Relative Pricing – Active Rebalancing across Asset Classes and Factors

I went to buy some fruit the other day. I found myself questioning whether it was expensive, cheap or fairly priced – I came to realise that things are only expensive relative to something else. – Relative to what I earn, what I have, what I value, the currency I hold, what other things costs, what I have paid before, what I expect to pay in the future, the convenience. It is all relative.

The same is true for investments, if I want to build in buying low (during wealth accumulation) and selling high (during the protection and drawdown phase), I need to look at it from a relative pricing perspective.

My investment philosophy follows the Simple Path to Wealth. I have a few core fundamental principles, these haven’t changed in almost a decade, as they shouldn’t. My investing portfolio strategy has changed though, once, for the first time in January, shifting from 100% Equities Market Weighted (E.g. VT or VTI + VEU) and two properties (one in London and one in Cape Town), to one that has a greater class and factor exposure.

As I am targeting FIRE I need a portfolio that continues to grow, as I don’t want to be constrained by the 4% rule (4.5% with Small Caps and 5% with other factors/classes, potentially as high as 6.5%-7%) and I want to reduce the sequencing risk associated with drawdowns. I generally prefer the Dynamic Drawdown approach, but I need a decent return to optimise this, with a reduced standard deviation. For most, this is not necessary, with 30-40 years of accumulation before drawdown and then a set drawdown %, it becomes a moot question. For me, with a 3-4 year horizon, I need to examine things differently.

My thinking has continued to evolve and be refined over the last few months. I am sharing some of my thoughts below – which may help to inform your thinking, but my motivation is to increase my own clarity of thought. For clarity of thought, Ben Felix is my go-to Financial Digital Mentor and I’ve shared some of his key videos below. I have spent 100s of hours on this and probably so should you, but my goal is that the below helps as a starting point.

Relatively Constant Rebalancing – Key to protecting the downside and scaffolding in buy low

If something goes up, I buy less of it, if it goes down, I buy proportionately more of it.

What this practically means for me is that when I buy each month, I buy to get back towards my target %s. I cap this at 2X of my allocation. So if it’s 10%, I’ll only ever put 20% at most of my new investment. This is to prevent throwing it into a black hole and to allow momentum investments time to ride. I don’t sell at this stage, as it allows growth to compound and reduces taxable events. One day when I do sell, I will sell to trend towards my target %s.

Note, that I don’t subscribe (at all) to active trading and stock selection. This video just explains the value better than elsewhere.

Asset Class Allocation – Fundamental – Stocks 84%, Bonds 4%, Cash 6%, Commodities 4%, Property 2% – 50% in US, 50% ex US

I want assets that are are not strongly correlated, ones that move at different paces and at different times.

With a diversified asset allocation (classes and geographies) I can improve my expected return at a given level of risk or keep the same expected return, but at a lower risk.

Over the long term, Equities will almost certainly give me the best return, but it can be a bumpy ride. With constant rebalancing, as asset classes behave or move differently, I can buy relatively cheap classes. The classes move differently, they may crash at a similar time, but they will crash to a varying degree and they will recover at different times and speed.

With rebalancing, the actual %s are less relevant. Small amounts with an imperfect correlation to stocks does the trick.

Rebalancing Frequency and Safe Withdrawal Rates

How Diversification Improves Safe Withdrawal Rates

Asset Factor Allocation – Continuing to build in buy low, sell high – Stocks 84% split into – 58% Market (Beta), 12% Small Value (Size), 8% Market Value (Profitability), 4% Momentum, 2% Investment (Dividend)

In theory, adding specific factor exposure can enhance the return, without relying on the randomness of market timing and stock picking. For many, this is an unnecessary added complexity. It will likely give an enhanced risk-return ratio, but ultimately the savings rate and asset class decision is the number one driver towards Financial Independence.

Adding Factors has value for me, this is balanced against complexity (I have a spreadsheet that does it for me), cost and accessibility. The last two are related. I have added some factor exposure, particularly in my US investments, at this stage, I am battling to find cost-effective exposure internationally (ex-US).

(See more on Value and Small Cap Value in the videos below to see why I weight them more heavily, momentum is good for the short term and I have a little bit of investment.)

An excellent paper on Five Factor Investing

Gold, Silver, Bitcoin, Ether and other Commodities – Asset classes on their own – 4%

Gold is considered the typical safe haven, the place to rush to when stock markets are collapsing. This is sometimes the case, sometimes it is less so – Dalio loves it, Buffett does not, they both have very persuasive arguments. The expected return on a non-productive asset is low or sometimes even nil, but the volatility is there and they certainly all behave differently, at different times – which is great for active rebalancing, less relevant if not.

The below are some instructive videos who can explain it more clearly than I can.

There are some terrible opinions out there about Cryptos, largely disguised as predictive advice. What is clear is that the price is being driven through leverage by people who are not typical investors. The arguments are based on a very short time horizon and skewed knowledge and bias (for those interested, this is the most balanced view I have heard).

Bitcoin seems to be a religion, with polarised views. A more pragmatic view is probably better. Seldom is the truth in the extremes.

A reminder is that I am looking for uncorrelated returns in my asset classes to scaffold in relative buy low, sell high decision making.

I have chosen to include these “commodities” in my factors, simply because they are likely to move differently. I think Bitcoin specifically is one of the few classes in my portfolio that could 10x or 1/10x in a few year horizon. I personally think it should be later, but is probably more likely to be the former, with a rebalancing portfolio it matters less to me which occurs.

I have also included Ethereum and Silver, because they have actual use cases. They will move differently, at different times, with different scales. The usually segmented comparisons on static time horizons, do not show this adequately. With active portfolio rebalancing, volatility becomes my friend.

Although prices tend to move together, they don’t move at the same time. With active rebalancing, we can take advantage of this.

For Cryptos, I would prefer an index, but I have not found one accessible that doesn’t add complexity.

Property – An uncompensated risk factor – 2%

I already have property. One flat in London and one in Cape Town, these were bought with the rent vs. buy decision in mind, I have left them out of this decision. I will likely sell these at some point. I do not hold them for investment purposes, they are a concentrated risk, which requires active involvement.

My interpretation is that I should be against property investment class, but for property as an asset class.

In the Asset Allocation video, we could see 6% in REITs increased our return and decreased the standard deviation (riskiness/volatility). So REITs on their own, are not a compensated risk, but because they move differently, they are worth adding in my view. We could get a similar exposure elsewhere, but it is simpler to include 2% in my asset allocation.

So what does this all mean – Model Portfolios

Rational Reminder Model Portfolio

They looked to get exposure, with a limited number (6) accessible ETFs.


PWL Capital Felix Passmore Model Portfolio

This is of limited practical use at the moment for most investors. As we do not have access to Dimension Capital Funds – as they begin to release ETFs this may change. Avantis has a similar philosophy and is releasing more publicly available ETFs, but these may take a while to filter through to our investment platforms.


My current, target and simplified model portfolios

It’s difficult and perhaps irrelevant to back test this, as the future will different, additionally, it is not practical to model in active rebalancing through irregular purchases. The logic works for me though and this is what I would have, if the right products were available.

If I had easy access to right product (cheap, low tracking error) – this would be close to what I would do

Models are one thing, but it needs to be accessible. I am restricted by the availability in eToro and my TFSA. I’m getting most of my factor exposure in the US. The below is way too complicated for most, but I like it.

This is what I’ll trend towards over time

I have the first three factors Market, Small Cap (specifically value – see below) and Market Value that should be enough for most. The remaining two factors Momentum and Investment. Momentum (what goes up, continues to go up) is unlikely to be persistent (long term) and is largely captured in Index investing by its nature. Investment is that companies that direct profit towards major growth projects are likely to experience losses in the stock market, the rough corollary of which would be companies that pay higher dividends. This is more difficult to predict going forward, so I have limited my exposure to this factor.

For clarity, I am looking at holding the best-expected return (stocks) and then taking advantage of the different relative price (and currency) movements through active rebalancing. For those looking for a simplified model, I’d be looking at something like the below within eToro – depending on preferences.

This is the type of portfolio I think that most financially savvy and interested would like
Based on a classic 90:10 split, but adding a little bit of factor exposure

Or my reduced friction portfolio.

For most people (financially disinterested), this is perfect

80% of my target portfolio is in Etoro. If you are interested in following my eToro Profile. The rest is 6% in my Access Bond, 14% in my Easy Equities TFSA with 2% SYGP (tax efficient property), 11% GLOBAL (VT Feeder) and 1% ASHWGB.

I don’t believe anyone has not reached their financial goals because they haven’t had factor investing or didn’t go beyond a two asset class investment strategy. Savings rates, diversifying, consistency in strategy, and reducing fees and taxes through buying passive index funds are far more critical. I do believe that active rebalancing with additional factors does hold value, but not if the additional complexity is going to reduce action.

Why isn’t this getting more attention.

The discussion, is a little long, but if you have made it this far, could be of interest.

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