First, a look back at this past week. While the flash crash of 2010 was a memorable one, this past week saw many indices go down more than the week of the flash crash.
We have made the point over and over and over again in this blog (and indeed the underlying thesis of the entire website) of how tactical allocation is what really matters to portfolio performance. Picking stocks in an environment like August 2011 or May 2010 or Q1 2009 or 2H 2008 is akin to arranging deck-chairs on the Titanic. Material larger tactical adjustments are the key decisions. ETFs make at least the implementation aspect far easier for the investor.
Bonds have been in a bull market for 4-5 months now. We’ve written about the relative strength bonds have been showing --- but the parabolic moves of bonds here are unsustainable and lowering durations is a prudent move, relative strength or not.
The other big point we want to highlight is that of focusing on your Sharpe Ratio (volatility-adjusted returns) rather than just a traditional index. If you are going for good sharpe ratio – and you should – then you will quickly see that you are not going to be able to get a good sharpe ratio if your portfolios standard deviation is too high. Return is of course the #1 factor --- but remember this: the higher the vol, the higher the draw (as in drawdown).
When we released the backtesting applications in 2010, we fielded some questions about how to implement the concepts --- which we then enhanced the apps with solutions to address these. At the same time, we repeatedly discussed how the real important part was the higher-level decisions. Implementation techniques are of course important – and we strive to be as specific as we can by using well-defined rules for the applications – but in the end, this month again shows that implementing the concepts and even just getting it ‘generally right’ is plenty good enough.
After a few flattish consolidation months, it may start to seem frustrating --- but this is how markets are – lots of low returns and then some non-linear bursts of movement. Now after the steep losses of the market recently, getting bond market (positive) returns should sit just fine. Indeed, the updated performance of the sample portfolio is +12.3% vs -4.6% for the S&P 500 YTD. That is using ‘first day’ picks specified a full day in advance. Using actual picks the return spread is a bit higher. Similarly, the other simple portfolio we used as an example (last November) – called ’01 Beta Strategies’ is currently +1,590 basis pts better than the S&P 500 (+11.3% vs -4.6%) using first day picks.
We would like to emphasize though that your time and effort should not be to obsess over how to beat the models -- or even track them perfectly. Models always have some assumptions in them that will keep them from being perfectly realistic. In the end though, it should just be to get it 'generally right' as often as you can -- and good models can clearly help in that regard.
Lastly, we would highlight that research is an ongoing process, continual enhancing of strategies is important --- small improvements add up over time. ETFs are an empowering innovation -- there are always a few very interesting new products that come out each year. This industry is still in the early innings of its development.