How to Build a Sky is Falling Portfolio

Considering our current global economic environment, it is perhaps not surprising to find many investors with a rather pessimistic short term outlook for both the U.S. and the broader global economy. Despite the fact that markets are near a four year high, there are still plenty of issues looming that have the general public fearful for the future. And while many corners of the market have struggled to stay afloat, there have been some bright spots that have performed relatively well.

Some of these asset classes are historically known to be relatively low-risk investments that tend to fare well during uncertain or adverse economic environments, including inflation-protected securities, gold, and several other commodities. For bearish investors who wish to shift their assets towards these safer corners of the market, we outline an all ETF portfolio that could potentially provide meaningful return during economic turmoil [for more commodity ETF news and trading tips subscribe to our free newsletter].

Portfolio Snapshot

First things first, here are the ETFs that we have chosen for this particular portfolio.

Ticker ETF Asset Type Allocation Expense Ratio
DEF Claymore/Sabrient Defensive Equity Index ETF Domestic Equities 10.0% 0.60%
VTV Vanguard Value ETF Domestic Equities 5.0% 0.15%
VBR Vanguard Small Cap Value ETF Domestic Equities 5.0% 0.15%
VEU Vanguard FSTE All World ex-U.S. ETF International Equities 5.0% 0.25%
SHY Barclays 1-3 Year Treasury Bond Fund Fixed Income 25.0% 0.15%
TIP iShares Barclays TIPS Bond Fund Fixed Income 20.0% 0.20%
SGOL ETF Securities Physical Swiss Gold Shares Commodities 10.0% 0.39%
DBC PowerShares DB Commodity Index Fund Commodities 10.0% 0.83%
VXX iPath S&P 500 VIX Short Term Futures ETN Volatility 10.0% 0.89%
Weighted Average Expense Ratio 0.38%

As can be seen above, there are really only two fund that are directly related to the commodity industry, but allocations to precious metals, crude oil, and certain agricultural commodities are often times favorable during times of economic turbulence.

Holdings Overview

Below is a brief overview of each component of this portfolio.

  • DEF: This ETF is designed to invest in securities characterized by low relative valuations, conservative accounting, dividend payments, and a history of outperformance during bearish market periods. This ETFs holdings are determined through a proprietary stock evaluation and selection process. DEF is dominated by holdings in large cap and mid cap equities.
  • VTV: This ETF tracks an index that is designed to represent the large cap value segment of the U.S. equity markets.large cap equities tend to maintain lower volatility than small cap stocks, while value companies offer higher current returns than their growth counterparts.
  • VBR: This fund offers exposure to small cap value segment of the U.S. equity markets. While small cap equities are generally more risky than larger firms, this ETF provides some degree of diversification within the equity component of this portfolio.
  • VEU: This ETF tracks an index that includes about 2,200 equities in 50 countries outside the U.S. This ETF maintains part of its holdings in emerging markets, which can be volatile. While investments outside of the U.S. have historically perceived to be more risky than domestic equities, we have seen several recent crises originate in the U.S., an indication that some degree of global diversification is warranted.
  • SHY: This ETF invests in the short-term sector of the U.S. Treasuries market, holding dollar-denominated securities that have a remaining maturity of between one and three years. Because SHY limits its holdings to Treasuries, it offers a consistent, low expected return.
  • TIP: This ETF invests in inflation-protected securities, meaning that the principal of the underlying securities increases with inflation (as measured by CPI). Therefore, real returns on TIPS are guaranteed regardless of the level of price increases that may eat into nominal returns of equities and other fixed income investments.
  • SGOL: This ETF holds gold bullion stored in secure vaults in Switzerland. As a “safe haven” investment, gold has historically experienced significant price appreciation during times of economic uncertainty.
  • DBC: This ETF invests in a diversified basket of commodities, including crude oil, gold, aluminum, corn, and wheat. Since investors tend to view many of these commodities as stores of value in bear markets, they can experience healthy returns during downturns [see also The Ultimate Commodities Survival Kit: Five Must-Haves].
  • VXX: This ETF tracks the performance of a basket of futures on the S&P 500 Index. Since equity markets tend to experience significant volatility in uncertain economic climates, this fund can serve as an excellent hedge to equity investments.

Historical Return Analysis

Ticker 2008 2009 2010 2011
DEF -30.3% 22.3% 19.5% 13.0%
VTV -35.9% 19.9% 14.6% 1.1%
VBR -32.4% 31.0% 25.2% -4.2%
VEU -43.7% 37.7% 11.8% -14.0%
SHY 6.7% 0.4% 2.3% 1.4%
TIP -0.6% 9.0% 6.2% 13.3%
SGOL n/a n/a 29.3% 9.6%
DBC -31.8% 16.2% 11.9% -2.6%
VXX n/a n/a -72.4% -5.5%
Portfolio n/a n/a 3.2% 3.6%
Compare to SPY -36.7% 26.3% 15.0% 1.8%
Compare to AGG 7.6% 3.3% 6.4% 7.7%

The adjacent table provides historical results for each component of this portfolio, as well as backtested results (as available) for the entire portfolio during 2008, 2009, 2010, and 2011. The table also shows how this portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG).

Not surprisingly, this portfolio struggled in 2008 amidst a broad market recession. In 2009 and 2010, this portfolio reclaimed much of the ground lost during 2008 [see also Four Commodities To Buy Before Roubini's "Perfect Storm"].

The dismal equity returns during the market slump of 2008 highlights the importance of maintaining even a fairly minimal allocation to fixed income ETFs in this portfolio. Notice how all of the bond funds included in this portfolio were able to post positive returns during the stock market rebound in 2009 and 2010.

Portfolio Expenses

Although this portfolio is not designed for long-term investors, it is constructed to minimize expenses over the short term. Although the commodity and volatility ETFs included in this portfolio have expense ratios above most exchange-traded products, they remain well below fees charged by traditional actively-managed funds. The weighted average expense ratio of this portfolio is 38 basis points, which is significantly lower than fees charged by actively-managed mutual funds. The impact of this reduced costs structure over the horizon of this portfolio is significant [see also The Ten Commandments of Commodity Investing]:

Growth of $1 Million Over 10 Years @ Annual Return Of:
Portfolio Expense Ratio 5% 10% 15%
The Sky Is Falling Portfolio 0.38% $1,570,294 $2,504,606 $3,912,483
Actively-Managed Mutual Fund Portfolio 1.00% $1,480,244 $2,367,364 $3,707,221

While this can certainly be used as an all encompassing group of holdings, those wishing to establish a tactical tilt towards low-risk investments that tend to perform well in economic turbulence can also use this model portfolio as a smaller part of their overall group of holdings.

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Disclosure: Certain sections of this article were republished with permission from ETFdb.com. Click here to view the original portfolio. No positions at time of writing.

About Daniela Pylypczak

Daniela Pylypczak-Wasylyszyn is a regular contributor to CommodityHQ.com, where she primarily focuses on commodity producers equities. She is also an analyst for ETFdb.com, where she contributes articles and analysis each week. Since joining the team in 2011, Daniela has quickly grown to be one of the most widely-followed authors in the industry. Her articles are syndicated in a number of online publications, including Financial Advisor Magazine, Fidelity.com, and Yahoo! Finance. Daniela is also a contributor for TraderHQ.com and Dividend.com. Daniela graduated from DePaul University with a bachelor’s degree in finance and economics.
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