Wednesday, 12 January 2011

Cap-Weight vs Fundamental Portfolios: 2010 Year End Update

Last June I created two parallel test portfolios to determine whether Fundamental Weighting really does a better job than a Cap-Weighting as proponents like Robert Arnott say. The two portfolios have the same asset classes and proportions invested in each asset class. As much as possible, the portfolios mirror the investor experience, as I described in the initial post about this mini project.

The 2010 year end has come and the cash distributions have been received by the portfolios in a mix of Canadian and US dollars. Where offered by the ETF vendor - BMO and Claymore only - the distribution has been reinvested in its ETF. Per the intention announced in the October update, in the Cap-Weight portfolio, I've now sold the iShares S&P TSX 60 Index ETF (symbol: XIU) and bought in its place Horizons BetaPro S&P TSX 60 Index (HXT), which cleverly uses swap derivatives to track the same index but with the key difference that it implicitly automatically reinvests distributions. That will make a fairer comparison against Claymore Canadian Large Cap ETF (CRQ) which has a DRIP.

The Competition Results:
  • It is still more or less a dead heat overall between the two portfolios - only $128 dollars out of a portfolio total value of $113,400 or 0.1%;
  • Fundamental Weighting leads in four asset classes and Cap-Weighting leads in two (I ignore RWX since it is the same ETF in both portfolios and the Cap-Weight portfolio has one more share so it will always be ahead by that one share)
  • Cap-Weighting is ahead in Canadian large cap equity but Fundamental Weighting leads by a significant margin in the two small cap equity ETFs for the USA and for Developed Markets. It is curious that Fundamental Weighting leads by most in two of the asset classes which have had the biggest increases. Cap-Weighting is supposed to be the bubble follower I thought. Maybe it's a sign that the rise in those stocks is not a bubble at all, that in fact the previous weightings were out of whack - Cap was too high - and now Fundamental has been catching up.
General Investing Results:
  • Both portfolios are up a healthy 13% since June, when we pretended to invest $100k
  • Every asset class is up by double digits, except Bonds
  • The rise of the Canadian dollar has reduced foreign returns but they were still much stronger than those of Canadian holdings after conversion
  • None of the asset classes is anywhere near the threshold set for rebalancing (1/4 of its allocation percentage), which we said anyway we'd only do after a year.
  • Cash inevitably has started to pile up unproductively in these accounts as in real life when distributions are not immediately reinvested. The Fundamental portfolio has $1767 in cash (1.6% of its total value) and the Cap portfolio a bit more at $2066 / 1.8% (since fewer of its ETFs offer a DRIP). This brings out the real-life no-perfect-answer dilemma of having idle cash vs paying too much in trading commissions to reinvest small amounts. At the year anniversary in July after two more quarterly distributions by the ETFs, there will be more cash and we'll reinvest & rebalance per our portfolio policy.
The details of the two portfolios are in a Google spreadsheet at the bottom of this blog page.

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