Thursday, December 11, 2008

A FEW MORE COMMENTS ON DYNAMIC ASSET ALLOCATION

I thought that I would add a few more comments about dynamic asset allocation to my earlier post. Static v. Dynamic Asset Allocation  I am bored today and have time on my hands.  Boredom is the major reason for writing these blogs since my VIX asset allocation model has severely restricted my daily stock buying routines.  

In dynamic asset allocation, I would never reduce a major asset class like stocks and bonds to anywhere near zero for me now. I would reduce a minor class or a sub-class to zero or near zero.  An example would be commodities. An individual can now gain exposure to a particular commodity like gold, silver, oil, and natural gas by buying an ETF (USO, UNG, GLD, SLV, OIL).

Exposure to commodities as an asset class can also be made by buying an ETF that tracks a commodity index such as GSG. I reduced this category to near zero in 2007, missing the last parabolic rise in mid 2008 but not suffering any of the recent severe declines.  So, exposure to commodities is something that I will reduce to a  zero percentage. An example of a sub-class that I will reduce to near zero, but not entirely eliminate, would be emerging market stocks or over-exposure to a particular category of stocks like energy and natural resource.  I eliminated all of my natural resource mutual funds before the fall in energy prices. Some of the prior posts relevant to this discussion include the following:

Since I have trouble sticking to one topic per post, discussion about asset allocation theory is scattered all over the place.

I would also say that most individuals should avoid making any individual security decisions.  I do it to relieve boredom and because I am interested in doing it. At times, I will outperform an index. Sometimes I may even make a brilliant decision like buying Apple around 10 and sometimes the decision is so idiotic that I would be ashamed to even mention it.  It is difficult for me even though I know more than any stock broker that I have ever met and I also believe that I would do better than the vast majority of mutual fund managers.  Those ups and downs on individual security selections, and inconsistent judgments on the same, can be avoided by securing broad exposure to stocks and bonds solely via ETFs.

With the wide variety available today, ETFs would be the best way to work an asset allocation model. They are low cost and virtually all asset classes can be found in the ETF universe. It would not be difficult to find low cost ETFs for bonds, including U.S. Treasuries of varying maturities, international government bonds, inflation protected bonds both international and domestic, emerging market bonds, high yield domestic bonds and investment grade corporate bonds. The same is true for stocks and commodities.  

I sold most of my stock ETFs last year and have not bought them back.  For the next bear market, I may keep those and eliminate entirely my closed end investment funds and reduce my individual stock selections.  I also reduced my small cap exposure to virtually nil last year.  I would do that again under my volatility asset allocation model based on the RVX.  I am now thinking about when to add back some of the stock ETFs that I sold and this included IYY, VEU, VV, and VIG.  My current thinking is to wait for the formation of a stable VIX pattern and then add them back all at once as part of my stock allocation and reinvest the dividends.  I am not inclined anymore to add to stock mutual funds for reasons previously discussed.  

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