A New Set of Dynamic Tools for
Creating Superior Portfolios
Dynamic Investments give portfolio designers, creators, managers and strategists an amazing new array of tools and investment types for increasing returns, lowering risk and meeting the goals of their clients and/or organizations.
Dynamic Investments: A Powerful Performance Booster
Constrained by MPT design methods, Portfolio Designers and Managers today struggle mightily to beat market averages. Adding equities for different asset types, markets and market segments to a portfolio in search of increased returns and lower risk is a guessing game at best. This all changes with the introduction of Dynamic Investments. DIs as standalone investments have been shown to produce 20%+ returns per year on a consistent basis. But many portfolio managers today would not be willing to give 100% allocation to one ETF in a portfolio at any given time as is the case with single DIs. However, by using DIs as just one component of a traditional MPT portfolio, returns can be "boosted" significantly while actually lowering risk! How this is done is discussed in detail in Chapter 7 of The Dynamic Investment Bible where Dynamic Hybrid Portfolios are introduced. The simple addition of the NAOI Primary DI alone can double the returns of most traditional MPT portfolio designs today.
Example Portfolio Configurations and Performance
The table below illustrates the benefits of adding an NAOI Dynamic Investment to an asset allocation portfolio. Here I show three investment types and four portfolio allocations that include them. Let's walk through the table information.
In the left column I show two standalone ETFs that are available from a variety of developers today - one that tracks a total stock market index and one that tracks a total bond market index. The third investment type is the Basic NAOI Dynamic Investment discussed on the home page of this site that includes the two standalone ETFs in its Dynamic ETF Pool (DEP).
In columns 2-5 I show various allocations for each of these investment types in example MPT-based portfolios. In the bottom two rows of each column I then show the performance of each of these portfolios for the 10 years from 2007 to 2016. Performance consists of Average Annual Return for the period and the Sharpe Ratio for each portfolio for the period. I analyse these results below the table. The Sharpe Ratio is a measure of how much return is obtained for each unit of risk take; the higher the number the better and value above 1.0 indicates a superior investment.
As a portfolio creator or manager, you can see from this data the performance boost that Dynamic Investments give to you. The first portfolio column (Port. 1) shows the performance of a single ETF that tracks the stock market during the ten year period from the start of 2007 to the end of 2016. You can see that average annual returns for this single ETF are mediocre and risk is high.
The second portfolio column (Port. 2) shows a typical MPT stock/bond allocation. Note that for this portfolio allocation the Sharpe Ratio is higher, meaning the risk is lower, than the standalone ETF but performance is still mediocre. The third portfolio column (Port. 3) includes a 50% allocation to the Basic NAOI Dynamic Investment that rotates automatically and periodically between the stock and bond ETF. Suddenly, returns double and risk is cut in half compared to the first two allocations.
The final portfolio column (Port. 4) shows a 100% Dynamic Investment portfolio. Here the returns are through the roof and risk is significantly lower than the stock/bond portfolio.
The Effects of Time-Diversification
How is it possible to get higher returns with less risk? MPT says this isn't possible. It comes from the Dynamic Investment including "time diversification", an element not present in MPT portfolios. This is an element that not only reduces risk but also increases returns.
This example illustrates the power that DIs give to portfolio creators and managers - power that does not exist today!
Taming ETF Volatility in a Portfolio
In addition to boosting portfolio returns, DIs provide other benefits, one of which I will discuss below. This benefit is the "taming" of ETF volatility in a portfolio.
Portfolio Managers who read The Dynamic Investment Bible will learn how to take full advantage of volatile ETFs that are typically not appropriate for traditional MPT, buy-and-hold portfolios. ETFs that track areas of the market such as commodities, emerging markets, single county stocks and even the energy and healthcare sectors all have significant upside potential but also significant downside risk. Most portfolio managers would think long and hard before putting these investments in a traditional MPT portfolio – they are just too risky. But when placed in the Dynamic ETF Pool (DEP) of a Dynamic Investment this concern goes away.
As you know by reading this site, a Dynamic Investment holds multiple ETFs as purchase candidates in its DEP. A volatile ETF in a DEP will only be purchased when/if it is trending up more strongly than any other ETF in the DEP at the time of a periodic review. It will then be held for one period (e.g. one quarter) at which time the DEP will be ranked again.
If the volatile ETF owned at ranking time is still the one that is trending up most strongly it will be held for another period. But if it starts to gradually trend down during its holding period it will likely be replaced at the next Review by another ETF in the DEP that is trending up more strongly. This provides one level of risk reduction. Another risk reduction factor comes into play if the volatile ETF being held starts to drop suddenly. To protect against the risk of such an event, DI’s use a Trailing Stop Loss order that automatically sells the ETF before significant value is lost. In this manner, a DI is capable of capturing the upside potential of a volatile ETF while being protecting the value of the DI from its downside risk. Let’s look at a real-life example of this dynamic.
Profiting from China
PEK is an ETF that holds China stocks. It is a very volatile investment producing both extreme positive and extreme negative returns. Because of its high risk profile, PEK will not be found in many MPT portfolios recommended to the public. Therefore, its trading volume is low. But putting PEK in a Dynamic Investment’s DEP can produce significant returns without excessive risk.
Let’s look at an example. Below is PEK's price chart for 2014-2015. (source: finance.yahoo.com)
The chart shows that that PEK was very volatile during this period. You can see the returns potential that PEK offered during this time. But if owned in a buy-and-hold portfolio the holder would have watched PEK's price soar and then give back most of its gains.
Returns for a Dynamic PEK
What if, instead of just buying and holding PEK, we placed this ETF in the DEP of the NAOI Core Dynamic Investment along with RZG (a small cap stock ETF) and TLT (a long term bond ETF)? This makes PEK “dynamic.” Below is a Table that shows what this Dynamic PEK Investment would have owned for each quarter during 2014 and 2015 along with the associated returns. (Note that this is chart is taken from The Dynamic Investment Bible, thus the "Table 11-B" reference.)
The backtest period started with the Dynamic Investment owning RZG, followed by two quarters owning TLT. Then China stocks started roaring upward and PEK was owned by the DI for four consecutive quarters – a full year. During that year its price increased about 65% and then ended its upward trend with a loss of close to 30% in Quarter 3 of 2015 at which time it switched back to TLT in Q4. So, a net gain of 35% in the year of holding only PEK is not bad, right?
But wait, each time PEK was bought at a quarterly Review, a new Stop Loss Order of 10% (a price-drop parameter used by designers for the most volatile ETFs) was put in place. Thus, instead of losing 30% in the Quarter 3 of 2015 it lost only a maximum of 10% - so for the year of holding PEK the net gain was 55%! And then PEK again went dormant in the DEP as either RZG or TLT regained control. But PEK was still lurking in the DEP, waiting and watching for the next China stock boom to emerge again.
Just Two Benefits of Using NAOI Dynamic Investments
You can see from this simple example how volatile investments can be “tamed” by using the Dynamic Investment structure and management process. DIs own these investments only when they are moving up in price and sell them at the first sign of price deterioration. In this manner, DIs enable Portfolio Designers and Managers to take advantage of a whole world of volatile ETFs with high returns potential that are not available to them in the buy-and-hod MPT portfolio design world because of their risk!
The taming of ETF volatility by the Dynamic Investment structure is a gigantic leap forward in the field of portfolio design and management!
The NAOI is available to consult with, and train, Portfolio Managers to take maximum advantage of the power of Dynamic Investments to increase portfolio returns while actually reducing risk. Click here for more information on NAOI Consulting Services.