I recently finished reading Teresa Lo's excellent series on building your own portfolio. Now I find myself rethinking my portfolio's construction even more intently than I already have been.
Its not that I think my portfolio is poorly constructed, but it is an amateur's portfolio. I know it has weaknesses, the biggest of which (in my opinion) is the number asset classes. It really is too many. As Teresa excerpted from David Swensen's book, Pioneering Portfolio Management, a theoretical ideal floor may be 10% of assets per class. I have experienced this problem within my asset allocation, and it has irritated the hell out of me. Many of my re-balancings tend to be done outside of the portfolio entirely, mostly because I want to invest more in the under-performing or under-invested classes. As many of my asset classes stand, they are underrepresented within the portfolio, which dilutes their impact. So reducing the number of represented asset classes would tend to simplify the entire process.
The other big problem I find myself facing is that I like the "core and explore" approach, with alpha overlays on top of a core portfolio. However, I've never been quite sure what the complexion of the core portfolio should be. All I've known, in the back of my head, is that I have too many asset classes which I consider core which really aren't. In fact, I'd go so far as to say that most of them have been considered "core". Teresa's series really covers this issue well, and I must say it was a breath of fresh air for this amateur.
The "money shot", so to speak, is part 4 of the series. However, part 4 cannot be taken in a vacuum, so I recommend starting at the beginning and working your way through. It won't take very long.
I think Teresa's series is the best prose, short or long form, that I have read on the subject to date. That's why InVivo Analytics is joining my recommended blog list immediately. I mean, I've caught some of her work from the powerswings.com site, but this series sold me completely. Simply explained, well reasoned, quantitative, and with solid results. I also am totally on board with the idea of frequent re-balancing. The average investor who knows little about investing (and is happy as such) can keep the annual re-balancing schedule. I, however, find various asset classes going way over their target allocations far to frequently. I also like to capture those moves to my advantage, and the only way to do so is frequent re-balancing. The best example I can give of the benefit of frequent re-balancing has been performance in my old 401(k) due to the recent run-up in Treasury prices (a so-called Flight to Quality). I used this opportunity to let go of a nice sized piece of my Treasury allocation, and the resultant strength in the remaining asset classes has helped keep my old 401(k) buoyant. (Even though no new funds have been added in 2 years, that account keeps growing steadily. The only explanation I can come up with for its performance is the regular re-balancing. Good asset allocation probably plays a role as well, but it is still a bit too diversified.)
Now, there are some other things out there I plan to read. For starters, Investopedia has a guide to portfolio construction. And it goes without saying that reading Swensen's book moved up several notches on my to do list. But for the money and time, Teresa Lo has the best practical guide to portfolio construction I've seen. She put into words things I could only say I've assumed or "felt" (that is, instinctively known).
I think that, with a little bit of effort, I can come up with a suitable re-balancing model that will work for me. Having direct access to Teresa's model doesn't interest me beyond the educational value. The theory is well established with me, so its not a matter of implementation, and every implementation will vary because every investor has different goals.
Now to formalize what I've learned in the last few hours! Woo hoo! There will be more on this topic in the future.
Until next time...
Note: The above link to Pioneering Portfolio Management is a sponsored link. Yes, I'll be rewarded if you purchase via that link. I think I get 1/200th of a cookie or something like that.