” and the unsecured bond issues would be on a low.

The Coupon Rate

At 3.03%, this coupon rate is considered low among corporate bonds. Taking a 5-year Singapore Government bond that was issued recently on 1 Feb 2019 (at 2% coupon rate, which I use it as the risk-free rate) for comparison¹⁰, the risk premium is 1.03% (3.03% – 2.00% = 1.03%). Meaning for that extra 1.03%, assuming holding the bonds till maturity, you will have to worry whatever bad points that were said in the above sections. 

Seedly had compared the coupon rate with other investment instruments with different tenures, like CPF, fixed deposit rates, etc¹¹.

Finally, The Bedokian’s Take

And the anti-climatic answer is: it boils down on the individual’s comfort level and risk tolerance. If you are interested, do remember that diversification is paramount in an investment portfolio, and adhere to the 12% limit rule.

You have until 26 Mar 2019, 12:00 pm to decide, so take this weekend to have a thought-out.

1 – The Bedokian Portfolio, p100-101

2, 5, 9 – Product Highlights Sheet. 19 Mar 2019. https://www.singaporeair.com/saar5/pdf/Investor-Relations/SIA-Retail-Bond/product-highlights-sheet-19March2019.pdf (accessed 22 Mar 2019)

3 – Singapore Airlines Limited. Yahoo Finance. https://sg.finance.yahoo.com/quote/C6L.SI/key-statistics?p=C6L.SI (accessed 22 Mar 2019)

4 – The Bedokian Portfolio, p96-97

6 – Singapore Airlines SIA issues a Safe 5 Year 3.03% Retail Bond – My Take. Investment Moats. 19 Mar 2019. http://investmentmoats.com/money/singapore-airlines-sia-5-year-3-03-retail-bond/ (accessed 22 Mar 2019)

7 – Kaur, Karamjit. SIA bags world’s best airline title. The Straits Times. 18 Jul 2018. https://www.straitstimes.com/singapore/transport/sia-bags-worlds-best-airline-title (accessed 22 Mar 2019)

8 – Statista. Annual growth in global air traffic passenger demand from 2006 to 2019. https://www.statista.com/statistics/193533/growth-of-global-air-traffic-passenger-demand/ (accessed 22 Mar 2019)

10 - The Monetary Authority of Singapore. Results of auction of taxable book-entry Singapore Government Bonds to be issued on 01 February 2019. 29 Jan 2019. http://www.sgs.gov.sg/~/media/SGS/SGS%20Announcements%20pdf/Bonds%20PDF/2019/N519100A%20Result.pdf (accessed 22 Mar 2019)

11 – Tan, Cherie. SIA Retail Bond 2019 – The Good, The Bad and Everything You Should Know. Seedly. 21 Mar 2019. https://blog.seedly.sg/sia-retail-bond-everything-you-should-know/ (accessed 22 Mar 2019)

The Rise of The Tech Conglomerates

The moment we see the word “conglomerate”, we began to associate it with companies that have multiple business divisions doing all sorts of stuff. General Electric, Siemens and Keppel are some examples of conglomerates. Most of these known conglomerates have a very long history. Jardine Matheson started off in the 1830s as a trading company in the Far East; Philips was founded in the late 19th century manufacturing lamps. 

Over the years the name of these companies became great intangible assets. Think “Mitsubishi” and the things that pop out of our heads will be cars, air conditioners and the WW2 Zero fighter planes. Or when we talk about Samsung, smart phones, televisions and shipbuilding will come to mind.

While these conglomerates took a long time to become what they are now (so-called traditional), there is a new breed coming up fast and hard, and from a sector that we did not expect it; technology. Recently we are seeing some tech firms rapidly becoming conglomerates, doing (or about to do) things that are not what they were in their beginnings.

Amazon came about as an online bookstore in 1995, but now they have become a huge e-commerce powerhouse and ventured into traditional sectors such as supermarkets (through their acquisition of Whole Foods). Grab originated as a taxi-hailing app in 2012. Today, besides being a ride-hailing company, Grab also has a food delivery network, a payment platform and is about to offer loans to companies¹. What are the main factors for their rapid rise to conglomerate status as compared to their traditional counterparts? Three reasons: platform, data and network, and they work in synergy with one another.

Reason #1: Platform

A platform (in my definition for tech) is an integrated system that encompasses backend processes, front-end interface by consumers and any supporting components in between that make it work. The key attributes of the platform are that it should be scalable and adaptable to suit different situations and business needs.

Apple’s platform (or ecosystem as most called it) allows seamless integration between one’s computer, mobile device, entertainment and even exercise regime. The Grab app now includes looking for a ride, topping up your electronic wallet and scan QR codes to pay for your purchases (and earn some points). 

Reason #2: Data

In the 21st century, data is the new gold. Why is this so? Sieving through data carefully, you will get information. Digesting that information, you will gain useful knowledge. Now you know why data analytics is so “in” now.

Tech firms, through their platforms, have amassed tons of data from consumers. With this and through data analytics, they can roughly estimate the “5 Ws and 1 H” (what, where, when, why, who and how) of customers. With these outcomes, they could provide new products and services, and/or improve on existing ones.

Amazon, by using data collected from customers buying from its website, would further recommend products that they think the customers may be interested in.

Reason #3: Network

“Network” here means a slew of things, ranging from collaboration with other firms to the outright buyover of companies. Big businesses, both traditional and technological, carry out the “networking” to venture into a new sector and/or to gain some product, service and/or expertise to synergise with their operations.

The earlier cited example of Amazon buying over Whole Foods is one aspect of “network”. In 2002, eBay acquired PayPal to better integrate the latter’s online payment service to the former’s e-commerce operations.

So What Do All These Mean?

As an investor, these things present opportunities for your investment portfolio, although I must say it is not so simple as it seems. Admittedly I did not foresee Grab’s move into the online payment sphere, even though I had mentioned that payment solutions are trending in the days to come. Though I had written on looking for the next big thing, these only provide some partial guesstimates and half-baked clairvoyance into the future.

Then on the political front we have an American politician wanting to break up big technology companies. Just a few days ago, Elizabeth Warren, a senator who may be running for the United States Presidential Elections next year, was quoted in an interview²:

"Amazon operates this platform. That's cool. I'm for that. But Amazon does a second thing. They suck up information from every single transaction — information about buyer, information about the seller. And they then can use that information to make a decision to enter the marketplace themselves."

And this was directed at Reason #2 above.

In the meantime, disruptions are still ongoing, and who knows we may see a “network” between traditional and technological conglomerates working together.

1 – Cheng Wei, Aw. Grab offers firms loans of up to $100,000. The Straits Times. 14 Mar 2019. https://www.straitstimes.com/business/grab-offers-firms-loans-of-up-to-100000 (accessed 17 Mar 2019)

2 – Taylor, Jessica. Sen. Elizabeth Warren Blasts Big Tech, Advocates Taxing Rich In 2020 Race. www.npr.org. 15 Mar 2019. https://www.npr.org/2019/03/15/702707734/sen-elizabeth-warren-takes-longtime-fight-for-a-level-playing-field-to-2020-race (accessed 17 Mar 2019)

Which Bedokian Portfolio Combination Is Suitable For You?

In my eBook I had touched on three different Bedokian Portfolio variations¹, each broadly suited for investors of different age groups and/or risk profiles. Let us revisit what are the three:

• Young investor aged 21-35 / Aggressive investor: 40% equities, 40% REITs, 10% bonds, 5% commodities, 5% cash (we call this Portfolio 1).
• Middle-aged investor aged 36-55 / Moderate investor: 35% equities, 35% REITs, 20% bonds, 5% commodities, 5% cash (also known as the balanced Bedokian Portfolio, which I use most of the time as an example)(Portfolio 2).
• Retiree investor aged 56 and above / Conservative investor: 20% equities, 20% REITs, 40% bonds, 10% commodities, 10% cash (Portfolio 3).

What would be the performance of these three portfolio combinations? Using U.S. market data from the Portfolio Visualizer (www.portfoliovisualizer.com), let us assume a U.S. Bedokian Portfolio investor with an initial amount of USD 10,000 and does annual rebalancing. Since the site’s earliest data on REITs was from 1994, we shall use the period of 1994-2018, a 25-year span. We will also include the S&P500 ETF as a benchmark, since this roughly represents the U.S. equity market as a whole.  

Fig.1 – Portfolio returns, table view, 1994-2018. Inflation is not factored in.

Fig.2 – Portfolio returns, graphical view, 1994-2018. Inflation is not factored in.

Let Us Compare

Looking at the whole thing, it is no doubt that investing in the S&P500 for 25 years will trump every Bedokian Portfolio combination out there, even the most aggressive one (Portfolio 1). Yes, the results are there and I do not dispute it. However, this just highlights the fallacy that most investors would tend to fall for, and that is looking at just the returns.

If we run a similar test, but making 2009 as the end year, the results would be vastly different:

Fig.3 – Portfolio returns, table view, 1994-2009. Inflation is not factored in.

Fig.4 – Portfolio returns, graphical view, 1994-2009. Inflation is not factored in.

And in 2009, naturally the returns-only investor would proclaim that the aggressive Bedokian Portfolio was the best.

Returns are very subjective and will change from time to time, depending on what you are invested in and when you are looking at your investments. A well-known way to have good returns all of the time would be tactical asset allocation, where you adjust the weightage of the asset classes, sectors and/or individual companies to capture the best returns. Problem is, this meant a very sound grasp of what is coming, and I can say not even the best investor or fund manager can do it 100% of the time.

Risk And Returns

There are two ‘Rs’ in investing, one is returns and the other is risk, specifically market risk. These two attributes form the very basic premise of the Modern Portfolio Theory (MPT), where investors build portfolios to optimize returns based on a given level of risk, and it also advocates the advantages of diversification.

There are a few ways to measure risk. One is to use standard deviation, which measures the past volatility of an asset class or security. The higher the standard deviation, the more volatile the asset class/security is (and thus, more risky). Another is the Sharpe ratio, where it is the measure of the excess returns above the risk-free rate over the standard deviation. The higher the Sharpe ratio, the better it is.

Lastly we have the Sortino ratio, which is similar to the Sharpe ratio, but it uses only the downside standard deviation instead. Like the Sharpe ratio, the higher the Sortino ratio, the better it is.

Let Us Compare Again

Reevaluating the numbers in Fig.1 and Fig.3, taking risk and returns in mind, Portfolio 3 stood out as the best with a lower standard deviation, and higher Sharpe and Sortino ratios. This concludes the suitability of Portfolio 3 for the conservative and/or retiree Bedokian Portfolio investor.

The results also highlight a common adage in investing; higher returns typically require higher risks. In Fig.1, the S&P500 ETF gave the highest returns, but also the highest risk based on the three risk measurements. But in Fig.3, Portfolios 1 and 2 gave the higher returns with lower risk than the S&P500 ETF (hence my bold on the word ‘typically’). This reinforces the importance of diversification at the asset class level, where risk is tapered and correlation may bring higher positive returns and lower losses.

Still, I acknowledge every person’s personality and characteristics are different, and so is the respective person’s risk appetite and investment style. The usual disclaimer applies and of course, the phrase: "past performance does not indicate future returns".

1 – The Bedokian Portfolio, p72.

Assumptions on Portfolio Visualizer Data

Asset class representations used in the data: Equities = U.S. Stock Market; Bonds = Total U.S. Bond Market; REITs = REIT, Commodities = Gold; Cash = 1-month Treasury Bills. All dividends are reinvested and transaction costs (e.g. commissions) are not included.

Results

To see the results in its entirety for the 1994-2018 period in Portfolio Visualizer, click here.

To see the results in its entirety for the 1994-2009 period in Portfolio Visualizer, click here.

References

Standard Deviation – https://www.investopedia.com/terms/s/standarddeviation.asp

Sharpe Ratio – https://www.investopedia.com/terms/s/sharperatio.asp

Sortino Ratio – https://www.investopedia.com/terms/s/sortinoratio.asp