My ability, willingness, and need to take risk is likely different than yours, possibly a lot different, so this should not be considered investment advice or recommendations.
Before I dive in, I should generally describe the principles that make up my investment philosophy.
No pain, no gain! I believe markets are not perfectly, but highly efficient, where the path to higher returns is paved with higher volatility. Since I believe in massive diversification, some of this pain also means occasionally large tracking error relative to conventional benchmarks.
Diversification is your best friend. There are many ways I diversify my portfolio including asset classes (stocks, bonds, cash, alternatives), geography (global stocks and bonds), and factors (market, term, size, value, momentum, trend, volatility) just to name a few.
You can eat Sharpe Ratio’s if you understand how to thoughtfully apply leverage to a mixture of evidence-based strategies. I believe a well-diversified portfolio with modest leverage can be safer than a highly concentrated portfolio without leverage. I seek to build out my portfolio with a high Sharpe Ratio, then lever it to my desired risk level.
My current asset allocation:
- Dimensional equity mutual funds
- Dual momentum equity strategy with ETF’s
- Equity index and ETF put and call option writing
- Dimensional global bond mutual fund
US treasury futures
- Bank accounts
- Brokerage account with check writing & debit card
- Treasury Bill ETF
Cash value of life insurance
Long/short factor mutual funds
Total: 241% (don’t worry, I’ll explain)
This does not include other items that make up my net worth such as the present value of a future pension I’ll have from a prior employer, my current equity ownership in Lorintine Capital, my home, and other valuable personal property and belongings.
When I say “stocks”, I’m lumping together certain strategies like passively held buy/hold/rebalance allocations to Dimensional equity mutual funds, equity index and ETF put option writing, and dual momentum with ETF’s. These are all strategies with material long term exposures to equity market beta. For example, if you were trading my Steady Momentum PutWrite strategy, you could consider your allocation 125% stocks (short puts) and 100% bonds (treasury ETF acting as the collateral) for that portion of your portfolio. Of course, there is a lot of nuance in that statement. I don’t own individual stocks as I build my portfolio around the principle of only taking compensated risks.
With bonds, I’ve already described how some of this position is created (collateral for put selling), although I further add to that in a personal account with treasury futures. This creates more of a “risk parity” type of portfolio…since stocks are far more volatile than short/intermediate term treasuries, it takes a much larger allocation to bonds to balance out the volatility of stocks. And even at 142%, it's still not enough to create risk parity, but it gets me closer and is within my comfort level. US treasuries have a track record of acting as a flight to safety asset during periods of equity market crisis, so this “overlay” asset can actually reduce risk at times where this happens. It’s also possible this position could increase risk if we experience higher than expected inflation as well as unexpected interest rate hikes. I understand the risk I’m taking (key, as surprise is the mother of panic), and as long as the term premium is positive in the future (as futures embed borrowing costs at approximately the risk-free rate), this position will increase my portfolio returns. The term premium is a well documented and intuitive risk premium, so I’m comfortable with this long-term assumption and I know the historical data well.
Cash is pretty straightforward, consisting of a small amount in checking/savings, although I primarily use my brokerage account like a checking account since it currently yields more than 2% with a cash sweep money market mutual fund. I have a debit card and checkbook for this account if I need it, ATM fees are rebated, and there are no minimums or transaction requirements. This part of my portfolio simply acts as my source of short-term liquidity and emergency funds. If I have any large upcoming lump sum expenditures within the next few years, I’ll increase my cash position. Part of this cash position is also cash value in a small whole life insurance policy I fund annually up to the IRS “MEC” limit, as I have a deep understanding of how to make these contracts work as I’m also a licensed insurance agent.
The last asset class is what I’ve classified as alternatives. This includes a mixture of long/short factor mutual funds that have little to no equity market correlation, and are therefore true alternative strategies and fantastic diversifiers. This includes classic CTA style trend following with managers such as Dunn, Chesapeake, and Winton Capital, as well as long/short factor exposures to value, momentum, carry, and defensive with AQR.
Even though my asset allocation is levered up to more than 200%, the historical volatility over the last 30 years is only about 10% due to the substantial (and unconventional) degree of diversification. The historical Sharpe Ratio might have been in the ballpark of 1 according to backtesting I’ve done, although I have lower forward-looking expectations and would be happy with 0.6 and thrilled with anything higher. With T-bills yielding around 2% today, this implies an expected return of approximately 8%. This might sound high to some, and a sobering dose of reality to others. I think it’s realistic, as I know how few have been able to sustain a Sharpe Ratio higher than this over the long-term.
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios.