Keep the best ETF performance and skip the rest

VTS Community,

Keep the best performance and skip the rest

One of the recurring themes in my content, and one of the foundational ways I manage my VTS Total Portfolio Solution is I believe that all asset classes have both good and bad periods.  And when I say all, I mean ALL.

There's nothing wrong with the stock market about 65% of the time.  In calm stable markets with relatively low Volatility, stock market performance is good.  However, about 35% of the time I don't want anything to do with stocks because that's when all the drawdowns happen.

Bonds and gold are the same thing, but typically flipped.  During more uncertain times with elevated Volatility, they perform pretty well.  It's all those other more stable calm periods in the market that I wouldn't want to be holding bonds and gold.

The same thing applies to Bitcoin.  Fantastic performance during certain types of market environments, but horrendous drawdowns in all the other times when those conditions are not present.

Today I'll prove to you with real numbers exactly what I mean by highlighting all of the "safety" positions within our three main strategies here at VTS:

- Tactical Volatility Strategy uses GLD Gold for safety

- Defensive Rotation Strategy uses XLU Utilities for safety

- Strategic Tail Risk Strategy uses IYR Real Estate for safety 

VTS Tactical Volatility  -  The best of Gold

This is a strategy that uses Volatility metrics to filter for the most advantageous times to be holding Short Volatility SVXY, Long Volatility VXZ, or just in our safety positions of GLD Gold.

One of several cool things about systematic rules based strategies is I can easily isolate any section of the strategy and JUST show those trading days.  In this case, I can isolate just the days our Tactical Volatility Strategy was holding GLD Gold.

The strategy held GLD Gold on 25.76% of trading days 👇 

So long-term, those GLD Gold positions that are only held on about 25% of trading days have added 4.1% annual return to the overall strategy.  In my opinion that is well worth it for a period in the market when it's too risky to be Short Volatility or holding equities.

The question is, how did GLD Gold perform on a buy & hold basis on 100% of trading days?  Surely holding it every day is better than only holding it on 1/4 of days right?

Green  -  GLD Gold on 25% of trading days in our strategy

Black  -  GLD Gold on 100% of trading days buy & hold

As we can see, buy & hold Gold on 100% of trading days actually performed WORSE than just filtering for the best 25% of trading days.  This is what I mean when I say that every asset class has periods where it's advantageous to hold it, and periods where it simply isn't.

In the case of Gold, in calm markets it's just a poor allocation and investors would be much better off just skipping it entirely.  We can do that within our tactical rotation strategies.

Our goal is to just target the best performance and skip the rest... 

VTS Defensive Rotation  -  The best of Utilities

This is also a "Volatility Targeting" strategy to isolate the best market positions, but it uses a different set of Volatility metrics than the Tactical Volatility Strategy does.  That's what diversification means right?  If it was using the same metrics, the correlation would be too high.

The 4 potential positions here are 2x Nasdaq QLD during stable market periods, VGLT Bonds during extremely low Volatility, Cash during the highest Volatility periods, and XLU Utilities for safety.

Those XLU Utilities positions only occur on 15.35% of trading days, and just like before I can easily show the performance of just those signals to get an idea for how much it's contributing to the overall strategy. 👇

As I've written about many times, Utilities are arguably the best safety position when Volatility is elevated, and we can see that in the performance.  They are adding 7.27% annual return to the strategy from only 15% of trading days.

So again, how does that compare to a buy & hold XLU Utilities position being held on 100% of trading days?

Orange  -  XLU Utilities on 15% of trading days in our strategy

Black  -  XLU Utilities on 100% of trading days buy & hold

I suspect many of you will be quite surprised to see that in fact, buy & hold on the XLU barely outperforms just holding it on the best 15% of trading days like we do.  Now even though the annualized return is a little higher for buy & hold, 9.68% vs 7.27%, look at the difference in drawdown.  36.07% for buy & hold vs just 14.83% when we filter the signals.

I don't know about you, but I will happily give up 2% CAGR to cut the overall drawdown in more than half. 

VTS Strategic Tail Risk  -  The best of Real Estate

Our third strategy here is the only one where I would say we have a "variable" safety position.  Variable in the sense that over the years we have used several different assets in that slot.  Now the low Volatility S&P 500 and high Volatility VXZ positions have always been the same, but those IYR Real Estate positions have in the past been Cash, Bonds, and even Gold for a spell early on.  Currently though we are using IYR Real Estate so let's do the same test again.

For diversification purposes the strategy is again using a different set of Volatility metrics, and different threshold levels compared to the other strategies we have. 

Strategic Tail Risk exits to safety faster and as a result, that middle range is held on roughly 30% of trading days. 👇

That underperformance in the last few years is just filling in the backtest, but just note that for much of that we were actually just using Cash in the official results.  We only recently started using IYR again, but I wanted to show Real Estate for the entire range since 2012 to make the point.

Red  -  IYR Real Estate on 30.01% of trading days in our strategy

Black  -  IYR Real Estate on 100% of trading days buy & hold

Here we see the same pattern.  The rate of return for buy & hold IYR Real Estate is very close to the performance of just picking out the best 30% of trading days, with the added benefit that the drawdown is lower as well. 

Why do we love buffet restaurants?

I do try to watch what I eat and reduce my calories, but I'd be lying if I said I don't destroy buffet restaurants every now and then.

What do we love best about the buffet?

The fact that we can walk down the whole line and ONLY take our favourite food right?  I can just skip right past all that other junk like salads and breads that don't appeal to me and just go straight to the meat, seafood, and desserts to get my money's worth!

Tactical Investing through Volatility Targeting is a buffet

Why would I want to buy & hold an asset class for a single digit return when I can use my Volatility metrics and filter for only the best periods of performance.

- GLD Gold is useful, but only 1/4 of the time

- XLU Utilities are a great safety position, but not great for much else

- IYR Real Estate is solid, but there's many periods you don't want it