Create Value Weighted Multiple Asset Index Fund Using ETFs Part 3

Part 1 Value weighted Index Fund and Multiple Asset Index Fund
Part 2 Creating Your Own Value Weighted Multiple Asset Index Fund


The fundamental reasoning behind this approach we covered is:
1)Markets move in unpredictable ways
2)Capital in markets will often times flow into one asset and will have to flow out of another
3)Markets may perform irrationally for long periods of time.
4)We may be able to identify areas of value over the long term
5)If we are able to identify those areas of value, we should position our portfolio as such
6)Based on #2, we will sell areas of the market if certain areas tend to outperform the market more than we expect to be “rational” but because of #3 we will still will aim to own roughly the same percentages, and meanwhile use the capital generated from such sales to buy areas which underperform. Basically if we own 50% of one area and 50% of another, and the one area increases to 60% of capital and the other declines to 40% we rebalance so both are 50% again.
7)Additionally, we will reassess the value, so if we believe such a move in that area is unwarrented or overdone, or the fundamentals have not changed with the price, we may eventually start to cut back on our allocation to that specific area, while increasing it in areas that become more undervalued or that decline while the fundamentals remain unimpaired.

The post does not go into in depth reasoning behind the allocation models or why, because the main focus is in teaching you how to fish so to speak, as I encourage you to come up with your own based on your determined “estimated probability” of how markets will do.
In the previous parts, we came up with the following general asset allocation model over multiple asset classes
30% stocks
25% commodities
5% real estate
25% currency
15% for Bonds+treasuries

Within these individual areas we want to try to weight it based on value and our outlook based on the probability that it is the best asset class to invest in. Since our time horizon is 10 years, we can do one of two things. If we invest in a lot of stocks, we can just take a value weighted index fund which has 1.35% fees like mentioned before. Or we can take a few ETFs to attempt to accomplish the same thing. Or we can take a limited amount of names. The important thing is to not own too many names ourselves as the rebalancing will cost fees as will the individual purchases. If you want to limit your names you will have to really be sure that the companies you own are predictable. Although he may have so much capital that he is restricted to large cap name, I still personally think that Buffett has done a lot of that work for me, and he heavily bets on value, so of the amount allocated towards stocks, I might put 40% into Berkshire Hathaway. You have to understand what Buffett owns and that’s 25% of his portfolio in coca-cola and 20% in Wells Fargo and he generally owns mega cap or at least the large cap stocks. I want to own small cap stocks too because Buffett is not going to give me exposure in that area. I can either identify a few of my own small cap stocks to invest in, or I can find an ETF that gives me coverage in midcap and/or small cap. As mentioned before, I want a more of a timeless strategy so 30% in RWJ which is a small cap fund that’s weighted by revenue.

Buffett’s portfolio is heavily weighted in financials and consumer goods so via Birkshire Hathaway and RWJ you will be overweight financials and consumer goods and underweight other areas. Personally, I think that we can look at consumer’s spending habits to see that there should be less focus on financials (spending towards housing) and more towards oil which is responsible for probably over 20% of consumer spending habits. (14% towards transportation plus heating and utilities). We will partially cover this in commodities, but oil stocks make up a huge section of investments as well as being responsible for a large portion of consumer spending in any market.
Buffett is lacking in the computer+technology area as well as he doesn’t understand it This will make up the remaining 10% of our stocks portfolio. I am a firm believer in basic materials as well, but we will cover this in the commodities sector. I could make an arguement that many people would be better off running a screen, looking into each one of several companies for predictable businesses with predictable earnings, and identifying 5 stocks yourself, and just having 20% of each of your “stocks” asset allocated towards each company. Personally though, that is a lot of work and cannot easily be explained and modeled in a way that the post will remain timeless while also providing examples. 50 years from now you could easily want the same allocation model and the ETFs could still be around. So we will stick to that.

I decided to reduce OIH to 15 and increase Buffett’s so we have:
Stocks 30% of wealth
45% of stocks BRK/B (A shares if you have hundreds of thousands or millions to invest)
30% RWJ
15% OIH
10% XLK

overall we can multiple each name by .3 or 30% to get the overall allocation of our entire portfolio into that specific name.
25% commodities
I believe the numbers I have indicate that there are 50 years left of oil supply. As for minerals, silver specifically has only about 20 years left of supply. In general though, minerals are more scarce, and there are fewer solutions. However, oil there is greater dependency at the moment. I believe oil is a very important investment, but I believe other energy based names should be included. Green energy has a big following and a great political advantage in that governments around the world in spite of the fact that climate change and global warming and climate gate is a bought and paid for fraud or at least appears that way (venus previously had global warming and as a result it is now a gaseous planet, and either there used to be life on Venus that caused it if it’s man made, or it’s a natural caused event. I know that’s a lot to explain just to say that global warming may be a fraud but my point is, that it doesn’t matter because there is a movement to harvest the sun’s energy and if the world indeed is scarce in oil, it’s a good thing. Alternative energy is a good way to play oil’s scarcity and will be included.
If we are going to break down commodities into materials as one sub asset class and energy as another, I think it should go like 15% materials 10% energy

Of energy, I have ran a lot of numbers based on how the market plays it, what I think and based on “years left of supply” as well as my own predictions on how each group will perform and averaged it to get
55.6% oil+gas (60% oil 40% gas)
27% solar+alt energy
17.37% coal

For minerals I am not quite sure. I mean I have a clear, well defined actual allocation based on “years left” of each particular material. The problem is, it’s not easy to invest in each one of these.

For example, here’s a chart of global supply remaining in number of years for minerals Not only should minerals and oil be more heavier weighted in general, but they should be weighted within the mineral sector and the more scarce something is, the more you should invest in that particular item.

The way to calculate this based off all metals is to add up the “total number of years left, and divide the total by the specific metal, then sum up new totals based on these and then divide those new numbers by the total. This way you invest MORE if there are fewer years less in a proportional manner.

chromium 1.73%
copper 4.06%
gold 5.50%
hafnium 24.74%
indium 19.03%
lead 5.89%
nickel 2.75%
phosphorus 0.72%
platinum 0.69%
silver 8.53%
tantalum 2.13%
tin 6.18%
uranium 4.19%
zinc 5.38%
aluminum 0.24%
antimony 8.25%
gallium ?
germanium ?
rhodium ?

There isn’t enough information on gallium, germanium and rhodium.
update: from what I can tell there is about a 6 or 7 year supply of gallium left and today indium is also scheduled to run out in the year 2017. Because of it’s scarcity, it remains a great investment, but perhaps it’s also worth considering it’s lack of ability for investors to easily trade along with much fewer people holding it for speculation purposes. As such, there is less likely for indium and gallium than silver and gold to be miss-priced to the upside during a bull market, and to the downside during a bear market. Speculators may inflate the price as they bid it higher which can more drastically effect the rate of industrial consumption, or as they panic sell making it more affordable. Also, it is widely believed by precious metals investors that the price of silver and gold has been manipulated. These metals are more commonly looked at when investors that don’t trust the government numbers are looking for a measure of true long term inflation in the money supply.

Additionally, some of these things can’t be invested in with ETFs and in portfolios, and a basic material ETF might not cut it. There may be clauses in the IRA law that allows investment in precious metals directly, rather than ETFs, as there is to invest in real estate directly, rather than REITs, so you may wish to consult a CPA who clearly understands the tax code. However, unless you have the money to buy lots of ETFs, or have a more exact allocation data on each ETF, I really don’t know what else to do other than just pick an ETF that covers “minerals” and go with it. If you want to allocate more of your portfolio to this area since this is a clear area in which you can identify value, you may wish to come up with individual investments that requires more work initially, but once done will give you exposure based on weighting by value and the number of years left. I also suggest you consider owning physical materials with these ratios in mind, and rebalance on your own which can be done outside of your stock portfolio. Own a few bars of silver and a couple gold coins. At a minimum it makes sense to try to own enough dollars worth of precious metals to pay for a year’s supply of food for yourself and your family in the event of major financial calamity such as hyperinflation.

But for now, MXI looks like a place to get exposure to mineral stocks even though it probably will accomplish the opposite of what we want in it’s weighting since it invests in miners and miners on average are naturally going to have the most exposure in what there is most of for the most part provided they still have profit in mind. You may wish to add a precious metals ETF like DBP to counter that even though that is probably too heavily weighted in gold.

real estate we will just use VNQ
Currency we want to have a mixture of long the dollar, short the dollar, and long Australian dollar, yen and Swiss frank.
Bonds we want to have 50% treasuries 10% inflation protected TIPs, 20% AGG 20% BND

Overall we can just multiple what percentage allocation to an area by what percentage within that allocation to get the overall percentage of our wealth going to each area
The results sorted by asset class and sub asset class are as follows

BRK/b 13.5
RWJ 9
OIH 4.5
XLK 3
USO 3.336
UNG 2.224
kol 1.737
PBW 1.35
GEX 1.35
MXI 15
VNQ 5
UUP 5
UDN 5
FXA 5
FXY 5
FXF 5
TLT 7.5
TIP 1.5
AGG 3
BND 3

Or if you prefer sorted by overall allocation by ETF

MXI 15
BRK/b 13.5
RWJ 9
TLT 7.5
VNQ 5
UUP 5
UDN 5
FXA 5
FXY 5
FXF 5
OIH 4.5
USO 3.336
XLK 3
AGG 3
BND 3
UNG 2.224
kol 1.737
TIP 1.5
PBW 1.35
GEX 1.35

If you have less cash and don’t like paying so many fees, you might simplify this down a little if you would like to to the following
Stocks
BRK/B 30%
Energy
XLE 10%
Materials
MXI 15%
Real Estate
VNQ 5%
Currency
17.5% UUP
7.5% UDN
Bonds/Treasuries
TLT 15%

To see a case study on a very simplified non value weighted multiple asset class investment check out this post, or part 2 to see the results of the multiple asset class investment case study.

The next part is on creating more of a “hedged” approach. For this you would actually have to identify

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