The SmallTrades Portfolio holds investments in five financial markets. Tax expenses are reduced by trading the Portfolio’s underlying holdings in a tax protected brokerage account. For tax reasons, any stock or exchange-traded index fund (ETF) issued by a partnership is excluded from investment.
The Portfolio has two subgroups:
- Established ETFs that are traded infrequently in the markets for global stocks, global gold, U.S. real estate, and U.S. bonds.
- Common stocks that are traded frequently in the U.S. market.
Both subgroups contain high risk investments which are expected to outperform a benchmark index called the Standard and Poors 500 Total Return Index.
The investment performances of the Portfolio and its benchmark index are measured graphically by plotting changes in the market value of an invested dollar (chart).
For every dollar invested on the inception date of 12/31/2007, the market values of the Portfolio and benchmark index dropped by nearly half during the Recession year of 2008. Recovery from the Recession left the performance of the Portfolio lagging behind the benchmark due to the underperformance of a large subgroup of stocks. Starting in 2013, the Portfolio’s investment capital was gradually shifted from stocks to ETFs and the result was a gradual rise in market value. Starting in 2014, the ETF for emerging-market stocks (VWO) was replaced by one for global stocks (VT). At the end of 2014, the market values of the holdings were distributed into a 79.4% portion from ETFs and 19.7% portion from stocks (table).
The Portfolio’s performance is measured statistically by its compound annual growth rate (“CAGR”) of market value since inception. The performance improved during 2014 (CAGR -3.3%) compared to 2013 (CAGR -5%), but still lagged the benchmark index (CAGR 7.3%) and U.S. inflation of prices (CAGR 1.8%) by considerable margins.
Calendar year 2014 was the inaugural year for graphing the performance of the ETFs and Stock subgroups. The following chart shows that stocks outperformed ETFs during the first year of assessing subgroups.
The ETFs subgroup is designed to match the performance of financial market indices for global stocks, U.S. investment-grade bonds, U.S. real estate, and global gold bullion when equal amounts of cash are invested in each market. The market indices for global stocks and U.S. real estate are expected to outperform the U.S. bond index. The gold index is expected to fluctuate according to changes in investor sentiment for stocks, bonds, currencies, and commodities. The gold index typically moves moves up when investors seek the gold market and down when investors seek other markets.
The main risk of losing money from established ETFs is derived from a large decline in market prices. Consequently, the risk management strategy is to rebalance every asset class to 25% of total market value when any asset class drifts below 18% or above 32% of the total market value. Drifts did not trigger a rebalance of asset classes during 2014 (chart).
The investment strategy is to buy stocks at a discount price and sell them at a premium price. Discount prices are selected from undervalued companies in several ways:
- Use of a stock screen
- IPO’s of potentially successful companies after the first day of public trading
- Media disclosure of good companies
- Previously owned stocks
Premium prices are discovered by setting alerts for rising prices and placing conditional sell orders in the broker’s trading platform.
The typical holding is selected by a stock screen, held less than one year, and sold with a conditional sell order. Small-cap stocks characteristically offer better growth potential and higher returns – but at a higher risk – compared to large-cap stocks. Consistent with the Portfolio’s high-risk investment goal, the total market value of the Stocks subgroup is divided into portions of 22% for large-cap stocks and 88% for lower capitalizations (chart).
The SmallTrades Portfolio is an unleveraged, diversified collection of high-risk securities that are traded in the U.S. stock market. The Portfolio continues its gradual improvement in performance following the 2008 Recession, but its performance still lags that of the benchmark index. Acceleration of the Portfolio’s performance will depend on the future resurgence of stocks in the emerging markets coupled with high performance of the U.S. real estate market. Rebalancing the Portfolio’s holdings is expected to partially offset the potential loss from a future declining market.
Copyright © 2015 Douglas R. Knight