It took me forty years to find an investment approach that was easy to follow and producing the returns and reliability I was looking for. These results have a proven record and they can be backtested in an easy way by any investor. I will show you several ways to invest your money and each one will have different features in terms of returns and risk. You will have the opportunity to decide which one or which ones you should use to manage your money.
This book discusses how to deal with two main issues concerning your portfolio management. The first one is the issue of managing risk. The paramount objective of any investor is to minimize losses. The more money you lose the more time it takes to recover your losses. It is therefore a foregone conclusion that managing risk is an important objective.
The second issue is the need to manage returns. In order to do so you have to rely on a framework to direct your money. You need a process. This book is not going to give you some general concept or generalities difficult to apply. I am going to show you specific portfolios and the rules I used to achieve the returns. These rules are simple and easy to follow. I will show you the performance of the portfolios and the risk associated with following the methodology.
Some portfolios and strategies will outperform handsomely the market over a long period of time with low risk. Others will outperform the market and reflect higher risk. These features will be quantified. I will use these data to make some important points about diversification, choice of asset classes and performance of high risk strategies. I must confess I learned a lot preparing these data and analyzing the summary tables enclosed in the following pages.
The reason we will discuss many portfolios is because of their different features. The interesting outcome of this analysis is that you will be able to recognize very specific and important patterns you can use to your advantage.
However, before showing you the specific portfolios and their attractive historical performance I need to tell you why and how I found them. In other words, what was my mental process to find these portfolios?
In order to do so I will discuss in Chapter 1 the concept of risk. What is risk? Why is it important? What is the frame of mind needed to manage it? What are the tools needed to manage it? I will explore the important issues related to managing risk. They are important because they will assist you in your approach to managing your portfolio.
But there is another important concept I need to discuss. It is one of the few important ideas that helped me manage billions of dollars. It is the concept of business cycle. Why is it so important? Very simply, the growth of the economy determines which types of investments you should make. The growth of the business cycle drives the prices of all assets. Why does the economy go through periods of faster or slower growth? This issue will be explained briefly in Chapter 2.
In Chapter 3 you will learn to recognize whether the economy is growing rapidly or slowly. I will show simple indicators (and where to find them) to establish whether the economy is strong or weak. This simple determination will tell you what type of investments you should make. In fact, I will use these concepts to show you why some of the portfolios I will discuss in the following pages are the lowest risk and produce the best returns.
In Chapter 4 I will discuss the importance of understanding the economic environment you are currently facing and its impact on the main asset classes and ETFs. Are all market sectors attractive during a complete business cycle? If not, which ones are more attractive when the economy is growing slowly and which ones offer the best returns when the economy is strong? In this chapter I will review the major stock market sectors as represented by the most important ETFs. You will see how they perform during different phases of the business cycle. Sectors that do well during periods of weak economic growth are not attractive investments during periods of strong growth. The opposite is also true. ETFs performing well during strong growth do poorly during periods of slow economic growth. This evidence will convince you, I am sure, why you need to recognize the role the strength of the economy has on asset class performance. This idea is of paramount importance in managing risk and improving the return of your portfolio.
Fortunately I found a simple way to determine whether the economy is strong or in the process of slowing down. In Chapter 5 I will show you a few simple and yet powerful indicators to determine the strength of the economy. These gauges will tell you whether the economy is strengthening or slowing down or whether it is growing slowly or expanding at a rapid pace. I followed the same information for many decades and it has been essential in my work when I managed $4 billion. These data and graphs are available, free of charge, from The Federal Reserve Bank of St. Louis. Why is it important to know how the economy is doing? Because it is the basis for the development of your investment strategy. This knowledge is crucial to determine whether you are facing a bull or a bear market and which asset classes, or sectors of the market, you should favor.
And now let’s tackle an important issue in money management. Are you investing in a bull market or in a bear market? In a bull market you can make mistakes and a broad rise of prices will hide your missteps. But in a bear market your mistakes will become painful. In Chapter 6 I will discuss a method to answer this crucial question. I will show you first what is a moving average and then I will demonstrate to you an easy and yet powerful way to determine the main trend of the market. I have run several tests with different moving averages. But only one moving average shows superior performance. These tests were made using the programs supplied by etfreplay.com and by portfoliovisualizer.com.
In Chapter 7 the major market sectors are studied using the model developed in Chapter 6 for the broad market. The purpose of this analysis is to determine which moving average provides the best return. Using this method it will be easy to recognize which ETF is most volatile and likely to offer the greatest risk and loss (drawdown). The reason is that all ETFs have different returns or volatility features over long periods of time because of their relationship with the business cycle. This step is used to decide which ETFs should be included in a portfolio depending on their historical performance and volatility. It will also help to understand why some portfolios perform significantly better than others depending on which ETF you use.
Chapter 8 shows you 14 ETF portfolios. Every portfolio has been tested with the model discussed in Chapter 6 from 2003 to 2015, a period with two bull markets and a major crash as in 2007-2009. Each portfolio is ranked for its overall performance, the maximum loss during the test period, its level of risk, and the number of trades performed during the period. Each portfolio has been chosen in order to prove or disprove some general ideas such as “is diversification a good strategy?”. The important aspect of this research is that it shows which ETFs you should select if you want to maximize returns and minimize the volatility of the portfolio. What makes these portfolios particularly attractive is that the buy/sell decisions are made monthly on the last day of the month, thus making the process of tracking their performance particularly easy and convenient.
Chapter 9 will summarize the main issues raised in this book and the practical implications you should consider in the management of your money.
George Dagnino, PhD
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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Author, Profiting in Bull and Bear Markets