Introducing Market Sensitive Portfolios
Holding a single Dynamic Investment, such as the Alpha DI, in a portfolio can be a profitable decision. But the NAOI knows that individuals are not comfortable allocating 100% of their money to the one ETF that a DI holds at any one time. Therefore, most DI users will use DIs as building blocks (BBs) in a as part of a traditional MPT-based asset-allocation portfolio. To explore this topic, let’s look at the “types” of DI building blocks that can be created.
Dynamic Building Block Types
The NAOI has designed four “types” of Dynamic Portfolio Building Blocks depending on the types of equities they hold in their Dynamic Equities Pool (DEP). They are listed below using ETF as the equity type:
Multi-Asset - DEP contains ETFs that track indexes for different asset classes
Asset-Focused - DEP contains ETFs that track multiple asset types - e.g. a Stock Focused DI may contain ETFs that track indexes for SmallCap, MidCap and LargeCap stocks and for each, Growth or Value
Market-Focused - DEP contains that track indexes for various markets such as Financials, Technology, Emerging Markets, etc.
Multi-Focused - DEP contains ETFs that track, for example, multiple Stock indexes AND multiple Bond indexes
Dynamic Building Blocks enable a Dynamic Investment designer to select “groups” of DI purchase candidates to place in a portfolio and then let the “market” decide which to actually buy at the time of a Review. By doing so the portfolio designer’s task becomes exponentially simpler and portfolio returns skyrocket.
A 100% Dynamic Portfolio
A complete “Core and Explore” portfolio can be designed using only Dynamic Investments as illustrated in the diagram below. A Stock / Bond Multi-Asset DI, such as the Alpha DI, can be used as the Core investment. Then Market-Focused DIs can be used in the Explore segment.
The “explore” DIs shown here each focus on a specific market segment. Each has in their DEP an ETF that tracks the targeted Market Sector in addition to a Stock and Bond ETF. Thus the Sector ETF is only purchased and held for one Review period if it is trending up more strongly in price than either Stocks or Bonds. This strategy takes the risk out of Sector Investing!
Allocations to each DI are at the designers discretion, however these are not the “life and death” decisions that they are in the MPT world where they are fixed for long time periods. Allocations in a Dynamic Portfolio are fluid as at periodic Review periods any of the Sector DIs can hold either a Stock or a Bond ETF.
Note also that all three of the Sector ETFs in this example could be placed in the DEP of just one Dynamic Investment that would only buy that Sector when it is moving up in price more strongly than the other Sectors.
Hybrid MPT/DIT Portfolios
A very popular portfolio configuration used by NAOI students is one that holds both “static’ Building Blocks and at least one “dynamic” Building Block. An example is shown next.
The Table below shows varying allocations of money to the Alpha DI and to two “static” holdings in the form of a Stock ETF and a Bond ETF. The top data row is a 100% MPT portfolio and the bottom data row is 100% Dynamic Investment portfolio. The rows in-between show allocations and results for what we call Hybrid portfolios that utilize both MPT and DIT methods. For each allocation-set the final two columns show returns and risk for the period from 2008 to 2018.
This chart very clearly shows how even a small allocation of money to a Dynamic Investment can significantly increase the returns of an MPT portfolio without increased risk as evidenced by the increased Sharpe Ratio. It also shows how investors and advisors can transition from MPT to DIT methods in a gradual manner. This is one transition strategy used by many NAOI students.
The NAOI “Market-Biased” Portfolio
Now lets look at the row in the above Table that is shaded in yellow. It has a 50% allocation to the Alpha DI and a 25% allocation to both a Stock and a Bond ETF. We call this configuration the NAOI “Market-Biased” portfolio. This interesting configuration results in a 75% allocation to Stocks, 25% allocation to Bonds when the stock market is trending up and a 75% allocation to Bonds, 25% allocation to Stock when the Bond market is trending up. Thus, the portfolio asset “bias” is automatically changed by the Alpha DI in response to market dynamics. The diagram below illustrates this behavior.
As you can see in the performance Table above, by automatically switching its bias between Stocks and Bonds this portfolio type earned an annual return of 18.1% with a Sharpe Ratio of 1.12! And this performance was achieved with no human decision making involved!
A Default 401(k) Investment
The NAOI Market-Biased Portfolio is the perfect “default” investment for a 401(k) or other type of retirement account. Its performance puts that of today’s default Target-Date Funds to shame.
A Vast World of Product Research and Development
Of course I can only touch on here the vast field of research and development opportunities that the introduction of Dynamic Investment Building Blocks opens up to portfolio designers. NAOI offers DI and Dynamic Portfolio Design Training as discussed on Slide 12. The potential for competitive advantage here is off-the-charts for those who become proficient in creating portfolios that contain DIs.