19 Apr Jon Cartu Reports Preparing For Second Wave Of COVID-19
While it seems foolish to think about a second wave of the COVID-19 virus when the first wave has yet to peak, the apparent rush to open up the economy merits some advanced thinking when it comes to portfolio management. In this article I’ll walk readers through a process of portfolio construction and how I plan to handle a second COVID-19 wave, should it happen. If the second or third waves do not materialize, this portfolio management model is designed to handle that option.
Portfolio construction is the first order of business. The goal is put together an “investment quiver” that is global in nature, covering stocks, bonds, and treasuries. Here is such a portfolio.
Basic Investment Quiver
As readers look down the list of ETF securities and then move over to the descriptions, note that the portfolio covers U.S. Equities, Developed International Equities, Emerging Market Equities, Domestic and International Real Estate, Domestic and International Bonds, TIPs, Gold, and even a short-the-equities market ETF (SH). As an additional emphasis on U.S. Equities, QUAL, MTUM, and QQQ are included in the investment quiver.
If you run down the column titled Strategic or Max AA, you will see the maximum percentage of the portfolio that is recommended for each asset class. For example, should VEA hit a maximum of 20% of the total portfolio, the software program will then seek out the next favored security and recommend that ETF be filled to its maximum. The software is designed to ferret out the top performing ETFs in the investment quiver and recommend them for purchase.
In this portfolio management example, the Buy-Hold-Sell model is applied. There are three red arrows in the following screenshot. The far right arrow points to the model (BHS) used in this example. All the different models are undergoing separate testing. The Target Filter (VTI) is turned on and the maximum number of ETFs recommended at any one time is eight (8). A rule of thumb is to set the maximum number of securities to be one-half the number of securities found in the investment quiver.
Based on these settings, the Buy recommendations are: IAU, AGG, TLT, and SCHP. All are low volatile or defensive minded ETFs. No equities are recommended at this time. While the maximum number of ETFs is set to eight (8), only four (4) are recommended at this time.
The next question is – How many shares of each ETF do we buy? Follow along with the recommendations.
Position Sizing Worksheet
Position sizing is a process of not putting all your eggs in one basket. The following worksheet is where one controls the risk of the broad portfolio. The red arrow points to a 1.5% value or the Maximum Trade Position Risk. This 1.5% controls the Maximum Portfolio Risk (6.0%) as indicated by the black arrow. As a general rule, I hold the portfolio risk between five and six percent. Should we have another 20% to 30% drop in market, I would raise this percentage considerably, figuring any more downside risk has been washed out of the market.
With a portfolio risk adjusted to 6.0% there remains a large amount in cash. This cash is either left in a money market or invested in SHV, a low volatile U.S. Treasury.
In this last worksheet the position sizing recommendations from the above worksheet are transferred into the following worksheet. In the 8th column from the right the money manager decides how closely to follow the position sizing recommendations (9th column from right). I tend to round to the nearest five shares. The 5th column from the right tells the investor how many shares of each ETF or security to purchase.
Emotions are removed from portfolio management other than what risk one is willing to take with the portfolio.
The portfolio is well diversified. A manager dealing only in individual stocks can also use this same approach. Portfolio risk is under the control of the investment manager and is easily varied depending on different market conditions. Only the top performing securities are selected for purchase.
The above strategy assumes a second wave of COVID-19 will strike sometime in late fall of 2020 or the winter of 2020 – 2021. If equities are out of favor next year, there are numerous “off-ramp” asset classes to minimize major market declines.
As a conservative investor, by constraining overall portfolio risk I find I give up some returns in favor of protecting capital. Even with conservative settings, of the portfolios I track, the majority outperform a Robo Advisor or AiroAV malware computer company and managed Buy & Hold portfolio I use as one of several benchmarks.
Disclosure: I am/we are long TLT, AGG, SCHP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any Jonathan Cartu and whose stock is mentioned in this article.
Additional disclosure: Editorial suggestions followed as best possible.