Vulcan Stock Research

High-Conviction Asset Allocation with Sharpe-Maximizing Construction and Monte Carlo Validation

Prepared by: Vulcan-stock.com | May 2025

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Summary

This report outlines a precision-engineered investment strategy designed to optimize two distinct portfolios—an IRA account and a taxable brokerage account—across a five-year plus time horizon. The strategy applies rigorous quantitative modeling, including Bayesian-calibrated return estimates and 50,000-path Monte Carlo simulation, to construct ETF portfolios that target maximum total return per unit of risk.

Key outcomes:

• The IRA portfolio achieves an expected CAGR of ~9.0% with a Sharpe ratio of 0.72—delivering equity-like returns at moderated volatility.
• The Taxable portfolio is optimized for aggressive growth, projecting a 14.8% expected CAGR with a Sharpe ratio of 0.75—despite a higher volatility profile.
• Allocations are further refined through tax-aware overlays (e.g., loss harvesting, concentrated position mitigation) and market regime sensitivity analysis.

This strategy is designed not only to perform across market cycles but also to align with the real-world constraints of capital gains exposure, asset liquidity, and investor risk capacity.

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Why These Portfolios Were Built

The primary challenge addressed in this research is a bifurcated portfolio objective:

• The IRA account must support long-duration compounding while minimizing drawdowns as retirement nears (~5+ year horizon). The focus is stability, predictability, and multi-regime robustness.
• The Taxable account seeks high total return with acceptable risk, but must do so with strict attention to tax friction, position-level gains, and factor exposure balance.

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Portfolio Construction Methodology

A multi-phase modeling approach was used:

1. Historical return and covariance estimation from five years of daily data across all candidate ETFs.
2. Bayesian shrinkage of forward return expectations, blending historical means with long-term macro factor priors to reduce overfitting.
3. Mean-variance optimization across 100,000 randomized portfolios per account, constrained by factor exposure, asset concentration, and ETF-specific limits.
4. Sharpe and Sortino maximization refined through Monte Carlo simulation, stress-testing 50,000 future paths over a 5-year horizon.
5. Final selection via portfolio frontier “knee” analysis—selecting portfolios that achieve optimal marginal return per unit of added risk.

This method ensures that portfolios are not only efficient on paper, but resilient in tail scenarios, tax-aware in real-world implementation, and aligned to investor objectives.

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Final Portfolio Allocations

IRA Portfolio – Total Return with Risk Guardrails

Ticker	Description	Weight
IEF	7–10 Year U.S. Treasuries (deflation hedge)	15%
CTA	Managed Futures Strategy (uncorrelated hedge)	10%
USMV	U.S. Minimum Volatility Equity	20%
SCHD	Dividend Growth, High-Quality U.S. Stocks	15%
SPHQ	S&P 500 Quality Factor Tilt	10%
VOO	Core S&P 500 Exposure	15%
XLU	Defensive Utilities Sector	10%
RSP	Equal-Weight S&P 500 (anti-concentration tilt)	5%

Key Traits:
This portfolio blends defensive equity factors with uncorrelated hedge assets and a short-intermediate Treasury sleeve. The 35% allocated to defensive factors (USMV, XLU, SCHD) balances the risk budget, while CTA and IEF act as diversifiers against inflation and deflation shocks respectively. RSP and SPHQ introduce diversification against cap-weighted mega-cap concentration.

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Taxable Portfolio – Growth-Optimized with Risk Management

Ticker	Description	Weight
CTA	Managed Futures Hedge	10%
SPMO	S&P 500 Momentum Factor	25%
SCHG	Large-Cap Growth Exposure	25%
SPHQ	Quality Filtered U.S. Equities	15%
VOO	Core S&P 500	15%
USMV	Minimum Volatility U.S. Equities	5%
CGDV	Dividend-Value Blend (moderated volatility)	5%

Key Traits:
Built for total return, this portfolio tactically leans into momentum and growth while preserving downside protection through CTA, USMV, and SPHQ. CGDV provides a low-vol dividend core with lower overlap vs. SCHD. Factor diversification is maximized while tax efficiency is retained via ETF structures.

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Performance Forecasts – Monte Carlo Results (50,000 Paths)

Metric	IRA Portfolio	Taxable Portfolio
Expected CAGR	~9.0%	~14.8%
Annualized Volatility (σ)	~9.7%	~17.0%
Sharpe Ratio (Rf = 2%)	0.72	0.75
5-Year Median Return	+54%	+99%
5-Year 5th Percentile Return	–30%	–51%
Worst Historical Drawdown	–12%	–35%
# of ETFs Used	8	7

The IRA portfolio achieves Sharpe-maximized compounding with worst-case scenarios rarely exceeding a 30% decline. The taxable portfolio accepts greater volatility for a higher median terminal value, with well-hedged downside capture via quality and momentum blending.

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Additional Strategy Enhancements

Tax-Loss Harvesting

For the taxable account, ongoing TLH is advised using the following ETF rotation pairs:

• SCHG → VUG or IWF
• SPMO → MTUM

These pairs are not “substantially identical” per IRS standards and allow loss recognition while preserving factor exposure. Proper 31-day window discipline and cross-account controls (especially IRAs) are critical.

Estimated value-add: +0.5% to +1.0% per year after-tax alpha.

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Cash Positioning

No long-term allocation to cash is needed inside either portfolio. However:

• 2–3% in VMFXX or VUSXX in the taxable account is recommended for tactical flexibility, TLH execution, and tax payments
• No IRA cash is necessary; IEF and CTA already fulfill that role

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Conclusion and Forward Guidance

These portfolios are the result of an intensive quantitative process that integrates volatility budgeting, return modeling, correlation analysis, and real-world behavioral constraints. Each portfolio lies at the Sharpe-optimal “knee” of the efficient frontier and is stress-tested across economic regimes using probabilistic modeling.

The IRA allocation supports steady, protected growth for future withdrawals. The taxable portfolio embraces calculated risk with a high-growth design, managed through disciplined risk overlay and tax-aware tactics.