- Part I: Picking the Right Investment Vehicles
- Risk: Reward Comparisons Between More Volatile and Less Volatile Equity Mutual Fund Portfolios
- Drawdown: The Measure of Ultimate Risk
- Changing Your Bets While the Race Is Still Underway
- Increasing the Risk: Maintaining a Portfolio of Somewhat More Aggressive Mutual Funds
- Upping the Ante: The Effects of Applying the Concepts of Relative Strength Selection to a Still More Volatile Portfolio of Mutual Funds
- A Quick Review of Relative Strength Investing
- Summing Up
This chapter is from the book
This chapter is from the book
This chapter is from the book
Increasing the Risk: Maintaining a Portfolio of Somewhat More Aggressive Mutual Funds
The suggestion has been made that there is little to be gained by investing in more volatile equities (or their equivalents) rather than less volatile equities. To test this hypothesis, a study was undertaken in which the quarterly ranking and rebalancing procedure was carried forth, but this time with a portfolio of mutual funds ranked 1–7 in volatility instead of 1–5. Because the "5" group represents mutual funds that are roughly equal to the Standard & Poor's 500 Index in volatility, including the 6 and 7 volatility groups brings the total portfolio universe to roughly the equivalent of the S & P 500 Index in volatility, whereas the total 1–5 universe carries less volatility than the Standard & Poor's 500 Index.
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Chart
1.6 Performance of the Relative Strength Investment Approach (1990–2003),
Including Groups 6 and 7 in Addition to Groups 1–5
Rates of return for
the better-performing deciles are slightly greater than rates of return for the
leading deciles in the lower-volatility Group 1–5 portfolio, but risks were
clearly increased for this higher-volatility universe of mutual funds. Returns
were very consistent, again, with decile rank: The higher the decile group was
at the start of each quarter, the better the performance.
Chart 1.6 shows the results of the study, which employs a 1–7 volatility universe instead of a less volatile 1–5 universe. Let's move right along to a tabular listing of the study results.
Investment Results of Quarterly Rebalancing (June 1990–October 2003) for Mutual Funds with Volatility Ranks 1–7 (Below to Above the S&P 500 Index)
|
Performance Decile |
$100 Becomes |
Gain Per Annum |
Maximum Drawdown |
|
First decile |
$640.05 |
+14.7% |
25.7% |
|
Second decile |
598.58 |
+14.2 |
26.1 |
|
Third decile |
546.91 |
+13.4 |
27.0 |
|
Fourth decile |
436.13 |
+11.5 |
33.1 |
|
Fifth decile |
377.81 |
+10.4 |
37.3 |
|
Sixth decile |
338.25 |
+9.5 |
39.3 |
|
Seventh decile |
338.48 |
+9.5 |
39.3 |
|
Eighth decile |
303.26 |
+8.6 |
39.3 |
|
Ninth decile |
262.72 |
+7.4 |
38.6 |
|
Tenth decile |
171.37 |
+4.2 |
44.2 |
The Standard & Poor's 500 Index advanced at an annual rate of 10.8% (including dividends) during this period, with a maximum drawdown of 44.7%.
Observations
Increasing the volatility range of the mutual fund universe from 1–5 to 1–7 resulted in a slight improvement in the best-performing decile (+14.7 gain per annum, compared to 14.1% for the lower-volatility group). However, maximum drawdowns for the highest-performing group increased from 20.3% to 25.7%. The average gain/risk level for the best-performing decile in the 1–5 group came to .69 (14.3% average gain, 20.2% maximum drawdown), whereas the average gain/risk level for the best performing decile in the 1–7 group came to .57 (14.7% average gain, 25.7% maximum drawdown).
Conclusion: There is little, if anything, to be gained in the long run by taking the risks associated with more aggressive stock portfolios.