Building a passive portfolio

[HavocXphere]

Judging by the active vs passive thread we've got some pretty knowledgeable people here so I'm curious what your thoughts are on building a passive portfolio.

Specifically on how to work out how much exposure to get on the various characteristics (for lack of a better word). Regional vs World. Emerging markets versus Developed. Blue chip vs small cap. Shares vs Bonds/cash. Hedged or unhedged.

Not ZA specific so more interested in the overall thinking on how to approach this.

I see I can get Excels (iShares) to see what exactly is in all the funds & crunch the numbers but that doesn't really help me if I don't know what to shoot for.

 

[gimpex]

The various exposure characteristics are very much dependent on you as a person. Not only your age , expectations , risk profile but also your personality / character. Your profile might suggest x but if you are not risk prone you will not sleep well at night.

 

[HavocXphere]

Copy the Asset Allocation of your favourite balanced funds

Thats a nifty idea. Thanks

 

[FxJalarupa]

Or you can build a portfolio model in excel and map standard deviation and Sharpe ratios with performance criteria, and using the solver function in excel you could solve for the most efficient portfolio mix (based on past performance of course)...

I have built such a tool a while back to build unit trust portfolios, maybe time to revisit with new focus

 

[Hamster]

Personally I'm guessing the trend of the Rand based on articles etc. I've read. While the Rand was plummeting over the last couple of years offshore ETFs were coining it.

The trend seems to be that it will be strengthening over the next year or two so it makes sense to shift balance to local shares.

All the said, the aim of a passive portfolio is to be on autopilot for as much as possible.

So:
35% DBXWD
10% PTXTEN
55% MAPPSG

Why? 10-15% property because that is the general consensus and gives you exposure to dividends and REIT. PTXTEN specifically because top 10 property companies equally weighted.

MAPPSG because it gives me 75% exposure to NFSWIX (top40) which self regulates depending on which sectors are doing well. Also gives me 20% bonds exposure.

Those three ETFs should require almost no maintenance for you.

This is the way I think about it anyway.

 

[HavocXphere]

Or you can build a portfolio model in excel and map standard deviation and Sharpe ratios with performance criteria, and using the solver function in excel you could solve for the most efficient portfolio mix (based on past performance of course)...

I have built such a tool a while back to build unit trust portfolios, maybe time to revisit with new focus

Clever. Thats not something I had thought of doing - respect.

You seem pretty good at crunching numbers - so question to you. Is there a good way of working out which categories did well @ 2008? i.e. If I think the market is feeling shaky...what is a good defensive move (ETF)? Gold and bonds?

Don't mind sacrificing gains here...my thinking is put the first couple chunks of money towards defensive now while the market is feeling shaky. And then later (hopefully after crash) fill in the "risky" equity part giving me a balanced portfolio at the end. Does that make sense?

Personally I'm guessing the trend of the Rand based on articles etc. I've read.

I take it you re-shuffle regularly if you're trying to guess ZAR direction?

(top40) which self regulates depending on which sectors are doing well.

Does it? My gut feeling tells me that equates to sell low, buy high. Shares entering the top40 are by definition doing well, while those bombing out are by definition doing poorly. Not criticising here...just wondering out loud.

Also gives me 20% bonds exposure.

Yeah tempted to go heavy on those as per above 2008 logic.

 

[Hamster]

I take it you re-shuffle regularly if you're trying to guess ZAR direction?


Does it? My gut feeling tells me that equates to sell low, buy high. Shares entering the top40 are by definition doing well, while those bombing out are by definition doing poorly. Not criticising here...just wondering out loud.


Yeah tempted to go heavy on those as per above 2008 logic.

No I don't reshuffle a lot. If the Rand starts showing real signs of depreciating further I'll shift monthly investments to offshore to give it more weighting instead of MAPPSG.

There's a reason the Top40 companies are the top 40. It does self regulate in the sense that if resources keep on doing well they'll re-enter the ETF in the same way they exited it a couple of years ago.

This is a very lazy passive portfolio (and cheap considering it's only 3 ETFs). If you put more effort into it and take a more active approach you can probably do a lot better.


EFIT: I do not own MAPPSG but NFSWIX instead. No exposure to bonds at all. Knowing what I know now I would've gone with MAPPSG because in the end what I'm doing is reproducing what it does at a higher cost.

 

[FxJalarupa]

Personally I'm guessing the trend of the Rand based on articles etc. I've read. While the Rand was plummeting over the last couple of years offshore ETFs were coining it.

The trend seems to be that it will be strengthening over the next year or two so it makes sense to shift balance to local shares.

All the said, the aim of a passive portfolio is to be on autopilot for as much as possible.

So:
35% DBXWD
10% PTXTEN
55% MAPPSG

Why? 10-15% property because that is the general consensus and gives you exposure to dividends and REIT. PTXTEN specifically because top 10 property companies equally weighted.

MAPPSG because it gives me 75% exposure to NFSWIX (top40) which self regulates depending on which sectors are doing well. Also gives me 20% bonds exposure.

Those three ETFs should require almost no maintenance for you.

This is the way I think about it anyway.

Or you could just buy Nedgroup Core diversified or a Prudential inflation plus or Balanced...

Would probably cost you about the same AND you get your portfolio balancing done by a professional fund manager...

Remember that asset allocation accounts for the bulk of return...

 

[HavocXphere]

Remember that asset allocation accounts for the bulk of return...

Interesting. Surprised the stock selection part is such a small component.

Found the associated study: (And tempted to go post it in the active vs passive thread )
https://www.williamblairdas.com/resources/docs/articles_and_books/Determinants_Article.pdf

This is a very lazy passive portfolio (and cheap considering it's only 3 ETFs).

Thats what I'm aiming for.

 

[Hamster]

Or you could just buy Nedgroup Core diversified or a Prudential inflation plus or Balanced...

Would probably cost you about the same AND you get your portfolio balancing done by a professional fund manager...

Remember that asset allocation accounts for the bulk of return...

Very cool, but I prefer the ETFs approach myself:



http://etfcib.absa.co.za/products/exchange traded funds/balanced/mappsgrowth/Pages/default.aspx

All that for a TER of 0.35%. If only they knew how to spell cash

 

[Jehosefat]

So there really isn't a simple answer to this. If there was, there would not be all the hundreds of fund managers selling different funds. Pretty much any approach has drawbacks.

The simplest approach is probably CAPM (Capital Asset Pricing Model) which basically ends up saying hold the index (market cap weighted). Pro: Its cheap, you can just buy an ETF. Con: Most sectors are at their highest market cap just before they crash.

Alternatively you can try to create a least correlated portfolio where you weight sectors (or shares) inversely based on how correlated they are with each other. Although this is quite a bit more tricky (and also more expensive because you can't just buy an index ETF). Pro: Very resilient to sector crashes (i.e. consistent). Con: Expensive and computationally difficult.

Or you could try to base your decisions on fundamental analysis but this involves going through each company's financials to try and find the ones you think will be the best performers (very subjective and most analysts don't get it right all that often). Pro: If you get it right you can get excellent returns. Con: Its very hard to get it right and its a lot of work to analyse enough companies to be sufficiently diversified.

And there are a bunch more but none come to mind right now.

 

[HavocXphere]

So there really isn't a simple answer to this. If there was, there would not be all the hundreds of fund managers selling different funds. Pretty much any approach has drawbacks.

The simplest approach is probably CAPM (Capital Asset Pricing Model) which basically ends up saying hold the index (market cap weighted). Pro: Its cheap, you can just buy an ETF. Con: Most sectors are at their highest market cap just before they crash.

Alternatively you can try to create a least correlated portfolio where you weight sectors (or shares) inversely based on how correlated they are with each other. Although this is quite a bit more tricky (and also more expensive because you can't just buy an index ETF). Pro: Very resilient to sector crashes (i.e. consistent). Con: Expensive and computationally difficult.

Or you could try to base your decisions on fundamental analysis but this involves going through each company's financials to try and find the ones you think will be the best performers (very subjective and most analysts don't get it right all that often). Pro: If you get it right you can get excellent returns. Con: Its very hard to get it right and its a lot of work to analyse enough companies to be sufficiently diversified.

And there are a bunch more but none come to mind right now.

Thanks

Ideally I'd want to do a mix of #2 and #3 eventually. However its currently only 200k which is probably a touch on the thin side diversification vs fees wise. Plus varsity didn't cover correlation calcs beyond two shares being compared....so would need to read up on how to do multiple share scenarios.

So very tempted to save myself the time and just throw together a mix of ~5 ETFs.

 

[Jehosefat]

Thanks

Ideally I'd want to do a mix of #2 and #3 eventually. However its currently only 200k which is probably a touch on the thin side diversification vs fees wise. Plus varsity didn't cover correlation calcs beyond two shares being compared....so would need to read up on how to do multiple share scenarios.

So very tempted to save myself the time and just throw together a mix of ~5 ETFs.

Yeah, 200k is probably a touch light unfortunately.

Correlation calcs don't change, you just have to do them more times:
2 shares A & B => corr(A, B)
3 shares A, B & C => corr(A, B), corr(A, C), corr(B, C)
4 shares A, B, C & D => corr(A, B), corr(A, C), corr(A, D), corr(B, C), corr(B, D), corr(C, D)
etc.

Calculating the correlations is the easy part. Any statistical software can do all of them very easily (returned as a matrix). The difficulty comes in specifying a "portfolio correlation" measure that makes sense and is consistent because correlation is defined between only 2 variables. And then secondly you need to find the portfolio with the lowest "portfolio correlation" which is not particularly hard but can require a whole lot of number crunching.

 

[FxJalarupa]

Just do the same as this guy.... (thats how I did it), the man is a genius of sorts... really worthwhile exercise...

[video=youtube;FZyAXP4syD8]https://www.youtube.com/watch?v=FZyAXP4syD8[/video]

 

[FxJalarupa]

[video=youtube;ZfJW3ol2FbA]https://www.youtube.com/watch?v=ZfJW3ol2FbA[/video]

This is how you establish your correlation matrix like an Excel Ninja

 

[Jehosefat]

Just do the same as this guy.... (thats how I did it), the man is a genius of sorts... really worthwhile exercise...

That's basically the CAPM approach that I referred to.

 

[FxJalarupa]

That's basically the CAPM approach that I referred to.

Great, now everyone can be a quant

 

[Ice2Cool]

There is alot of debate on whether or not CAPM is applicable in markets. CAPM relies on the efficient market hypothesis that investors are rational decision makers and that the share price is reflective of all publicly available knowledge. I for one can tell you that the south african stock exchange is far from being efficient. Even the NYSE is not even close to being efficient. Investors are biased people who often act based on a hunch or on speculation. That alone is enough to cause most exchanges to differ from the EMH. Having said that I have constructed a Markowitz based portfolio which was intended to maximize return while minimizing risk (aka volatility in my situation). My results were mediocre - I doubled my money in about 4 years so I performed marginally better than the market. A Markowitz portfolio is also tediously difficult to calculate correctly and minor changes in any one shares beta tends to have massive ramifications on the final selection - ie, it tends to be highly sensitive. The share price also has alot of impact on the solver used to balance the portfolios. And we all know its very difficult to buy into a share at a pre-determined price.

My suggestion is to develop a strategy and decide on selection critera such as growth or value, mid to large cap etc, and decide which sectors you want to be in or dont (ie resource vs non resource) and stick to it tooth and nail. You cannot predict the market, but you can decide what part of it you want to be a part of. Also understand the difference between investing and trading. As a trader youre a buyer and a holder with an infrequent rebalancing period (usually once a year). Also, diversify diversify diversify (but within your selection criteria). If you go and buy all the shares in the top 40 (since they represent 99% of the markets value), then you are essentially buying the market and are better off buying an etf that tracks the top 40. You cant beat the market by being the market ( and the JSE has averages on average a 15% return over the past 40 years - so your goal is to beat 15% total return).

Some links for reading:

http://www.iassa.co.za/articles/010_aug1977_02.pdf

http://www.iassa.co.za/wp-content/uploads/2009/06/009_mar1977_02.pdf

 

[TheKwok]

These guys use a momentum and value model to build their portfolio - http://www.relativevaluation.co.za