Portfolio Design

Advanced concepts in stock investment portfolio design.  Fundamentals, technical analysis and many other related topics are discussed.

Rebalance Your Portfolio like a Fund Manager

Dogs of the Dow Investment Strategy

Many Exchange Traded Funds (ETFs) reconstitute their stock holdings once per year (or sometimes twice) but reset to equal-weight (rebalance) more often than that, typically quarterly, By reconstituting the stock holdings only once per year, the turnover is significantly reduced, meaning less paid in fees and slippage. This tutorial demonstrates the above using the popular Dogs of the Dog investment strategy.

Stock market analysis fueled by Portfolio123.


The concept of separating the reconstitution of the portfolio from the rebalancing is not the norm for Portfolio123, but can be accomplished fairly easily once you know how to do it. "The Dogs of the Dow" investment strategy will be used to demonstrate this concept. The strategy requires the investor to select the ten highest dividend paying stocks from the Dow Jones Industrial Average (DJIA) on the last day in December and hold them for one year.

There will be two modifications to this strategy. First, the portfolio will be "examined" weekly. Therefore the portfolio will be reconstituted the last week of December, not the last day. Second, the portfolio will be rebalanced to equal-weight on a quarterly basis.

This first step in the creation of the trading strategy is to set up a high yield Ranking System as shown below.

High yield ranking system

Once the ranking system has been created and saved then it is time to move on to generating a simulation. Starting with the general setup, make sure that Rebalance Frequency is set to Weekly. Note: do not confuse the Portfolio123 terminology with our terminology.  In the context of the Portfolio123 environment, the Rebalance Frequency means how often the software updates the buy/sell rules for the system.  In our context, rebalance means resetting the stock holdings to equal-weight. The portfolio will be rebalanced on a quarterly basis, but Portfolio123 will process the buy/sell holdings on a weekly basis.  Weekly processing is how the system will manage to reconstitute the holdings during the last week of December.  If the Portfolio123 Rebalance Frequency were set to daily, then the system could be reconstituted the last day of December (with a few complications). We will stick with the weekly setting as it is more convenient to use, all around.

Simulation general setup

Next go to position sizing and set the % of Portfolio Value to 10. and 10% of Ideal Size.

Simulation position sizing

Then select the Dow Jones Industrial Average as the stock universe, and the previously created High Yield ranking system as shown below.

Selecting the stock universe and ranking system within the simulation setup

Now skip over the Buy Rule tab and straight to the Sell Rules. The reason is that the Portfolio123 S/W has to sell stocks before the port has cash to buy stocks.  Therefore the Sell Rules have to be designed first.

The first sell rule is to define a variable called @Rebalance, which is set to TRUE one month out of every three months. This is done using the Modulus (Mod) function. The rule is Mod(Month,3)=0.  The rebalance months will be March, June, September, and December. But the portfolio should only be reconstituted only during the last week of December.  We don't know which day will be the first day of the week so a window is defined... MonthDay>24.  Thus the portfolio will be sold in its entirety the last week in December, whatever day that may be.  For the other three months, the month may have 30 or 31 days, so a window is defined that accommodates all three of the months:  MonthDay>23 AND MonthDayDay<=30.  This will again cause all stocks in the portfolio to be sold. The difference between how December and the other three months are handled will be in the buy rule.

An Eval statement is used to determine whether December or other month is being processed and the time window is set accordingly.  The two sell rules are shown below.

Simulation sell rules

One special note here:  You have to put " & FALSE" after the SetVar rule in sell rules only.

Once the Sell Rules have been defined then it is time to rewind and go to the Buy tab. There is a single buy rule (Eval) that checks if the month is December or not. If it is December then TRUE is set, meaning that the highest ranked stocks will be bought, in this case the highest yielding stocks. Thus the portfolio is reconstituted, or refreshed, with new holdings. If the month is not December, then the logic is set to TRUE only if the stock(s) were just sold.  In other words, the previously held stocks are sold then bought immediately.  This will have the effect of resetting the stock holdings to equal-weighting, but without changing any of the stocks.

Simulation buy rules

Now set the simulation to run for the maximum time period that your Portfolio123 membership will allow, and click RUN SIMULATION.

Simulation period and restrictions

And there you have it.  I never said the results would be pretty!  That is why we all spend money acquiring sophisticated tools such as Portfolio123, so we can do better than such simple and basic strategies.

Dogs of the Dow simulation test results 1999-present

This tutorial has shown how you can separate "rebalancing" from portfolio "reconstitution", similar to the way many ETFs are managed.