An Overview of Our Allocation Changes (March 2021)

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We are constantly reviewing our portfolios’ asset allocations in order to bring them more in line with our Investment Committee’s current best thinking. Here is a summary of our recent changes.

Resource Stock and REITs

We have been working on an update to our Resource Stock allocations for several months. In August 2020, we lowered our Resource Stock allocation to a flat 10% of our Appreciation allocation. Then, in October 2020, we removed our Energy overweight from Resource Stocks. Since removing Energy, Resource Stocks has been composed of foreign real estate investment trusts (REITs) (VNQI) and U.S. REITs (VNQ).

While a 10% allocation to REITs can be justified using efficient frontier analysis, lower allocations are more easily justified. Furthermore, we believe that the real estate sector has seen several changes because of the pandemic which are likely to make the sector more volatile. To decrease volatility, hedge against a potential further correction, and reallocate into sectors we believe are better for the long-term, we decided to decrease our Resource Stocks allocation again. This time, we reduced from 10% of Appreciation to 4% of Appreciation.

We also decided to adjust our static allocations between foreign and domestic REITs. Previously, we were using a 50-50% allocation, which was then dynamically tilted to 35-65% in favor of foreign REITs. In light of suggestive research that foreign REITs are less efficient due to their added currency risk, we adjusted our underlying static targets to lean towards domestic REITs with a 65-35%. After the March 2021 dynamic tilt, this winds up with a dynamically tilted 50-50 allocation.

In our hand-traded accounts, this means we will be trimming both Vanguard Real Estate Index Fund ETF Shares (VNQ) and Vanguard Global ex-U.S. Real Estate Index Fund ETF Shares (VNQI), with VNQI trimmed a little bit more.

Freedom Investing

We have been advocating Freedom Investing since 2004. Every year, the Heritage Foundation evaluates all the world’s countries using their Index of Economic Freedom, where a high score correlates to nearly every positive measure of a country. We then use this ranking and efficient frontier analysis to craft our Foreign Stock investment strategy that we call “Freedom Investing.”

At the start of this month, the Heritage Foundation came out with their new 2021 Index of Economic Freedom. With that new release, we have updated our Foreign Stock strategies.

As you can read about in our separate article on the topic, Heritage removed Hong Kong entirely from its 2021 scoring. With that update, we effectively halved Hong Kong’s allocation.

Changes to the U.S. Allocations

As we have discussed previously, part of our U.S. stock strategy features an overweight to the Biotechnology subsector and the Healthcare, Technology, and Consumer Staples sectors.

This quarter, we reviewed how our portfolio allocations compared to the domestic total stock market index to verify that our overweight was on target with what we wanted. In doing so, we discovered that we were actually underweight in U.S. Technology because of our Mid and Small cap focus in our style box allocations.

As a result, we reallocated our U.S. sectors, decreasing our static asset allocations to Consumer Staples and Healthcare slightly, so that we can increase our allocation to U.S. Technology.

Also, while the forward price-to-earnings (P/E) ratio of Biotechnology is usually negative, this month, we developed a strategy to tilt Biotechnology using a modification of the Healthcare and Technology forward P/Es. This change means that the dynamically tilted Biotechnology allocation has increased slightly this month.

Schwab Institutional Intelligent Portfolios (IIP)

In our algorithm-traded Schwab Institutional Intelligent Portfolios (IIP), where we are limited to only 20 ETFs, we made several more fund changes.

We elected to remove VNQI from the allocations and let VNQ represent the whole Resource Stock allocation. We also removed Vanguard Energy Index Fund ETF Shares (VDE), as we had already dropped that allocation to 0% earlier.

With Hong Kong as the smallest country-specific allocation, we also elected to remove that one from the program.

Lastly, we elected to remove Consumer Staples. Consumer Staples is a portfolio dampener, increasing efficiency and reducing volatility but sometimes at the expense of returns, and we realized Schwab already requires our IIP portfolios to keep 4% in cash. Because that cash already adds extra Stability, we decided that Consumer Staples was likely less necessary in IIP portfolios.

These removals opened up four new ETF slots, which we filled with Finland, Netherlands, Taiwan, and Biotechnology. Of the four, Taiwan is the only new one to our asset allocations overall. You can read about its addition in our recent article here.

Photo by Fisayo Afolayan on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.