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I personally don't like the idea of clinging to a stock once XIU says otherwise. It's definitely a matter of personal taste, but I'm in the camp of mirroring XIU (passive indexing) rather than diverging the portfolio from it.

Already in this methodology, even with the occasional swapping or dropping of stocks, the holdings more or less stay constant for years on end. For example, all 18 years have held BCE without any substitution in that sector. The financial sector had RY for 17 years with one temporary swap to MFC (oops). The industrial sector had CNR for 15 years straight.

The SU/ENB swap is a rare event. It doesn't sit that well with me either, but this doesn't happen too often in my construction methodology. In other words I'm not sure it's really impeding the portfolio in the big picture.

One would have to evaluate the tremendous benefit of picking up the new top performers quickly (great example is dropping BBD.B and picking up CNR) against the inefficiency of doing a non-ideal swap at non-ideal prices. Yes maybe things like the SU/ENB swap are non ideal, but perhaps there is more benefit seen by the rotation into new high performers.
 

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I personally don't like the idea of clinging to a stock once XIU says otherwise. It's definitely a matter of personal taste, but I'm in the camp of mirroring XIU (passive indexing) rather than diverging the portfolio from it.
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I do see your point, and this is why I have always believed this low number method (i.e. 5) isn't very efficient because of the necessity to sell when a stock is low and buying when a stock is high. If you increased the number of stocks to 20 - 25, then you would basically have all the stocks. Sure, they'd rise up and fall down in the list, but it wouldn't matter with respect to the one's you owned because you'd have them all. Then the most you would have to do is rebalance your sectors once a year by buying more of the lowest price stocks in the weak sectors.

ltr
 

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I'm thinking of trying the following experiment tonight. What happens (over 18 years) if the rebalancing and replacement logic is modified in this way:

- take the top weighted XIU holding in each of these sectors,
- only allow a holding to be sold if XIU shows the portfolio value of the new stock exceeds the existing stock by at least 25%

The intuition behind this is that replacing a stock in the portfolio is a big deal, so we don't want to respond to just some noise. We want to replace a stock if the new one significantly or definitively pulls ahead, but not if the two are quite close (XIU weights them based on market cap so this is about competition in market caps).

Example: in 2017 the portfolio held SU. At the start of 2018, the XIU portfolio held $540 million of ENB and $496 million of SU. The top weighted XIU stock was ENB, but do we allow it to replace SU? The difference in portfolio value between these two was 9%, less than the 25% threshold for "significant". Therefore the current holding would not be allowed to be sold, and in 2018 the portfolio would continue to hold SU. We never buy ENB.

Metrics to evaluate this idea: what happens to the 18 year CAGR, and the # of replacements (turnover)?
 

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The intuition behind this is that replacing a stock in the portfolio is a big deal, so we don't want to respond to just some noise. We want to replace a stock if the new one significantly or definitively pulls ahead, but not if the two are quite close (XIU weights them based on market cap so this is about competition in market caps).
Here's a comparison of results. Using the initial method I suggested, where you simply pick the top weight stock in each sector at each year end (which as ltr pointed out is prone to selling a stock after a temporary weak year), the 17.5-year return was 9.1% CAGR with 9 stock changes over all the years.

Next I tried a smarter update strategy. Again it's done at each year end. This time, a new stock only replaces an existing one if its value in the XIU portfolio exceeds the existing holding by more than 25%. This allows an existing holding to stay whenever the market caps are quite close. The return increased to 9.6% CAGR with 6 stock changes.

While doing this I observed that when a new stock is replacing an existing holding for good, it's usually a very dramatic change in relative market caps. So now I increase that threshold to 50%. If the new holding is going to be a different stock, it has to be > 50% market value change versus the previous holding. Otherwise you keep the existing holding, a strong preference for keeping existing holdings.

The 17.5-year return becomes 9.6% CAGR ... did not increase further ... but the number of stock changes decreased to 4. Looking at these changes, all looked essential, not due to mere volatility. So I would say this looks optimal. The portfolio turnover has decreased as much as possible.

Some time, I will re-do my entire backtest from scratch with this "smarter" update methodology just to check that I got it right. But this is looking encouraging. By the way, this 9.6% CAGR long term return for my method (with smarter updates) compares to plain XIU's 5.9% CAGR in the same 17.5 years.
 

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This diagram shows the evolution of my 5-pack portfolio when using the smarter annual 50% change threshold. Note the continuity of the positions and no swap reversals due to volatility. This produced 9.6% CAGR with just 4 stock changes -- quite efficient. (Compare to XIU at 5.9% CAGR).

Blue Text Green Yellow Line


Changes like ECA -> SU are still needed, because without the eventual portfolio changes shown, returns would have been much worse.

like_to_retire: you described concern about selling a stock low and buying the new one high. I suggest an alternate way of looking at this. You're ditching a poorly performing stock and replacing it with a better performing one. That benefits the portfolio even if it means you sold at a low. I agree that you wouldn't want plain old volatility to trigger this, but I think I solved that now.

Thanks for helping me think about this, everyone. Once I confirm all this, I will update my methodology. I don't think ENB should have ever entered the portfolio.
 

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This diagram shows the evolution of my 5-pack portfolio when using the smarter annual 50% change threshold. Note the continuity of the positions and no swap reversals due to volatility. This produced 9.6% CAGR with just 4 stock changes -- quite efficient. (Compare to XIU at 5.9% CAGR).

View attachment 18842

Changes like ECA -> SU are still needed, because without the eventual portfolio changes shown, returns would have been much worse.

like_to_retire: you described concern about selling a stock low and buying the new one high. I suggest an alternate way of looking at this, as per this diagram. You're ditching a poorly performing stock and replacing it with a better performing one. That benefits the portfolio even if it means you sold at a low. I agree that you wouldn't want plain old volatility to trigger this, but I think I solved that now.
Yeah, I agree this is a much better solution. I'm not disagreeing with you about ditching a poorly performing stock, my point was a stock temporarily out of favour was getting the boot from your system and it was resulting in a selling low situation. From your new backtest that seems to have been ameliorated.

Perhaps with cases like TA (that many were hurt by), you might need to add some sort of special common sense rule, that when a stocks yield gets ridiculously high or it cuts its dividend that you're allowed to immediately sell it and substitute the next stock in the list.

ltr
 

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my point was a stock temporarily out of favour was getting the boot from your system and it was resulting in a selling low situation. From your new backtest that seems to have been ameliorated.
Yes, you're absolutely right. I'm glad you brought that up because it had not occurred to me before, but once I looked at the historical data again I saw exactly what you said. I think the smarter update rule with 50% requirement will help reduce that shortcoming. For example, if TD overtakes RY (very real possibility as they're now within 3% of each other) it would be a shame to temporarily switch RY -> TD -> RY. The new requirements would prevent that kind of mistake, and the same with SU -> ENB -> SU which just happened.

Again -- I want to double check all of this but unless I made a mistake, I plan to adopt this as a new methodology and clearly specify the rules for updating the portfolio.

Perhaps with cases like TA (that many were hurt by), you might need to add some sort of special common sense rule, that when a stocks yield gets ridiculously high or it cuts its dividend that you're allowed to immediately sell it and substitute the next stock in the list.
That might be a good enhancement too. Someone using that would still need to come up with a very specific criteria, and this is going to become difficult to test unless they have great historical data.
 

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That might be a good enhancement too. Someone using that would still need to come up with a very specific criteria, and this is going to become difficult to test unless they have great historical data.
That might be a good enhancement too. Someone using that would still need to come up with a very specific criteria, and this is going to become difficult to test unless they have great historical data.
I don't know if you have to be especially strict with yourself on this rule. You're allowed to make judgement calls that history tends to support. I followed the DOGs strategy for many years, and still follow it in my own modified way. That rule is in my list for sure. I don't act on rumours, only when the dividend is actually cut do I pull the trigger.

Originally, when David Stanley published his Dogs of the TSX, I always felt it was restricted a bit by allowing a stock to cut its dividend without any change to his stocks until the anniversary update each year. When Ross Grant took over for him, this was a rule that he added. It was a winning change.

The rule is simply, that if a company cuts or reduces its dividend, then the stock is sold immediately and replace by the next one on the list. Many stocks that reduce their dividend will carry on to do a further cut in the next year or so. And those that cut their dividend usually have a much lower stock price by the year end.

For example, TECK.b dropped their dividend from $0.44 to $0.15 in June 2015 and then again in Dec 2015 to $0.05 for a return from the time of the first drop to year end of -64%. Then CVE dropped from $0.27 down to $0.16 in Sept 2015 and then again in Mar 2016 down to $0.05.

Then of course you know all about TA. Anyway, my point is that as soon as a company drops or cuts its dividend, it ain't a bad idea to dump it and replace it with another stock. You can backtest the theory, but I'll bet it's a good rule.

ltr
 

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I welcome anyone to use any variant of my method. I've described all the parts of it I've figured out so far, and it's easy for anyone to replicate this just by looking at the iShares XIU page once a year and maybe adding some enhancements as you describe.

Overall, this is much less work than my higher risk small cap portfolio. This 5-pack approach is more or less passive (it's almost indexing) whereas that other portfolio is active stock picking.
 

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Updates to my 5-pack method

There was a great discussion in this thread that made me take a closer look at something I failed to clearly define earlier: the rebalancing methodology. like_to_retire and Eclectic got me thinking about this, and over the last couple of days I've been running historical simulations and clarifying the rebalancing rules.

Quick recap: my 5-pack aims to mirror XIU, but with equal sector weights. The top weight stock in each of 5 sectors (Energy, Financial, Industrial, Telecom, Utilities) from XIU is held in the 5-pack. For larger portfolios, you can do the same with the top two from each sector, a total of 10 stocks. Both the iShares web site and annual reports show the XIU portfolio, with weights.

Rebalancing methodology

Rebalancing should be done at the end of every calendar year. First, changes to the portfolio are identified. Second, stock changes (if any) are implemented and the portfolio is adjusted back to equal weights. The portfolio you create at year-end is then left alone for the entire next year.

Changes to the portfolio are identified as follows: for each sector (Energy, Financial, Industrial, Telecom, Utilities) identify the new candidate stock by looking at the top weight in XIU. If the new candidate is the same as your existing holding, then there's no change.

However if the candidate is different than what you currently hold, compare their market values in XIU's portfolio (a proxy for market cap). Replace your existing stock only if the candidate's market value exceeds the existing stock's by > 50%. This process ensures that we only respond to significant changes in the XIU portfolio, rather than minor changes in ranking due to natural stock volatility.

Current and historical holdings

The attached graphic shows what the holdings would have been since inception, using the rebalancing rules outlined above. The current holdings are: SU, RY, CNR, BCE, FTS

Blue Text Green Yellow Line


The last rebalance was at the end of 2017. The new Energy sector candidate was ENB because it had become the top weighted stock. Our existing holding was SU. As the candidate's market value did not exceed the existing stock's by more than 50%, the existing stock should have been kept.

In my actual portfolio, I made the mistake of selling SU and buying ENB. This should not have been done, so I will undo this in my portfolio and restore SU as the holding.

Performance since 2000-12-31

Over 17.5 years, my 5-pack portfolio as described would have theoretically had 9.6% CAGR, versus XIU's 6.0% CAGR. These are total returns including dividends.
 

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In my actual portfolio, I made the mistake of selling SU and buying ENB. This should not have been done, so I will undo this in my portfolio and restore SU as the holding.
I sold ENB and bought SU. The timing isn't great, but my thinking is that I'd rather get back on track with (the ideal) passive methodology than try to time the trades.
 

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Quick update, since my adjustments/trades on 2018-06-20, the 5 pack is performing fine, up 3.3% vs XIU up 1.0%. I think I'm back on track here and going forward, the portfolio should be more passive than before. I have 98 K invested in this portfolio.
 

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An illustration of how the 5 pack roughly follows the TSX Index, using my broker's Performance interface. Dashed blue line is TSX Composite, purple line is my 5-pack portfolio. I consider this method to be similar to index investing, with the big modification being equal-weight sectors.


Text Line Purple Plot Font
 

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First of all, James, thank you for starting this thread. I have spent the better part of today reading every comment and doing a bunch of research and number crunching throughout.

The only questions I'm left wondering is:

1- What do you personally have for a ratio of Can/US/Global stocks. Someone earlier in the thread seemed to indicate a higher Can to US ratio. So I'm curious what you and other think.

2- Does anyone care to comment on an entry point for this approach? I'm currently using VCN but would like to switch to this strategy. I'm going to do some research and evaluate the 10-pack with various value investing metrics, but I'm wondering if people have a sense that this is a particular good/bad time to start this strategy?
 

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In my TFSA 1, I hold RY, ENB, REI.UN, and EMA. The only one keeping the return high is RY since it is 60% of total - the others are flat or neg (ENB). total around 51K
In TFSA 2, I hold CM, BCE, VDY (an ETF), and around 30K cash in a cashable GIC (waiting for deployment). total around 72K.

Question - to stay in a well diversified TFSA like in the OP, should I be looking to
1. replace ENB with ENF?
2. buy an industrial CN or CP?
3. other - a proxy for US/Global equities?
 

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First of all, James, thank you for starting this thread. I have spent the better part of today reading every comment and doing a bunch of research and number crunching throughout.
You're welcome, glad it helped. Also take a look at Argonaut's approach
https://www.canadianmoneyforum.com/...s-5-pack-for-TFSAs-amp-other-starter-accounts
https://www.canadianmoneyforum.com/showthread.php/132442-The-6-Pack-Portfolio

1- What do you personally have for a ratio of Can/US/Global stocks. Someone earlier in the thread seemed to indicate a higher Can to US ratio.
While I'm not exactly where I want to be, my target geographic allocations for my equities are 50% Canada 50% US unhedged, and no global. If you're curious why I don't hold global, see this post from Argonaut that explains my views as well.

2- Does anyone care to comment on an entry point for this approach?
It moves almost the same way as the TSX index, I'd say it's equivalent to asking when to buy into a stock index. Sorry to say that I don't have an answer for that.
 

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Performance update on the portfolio (SU, RY, CNR, BCE, FTS)

Year-to-date return including dividends is -3.11%. In comparison XIU is -5.84% and XIC is -5.96%

So far this year, my 5-Pack is doing well despite the market turbulence. Yes I realize I'm cheating by showing numbers based on what I should have held instead of what I actually held. The last couple pages in this thread explain that issue.

I also want to reiterate that this 5-Pack is the majority of my Canadian equities, but just part of my overall portfolio. I also hold some small and midcap Canadian stocks, the US index, bonds and GICs, and gold bullion.

My overall asset allocation targets are: cash buffer + 30% stocks, 50% fixed income, 20% gold
 

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5 pack performance still looking strong heading into December. I'll post a year end figure of course but so far the portfolio is +1.66% for the year versus XIC -3.71%, outperforming the TSX Composite by more than 5%.

This is due to the sector selection and being light on commodities. Same story as many of the other X-packs around CMF plus ZLB, all of which benefit from the same effect. The possibility still remains, though, that eventually we could enter a strong bull market in commodities which would flip things.
 
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