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Pragmatic Capitalism

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Countercyclicing indexing

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Hi Cullen,

I just read your article Understanding Modern Portfolio construction and found it extremely interesting.

I summise that a countercyclical approach means rebalancing but also changing the weighting of each component (as opposed to a 60/40 portfolio which has a fixed weighting).
Am I correct in saying that the change in weighting is dependant on portfolio duration (as calculated in your article).

The reason i’m asking is for clarification, because part three of your article does not refer back to portfolio duration and doesn’t not mention criteria by which to re-weigh.

I hesisated to ask this question based on only one read of your article, so i apologise if this is a stupid question.

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Posted by Faramir
Posted on 10/08/2017 8:42 AM
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Hi Faramir,

It’s not a stupid question at all. I didn’t really explain it because there’s a lot of different ways that someone could implement a CI strategy. I do it by building a simple model to quantify the risk in the instruments. The duration is used to calculate which profile an investor is. And then the appropriate portfolio is rebalanced for each investor based on how risky the assets are. So, let’s say you’re a 5-10 year duration then you’re pretty conservative and that means you need the Conservative Countercyclical portfolio. So you’d build your portfolio so that it rebalances based on the conservative model. For me that strategy is always underweight stocks and basically rebalances between a 20-40 stock weighting depending on the cycle’s current status.

To me it just makes a ton of sense. 60/40 just has too many problems. The biggest is that it’s exposing you to the max equity risk at the max riskiest times because it’s really more like a 80/20 portfolio in terms of where its downside risk comes from. So it makes sense to rebalance it away from stocks if they are becoming riskier or exposing you to more behavioral risk. The bond piece is also problematic, but I actually run a countercyclical strategy WITHIN the bond piece so the whole strategy is a multi-strategy designed to take a 60/40 and fix what I think are a bunch of problems with it.

Make sense?

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Cullen Roche Posted by Cullen Roche
Answered on 10/09/2017 12:50 AM
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    Yes, great.

    The only issue I have with it is that I do not trust myself to quantify risk in each component. If i’m honest with myself, I do not have a good decision-making process and would end up changing my mind too much, exposing my portfolio to behavioral problems. Working on it though … 🙂

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    Posted by Faramir
    Answered on 10/09/2017 1:48 PM
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