Second opinion on Value + Crypto + Gold

I thought about this and I am ready for criticism:

Portfolio

  • 70% Value Stocks (100% VVAL)
  • 20% Crypto (50% BTC + 50% ETH)
  • 10% Gold (100% 4GLD)

I will use a Degiro custody account and Bitstamp.

Reasoning

The basic idea is to use a broadly diversified low cost value ETF for the value (and market) factor premium.

Additionally, volatile gold and highly volatile cryptos are not very correlated to value stocks. I will rebalance whenever an asset deviates from the target by a factor 3/2 relative to the portfolio (e.g. about +7.8/-9.1 pp around 70%). I will rebalance angainst the asset class that performs deviates in the opposite direction the most. That should lower the portfolio risk and give me some returns through statistically buying low and selling high.

Possibly the cryptos will also have a high to very high average annual return. I am less optimistic for gold in that regard. The longterm return of gold is not very good.

Questions

  • For the given asset class distribution are there superior products to use instead?
  • Should I diversify products or brokers?
  • Do you have recommendations regarding changing asset classes and target distributions?
  • How much better is 100% VT?
  • Any other remarks?
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VVAL would have returned 5.20% since inception (9 dec 2015). Overall, not annualised.
VT (or VWRL for that matter) on the other would have returned approximately 43% over the same period.

So as a rough estimate you could say VT would been roughly 700% better than VVAL. Of, if you had held a share in Bitcoin, it wouldn’t have mattered much, since your 10% share of Bitcoin would increased more than 20-fold in value since december 2015 (though only foregoing the rebalancing you intended).

While historical performance is no guarantee of future performance (or vice versa), given a difference of 5.2% return in VVAL against 42% in VT/VWRL, you might question your choice of ETF.

Put differently, you’ve got to be highly convicted of Vanguard’s (quotes) “actively-managed investment strategy” and “proprietary quantitative model” used in VVAL. Or rather, since it would have somewhat outperformed other value ETFs (IE00BP3QZB59) at least temporarily (until 2018 or 2018), the idea of a value ETF altogether. Personally, I’m not a big fan of strategies to buy “as long as it’s (relatively) cheap”.

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Thank you for your feedback :+1:

I saw the relative underperformance vs VT as well. Value in general has had a bad time the last few years. But according to quite a bit of economic research there exists a value premium for the risk of value stocks. Even those who argue against its existence don’t claim that the opposite is true. I guess it will reverse sooner or later, likely later.

The fund being “active” did not lead to a higher ongoing charge. It is the same as VWRL (Vanguard’s UCITS alternative to VT) at the moment: 0.22%. They do differ in portfolio turnover. The annual report 2019 shows that the share of transaction costs in total costs were about 21% for VVAL, but only about 6% for VWRL. Also the net assets were more than one magnitude apart 2705 M (VWRL) vs 199 M (VVAL).

As I don’t expect any alpha from their rule based “active” ways, I am happy with their very nice P/E (7.23) and P/B (0.60) numbers. I didn’t find other low cost value etfs with better numbers yet.

What are your reasons for disliking strategies that buy (relatively) cheap assets?

Hi Helix!

I have a few remarks.

Three three chosen asset classes are risky and fluctuate a lot. Have you assessed your risk aversion and your horizon, and considered adding a low-risk component (cash, short-term bonds) to your portfolio to fully control the level of risk you are willing to take? Even with a more diversified choice of asset classes, a risk-only portfolio would not be suitable to most people. One question to ask oneself is: will I still be able to sleep at night if it all goes down by 50% or even by 80%? Will I be tempted to sell in the worst moment?

From an asset class perspective, VT is more diversified whereas a pure value stock ETF amounts to a form of stock picking. Stock-picking based on factors (value is one of them) is motivated by published research (Fama, French), but it is also important to be aware that the higher returns of factors happen over very long periods of time (at the very least several years), which requires a lot of discipline to stick to a strategy and resist the temptation to deviate, and that once a strategy that leads to higher returns is found and becomes public and many investors start using it, there is no guarantee it will continue to work.

To not put all eggs in the same basket, some people choose to follow an approach of tilting towards some factors (such as value and small caps), rather than going all in on a factor. Concretely, this means allocating a significant part on the entire stock universe (for example VT), and one or more smaller parts on factors.

Funds come and go. With the very long time horizon needed by factors (according to Fama and French) to overperform, there is a risk that a product may close and that one is forced to switch to a different one (reinvestment risk). Finding several products that mirror an asset class would minimize this risk. It is hard to say what new trends will emerge in 10 or 20 years, and whether factors and smart beta will still be a driver of ETF offering. The same goes for brokers: it depends on the total amount. If the amount is significant, having several brokers would also make it less abrupt to handle if one of them stops its activities or goes bankrupt; even though there are laws in many countries that segregate customer assets from the broker’s, it may still be a bit of paperwork to claim them back.

The motivation for choosing to include gold in a portfolio is not its return (close to 0 over millennia), but to have some hedge against inflation and to optimize the risk-return characteristics of the portfolio with its negative correlation to some other asset classes. Also, not everybody agrees that gold or in general commodities belong to a portfolio, so this is a personal decision. 10% of gold is nevertheless a lot compared to typical allocations in pension funds, for example.

Planning to rebalance a portfolio with 20% of cryptocurrencies is a strong bet on the success of crypto. In the event (which may or may not happen) that crypto goes to zero, or even that it succeeds but another cryptocurrency than BTC or ETH takes over as the “mainstream winner”, rebalancing into BTC and ETH could drag down the entire portfolio to zero. Rebalancing is designed to work with broad asset classes that have a track record of performing well over the very long term. Gold has a track record of several millennia, stocks of several centuries. Many advertise a percentage of crypto closer to 1% partly for this reason. I am under the impression that the spirit of the FIRE movement would be to remain in control of the risk taken, keep it minimal, and diversify.

[Disclaimer: this is not investment advice, only the sharing of experience]

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Hi ProvidentRetriever

Thank you for this very extensive review! I hope I can do it justice with my answer.

Yes, I have considered low-risk, low-return assets. It impacts the performance very significantly. The longer it goes the worse it gets. Especially as base performance starts evening out unlucky entry points. I have a very long time horizon. Longer than RE as I need few and am more interested in the FI part.

Rebalancing in general seems to boost return and lower risk the higher the decorrelated volatility of the assets is. That also implies that a volatile asset has advantages over a steady one. But if the base performance differs to much, that will become dominant over the boost in return. It is also why I’m unsure about the gold: While it does tend to be decorrelated from stocks even more than money, base performance is far away from stocks.

Crypto on the other hand will likely stay very volatile for quite some time, and if it doesn’t, then it either has crashed to zero or become established. Till it becomes established it still has a huge potential upside. In my opinion it has a very bright future as an asset class, because it brings something new, unique, and needed to the table: Delocalized trustless value, services, etc.

As far as I understood, the higher return is supposed to be generated by the higher risk. The factors differ from strategies doing arbitrage over market inefficiencies thus making them disappear. Instead the factors are a part of the present efficient market. They should only go away once the risk has also reduced.

I thank you for asking. As standard as the question is, it still got me thinking. I do think the asset classes themselves are quite solid. There are other asset classes which could probably stand in for them, but my knowledge of them is not good enough.

As I won’t need this money to survive, my risk tolerance is rather high. I think the most I would do is stop adding money and stop rebalancing.

I am less sure about the products, though. They bring uncertainty that could make me sell and replace:

  • VVAL doesn’t follow any open index and has a rather low cap. A replacement could be VVL. But it is just Vanguard still. The reinvestment risk could strike exactly when they perform the worst and everybody wants to get rid of it. I am supposed to buy then. But I can’t buy a fund that doesn’t exist anymore. I will be forced to buy a fund with very different P/E, P/B and consequently assets. Maybe the suggestion with the tilt could be adapted to additionally buy a fund with less value tilt. I could select this fund for size and diversity in funds that reproduce the same open index.
  • I agree that allocating 10% each in BTC and ETH is bad risk. I must diversify. The problem is how. If I just take market cap, I will only hold BTC. I could cap BTC. About halve of the rest would be ETH. Below them come a lot of interesting and a lot of dubious coins. Additionally crypto market data is still prone to manipulation. Whilst I wouldn’t be lost having to choose, it would be a very active approach then. Any good ideas?
  • Also individual cryptos probably have a good potential to go to 0, even BTC. The relatively low weight of 20% does shield quite well against loss. With rebalancing every time it looses 1/3 relative to the portfolio, I calculate a factor of 0.93… on the whole portfolio for every occurence. Assuming it goes straight down, after 11 occurences the absolute value of crypto will be about 1/100 of the original price. The whole portfolio will be only about halved by that time. But yes, it will go to 0 together with the 20% crypto eventually. There needs to be some stop trigger. Some combination of time and total loss?
  • The gold can be diversified rather easily. How much is also a question of fees and hassle. Do you think 2-3 different products would be sufficient?
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