- 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
Upping the Ante: The Effects of Applying the Concepts of Relative Strength Selection to a Still More Volatile Portfolio of Mutual Funds
Let's try the procedure just one more time, this time with a universe of mutual funds that includes the most volatile sectors in the equity spectrum. This universe includes all the high-rolling areas of the stock market—gold, the internets, small caps, technology, whatever—as well as lower-volatility funds, encompassing the complete spectrum of mutual funds rated by volatility as 1–9.
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Chart 1.7 Performance of the Relative Strength Investment Approach (1990–2003), Including All Mutual Fund Groups, Rated as 1–9
Rates of return for the best deciles in the 1–9 universe remained in the area of returns secured from lower-volatility mutual fund universes 1–5 and 1–7. However, risks increased considerably, as you can see by the drawdowns reflected on the chart. The first-performance decile for the previous quarter proved, again, to be the best for the subsequent quarter, although the lead over the second-best-performing decile the previous quarter was not great.
Let's review, just one more time, a tabular table.
Investment Results of Quarterly Rebalancing (June 1990–October 2003)Mutual Funds with Volatility Ranks 1–9 (Virtually All Equity-Oriented Mutual Funds, Including Those Considerably More Volatile Than the Standard & Poor's 500 Index)
|
Performance Decile |
$100 Becomes |
Gain Per Annum |
Maximum Drawdown |
|
First decile |
$596.31 |
+14.1% |
20.3% |
|
First decile |
$614.44 |
+14.3 |
40.2 |
|
Second decile |
605.24 |
+14.3 |
34.2 |
|
Third decile |
539.98 |
+13.3 |
31.5 |
|
Fourth decile |
454.66 |
+11.9 |
38.6 |
|
Fifth decile |
388.29 |
+10.6 |
39.9 |
|
Sixth decile |
335.07 |
+9.4 |
41.8 |
|
Seventh decile |
330.19 |
+9.3 |
42.2 |
|
Eighth decile |
296.95 |
+8.4 |
43.7 |
|
Ninth decile |
267.68 |
+7.6 |
43.1 |
|
Tenth decile |
173.97 |
+4.2 |
50.1 |
General Observations
Again, we see a very linear relationship between fund performance in a previous quarter and its performance in subsequent periods. Within the highest-velocity mutual fund group, the second decile runs very closely in strength to the first decile. I have found this to be the case in studies I have conducted of other ways to employ past relative strength to predict future market performance. It seems that, among the most volatile mutual fund areas, more consistent performance is sometimes attained from second and third decile holdings than by first, although, in this study, the first decile produced the best rates of return.
The average gain/maximum drawdown ratio for even the strongest (first decile) area of the 1–9 group of mutual funds is low, at 0.36 (14.39 rate of return, 40.18% maximum drawdown). The gains can be there, but the pains can be considerable, indeed, for investors who live in the fast lane.
Although portfolios are rebalanced at quarterly intervals, this does not mean that you will have to replace your entire portfolio each quarter. On average, holdings are likely to be maintained through two quarterly cycles, or for six months in total.
Conclusion: Increasing the volatility of your mutual fund portfolio does not add to profitability in any significant manner, even though risk levels do increase. As a general rule, your emphasis should remain with funds of average or below-average volatility.