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ALL-SEASON ETF PORTFOLIO: MINIMUM

CORRELATION ALLOCATION
MARCH 10, 2013 | OYENSCOTT | 7 COMMENTS

In January I launched an “All-Season ETF Portfolio”. The portfolio began with a static allocation based on
a simplistic and unleveraged interpretation of Ray Dalio and Bridgwater Associates “All-Weather”
investment strategy. The proposed static allocation is below:

Name Symbol Static Allocation

Vanguard Total Stock Market VTI 18.75%

 PowerShares DB Commodity Index DBC 7.25%

Tracking Fund

SPDR Gold Trust GLD 7.25%

 iShares iBoxx $ High Yield HYG 6.50%

Corporate Bond Fund

iShares Emerging Markets USD EMB 14.50%

Bond ETF

iShares Barclays TIPS Bond Fund TIP 20.75%

iShares Barclays 20+ Year Treasury TLT 12.50%

Bond ETF

iShares Barclays Aggregate Bond AGG 12.50%

Fund
The proposed allocation is not intended as a one-size- ts-all allocation model, but it does serve as a
framework for further study and is based on having allocation to the four different market
environments espoused by Bridgewater (full paper here):

I backtested the static allocation using ETFReplay.com – it outperformed the Vanguard 60-40 (VBINX)
mutual fund since 2008 on both a total and risk-adjusted basis. The All-Season portfolio has a sharpe
ratio of .67 and max drawdown of -21.5% versus a sharpe of.25 and max drawdown of -34.4% for
VBINX. Positions were rebalanced annually:

Last week I introduced a basic risk-parity allocation tool for the All-Season ETF portfolio. The risk parity
allocation uses the trailing 20-day volatility of the adjusted closing prices of each ETF to calculate a risk-
based allocation. The risk parity allocation as of Friday’s close is below:

Name Symbol Risk Parity Weighting (unleveraged)

Vanguard Total Stock Market VTI 5.17%

 PowerShares DB Commodity Index DBC 7.22%

Tracking Fund

SPDR Gold Trust GLD 4.32%

 iShares iBoxx $ High Yield HYG 22.44%

Corporate Bond Fund

iShares Emerging Markets USD EMB 12.57%

Bond ETF

iShares Barclays TIPS Bond Fund TIP 15.62%

iShares Barclays 20+ Year Treasury TLT 5.41%

Bond ETF
 iShares Barclays Aggregate Bond AGG 27.25%
Fund

The All-Season ETF portfolio risk-parity allocation has performed relatively well since 2008,
also outperforming VBINX by a wide margin. Risk-parity posted a sharpe ratio of .82 and max drawdown
of -16.8%. Positions were rebalanced quarterly:

When researching the All-Weather portfolio I came across David Varadi’s work at CSS Analytics. Varadi,
along with Michael Kapler, Corey Rittenhouse, and Henry Bee,  published a paper in September 2012,
“The Minimum Correlation Algorithm: A Practical Diversi cation Tool”.  In the paper they introduce two
heuristic algorithms for effective portfolio diversi cation and passive investment management, which
they conclude “is an excellent alternative to Risk Parity, Minimum Variance and Maximum
Diversi cation.”

Their algorithm, in my own words, is an alternative asset allocation model which makes intuitive sense.
It uses both the historical volatility and correlation of securities in a portfolio to determine asset
allocation. Securities with low correlations and volatility relative to the other securities in the portfolio
receive higher weightings. The result is a portfolio allocation which changes over time to re ect the
evolving volatility and correlations of the securities in the portfolio.

I was happily surprised to discover David freely provides a downloadable “Mincorr spreadsheet” on his
site. The spreadsheet uses the algorithms presented in the paper and allows users to calculate their own
minimum correlation allocations.

50 Top Stocks

After downloading the spreadsheet from CSS Analytics, I tweaked it to incorporate eight securities (this
took a little more time than anticipated). I then created a template to download daily price data to
calculate trailing correlations and volatility for the eight securities in the All-Season portfolio (this took
a lot more time than anticipated). Finally, I used the Mincorr spreadsheet framework to calculate a daily
“minimum correlation” allocation for the eight securities in the All-Season ETF portfolio and I provide
the results on the All-Season ETF spreadsheet.

Backtesting this strategy is more dif cult than a simple risk-parity or static asset allocation model. The
most comprehensive tests are available in the The Minimum Correlation Algorithm paper, which has
tests dating to 1980 for a variety of portfolios. The authors of the paper were kind enough to help me
run some tests for the All-Season ETF portfolio. The tests are available in the pdf here: minn corr
backtests, with tests being run from December 2007 – February 2013. The “min.corr.excel” results used
a formula close to the calculation on my All-Season spreadsheet.

The current Minimum Correlation allocations are below:

Name Symbol Minimum Correlation Weightings

Vanguard Total Stock Market VTI 6.71%

 PowerShares DB Commodity Index DBC 8.86%

Tracking Fund

SPDR Gold Trust GLD 3.37%

 iShares iBoxx $ High Yield HYG 29.37%

Corporate Bond Fund

iShares Emerging Markets USD EMB 9.76%

Bond ETF

iShares Barclays TIPS Bond Fund TIP 14.01%

iShares Barclays 20+ Year Treasury TLT 4.71%

Bond ETF

iShares Barclays Aggregate Bond AGG 23.21%

Fund

Note: my minimum correlation formula differs slightly from the method in the The Minimum
Correlation Algorithm in that I use a 20-day historical volatility & correlation versus the 60-day range
used in the paper. Using a shorter time period allows the spreadsheet to load quicker, but I may change
the 20-day look-back period in the future.
Any errors or omissions in my Min Corr calculation are my own. I have done my best to review and scrub
the data, but I make no warranties. As my programming knowledge evolves I hope to post
additional minimum correlation backtests.

Past performance is no guarantee of future results. To learn more about the

Minimum Correlation algorithm please take a few minutes to visit CSS Analytics.

If you enjoy these free tools, please consider making a donation on the home page of Scott’s
Investments using the Paypal link in the upper-right corner!

AGG ALL-WEATHER CSS ANALYTICS DBC EMB GLD HYG MINIMUM CORRELATION TIP TLT

VBINX VTI

7 THOUGHTS ON “ALL-SEASON ETF PORTFOLIO: MINIMUM CORRELATION ALLOCATION”

Jack Brown
MAY 9, 2013 AT 5:12 AM

Hi Scott,

I don’t understand how this Minimum Allocation Correlation tool is supposed to help me manage
my All-Weather portfolio. A big part ot the theory behind the All-Weather is the fact that it’s a
passive approach and balancing is done on an annual basis. How am I suppose to implement the
Minimum Allocation Correlation results that change on a daily basis on a once-a-year balancing
strategy? Perhaps i’m missing something here.. Thanks

 oyenscott
MAY 9, 2013 AT 8:08 AM

The min corr allocation is more of an exercise, not a recommendation. The allocations change
daily but this does not mean rebalancing should occur that frequently. For example, the Ivy
portfolio spreadsheet signals have the potential to update daily, but I only write a monthly review.
I created the mincorr tool to allow for maximum exibility, thus, it updates daily.

Jack Brown
MAY 9, 2013 AT 8:55 AM
 Ok – got it. Thanks

Eric
JANUARY 26, 2014 AT 8:43 PM

Hi, your link is broken to the Excel download.

 oyenscott
JANUARY 26, 2014 AT 9:33 PM

Fixed, thanks for the note.

Michael Kane
JUNE 3, 2014 AT 9:25 PM

How does this frequent rebalancing impact the after tax return?

 oyenscott
JUNE 4, 2014 AT 9:40 PM

It will lower it, but I do not have gures since there are many variables to consider.

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