Fundamental vs Cap-Weight Portfolio: Surprise Performance Reversal after Year One

The first year has now passed in the head to head contest between the fundamentally-weighted portfolio and a parallel portfolio with the same asset allocation based on traditional cap-weighting. Both portfolios started out with $100k last June - see original post announcing the contest.

Both Portfolios Have Gained - up about 10% to $110,000 or so as of August 5th, though it was higher at the 1-year anniversary since the past few weeks have not been kind to market values. Every single asset class is higher than the value at inception. I note that our hypothetical investor is not panicking and is not / has not sold anything, unlike those mythical investors (why doesn't the press just call them speculators, anyway?) who have been obeying the chicken-little sky-is-falling market forecasting gurus.

Cap-weight Ahead Slightly! - Surprise, surprise, after being behind pretty well the whole year, sometimes by more than $1000, or 1%, the cap-weight portfolio spurted ahead in the last month or so and now leads by about 0.6%. I think the quick shift was the European banks getting hammered in the PXF vs VEU category but need to look further into this. Whatever the reason, this contest doesn't look very conclusive so far.

Rebalancing - After accumulating cash from most of the ETFs for the past year our policy called for review and reinvestment of the cash at each year anniversary. Note: Claymore CRQ ETF has automatic DRIP with distributions so I've tracked the reinvestment for CRQ. BMO also does auto DRIP but when BMO switched to monthly distributions with ZRR and ZRE it has not been worth my bother to do all the tracking of reinvestment for single share purchases, so I've simply tallied up the cash. Not one of the ETFs / asset classes had come near to the forced rebalancing point of 25% deviation from its target allocation in the portfolio. None are off even 10% from allocation target.

Nevertheless, to put the cash to work but not pay too much in commissions to rebalance small amounts, and to keep the asset class by asset class contest going, I've split the reinvestment cash to put another $1000 each into CRQ and it cap-weight rival HXT. The remainder has gone into XBB for each portfolio. These were the two asset classes with largest dollar amount divergence so it works out neatly as a quite realistic action.

More shares of XBB have been purchased (all purchases done at closing market prices of August 5th) because the cap-weight ETFs have paid out more than their fundamental weight counter-parts. That's interesting because the fundamental weight ETF holdings are supposed to be selected and weighted in part according to dividends. However, the higher MER's of the fundamental weight ETFs (about 0.5%) have to be paid. That's a cost performance drag of the real world for the fundamental ETFs that their superior index returns do not reflect. Our contest tests whether the stock performance is strong enough to overcome this impediment.

Fundamental DRW Replaces Cap-Weight RWX in the Fundamental Portfolio - Long ago reader Jordan suggested Wisdom Tree's Global ex-US Real Estate Index ETF (symbol DRW) as a fundamentally-weighted alternative to RWX. Now the switch is done it's done and there can be a contest in that asset class too.

As ever, the two portfolios can be seen side by side at the bottom of this blog page.