Global Economic Intersection
Advertisement
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
Global Economic Intersection
No Result
View All Result

Rebalancing Resurrected, Part 3: Canada

admin by admin
January 5, 2012
in Uncategorized
0
0
SHARES
4
VIEWS
Share on FacebookShare on Twitter

by Guest Authors Adam Butler and Mike Philbrick

Prologue: This is a ‘Canadian-ized’ version of an article we published on Thursday, December 29, 2011, which featured a study of US equity and fixed-income markets. As we are located in Canada, we were motivated to see how well the same techniques work in our home market using the S&P/TSX Composite. As expected, it turns out that they work quite well.


maple-leafThe investment community is in the midst of an identity crisis, though admittedly many in the industry don’t know it yet. At the heart of the matter is the following misconception:

Investors perceive that investment professionals add value via security selection and market timing. What’s worse, most investment professionals believe that they add value via security selection and market timing. This perception is dangerously misguided.

Repeat after me: Investment professionals add value via asset allocation, not security selection. Again: Investment professionals add value via asset allocation, not security selection.The following chart is from Pawley (2004) who sourced Brinson, Hood and Beebower (1986) and Simon (1998). The chart contrasts perceived sources of investment value from a large survey of investors with the empirical sources of investment value from the Brinson study. The average investor thinks that their Advisor adds value by picking stocks and bonds; my sense is that the average Advisor thinks that too. The reality however is that a good Advisor adds value by having a system to emphasize stocks versus bonds or cash, and vice versa. That is, a good Advisor adds value through intelligent asset allocation.

Butler-1-12-20-20111

Click on graphic for larger image.

The Brinson study is controversial, mostly because it is improperly cited as validation for pseudo (read false) asset class diversification, such as small-cap versus large-cap, or value versus growth. It is also used to justify Strategic Asset Allocation (SAA) whereby very long-term averages (returns, volatility and correlation) are used to model an ‘optimal’ allocation to stocks, bonds and cash for each individual based on their risk tolerance. While this justification for SAA makes intuitive sense, we will demonstrate how traditional SAA is a suboptimal diversification approach by every metric except perhaps ‘simplicity’. But then, why do you pay your Advisor those big fees?

The Magic of Simple Rebalancing

Strategic Asset Allocation requires one further step beyond the initial asset allocation decision: periodic rebalancing. This is the process whereby each asset is bought or sold on a fixed schedule to bring the stock/bond allocation ratio back into alignment. The assets frequently move out of alignment when one asset class outperforms the other in any period.

While adherents to a Strategic Asset Allocation approach are explicitly expected to perform rebalancing on a pre-established schedule, for example annually or bi-annually (defined in your Investment Policy Statement), in my experience many Advisors do not revisit the rebalancing decision on a regular basis, and so many clients miss out on the value of this simple exercise over time.

Let’s conceive of a real life example, say a retired couple with just enough money to sustain a reasonable lifestyle assuming that they are able to receive average returns in retirement. These Canadian domestic investors may have been advised to adopt a 50/50 stock/bond Strategic Asset Allocation with quarterly rebalancing. If they had started with this approach in Canada in 1993 (our earliest data), and stuck with the strategy through to the present, their returns would look something like this:

Butler-2-11-5-2012

Source: Butler|Philbrick & Associates  Click on graph for larger image.

The table at the bottom may require some explanation. For our purposes, you want to focus on the following data:

  • CAGR (second from the top on the left): This is the annualized return to the portfolio over the entire duration of the test. This strategy delivered a CAGR of 9.89% per annum.
  • Sharpe (third from the top on the left): This is perhaps the most common measure of the ‘efficiency’ of a portfolio, and in this case it measures the annualized return to the strategy divided by the standard deviation, which is the most common measure of portfolio risk. The higher this ratio the better. This strategy had a Sharpe ratio of 1.11.
  • Max Daily Drawdown (six from the top on the left): This is the worst drop in the portfolio from peak-to-trough measured from the highest closing high to the highest closing low. It is a measure of how much loss an investor had to bear when investing in this strategy. This strategy had a Max Daily Drawdown of -25.05%.
  • % Winning Months (top right): This is the percentage of months in which the strategy delivered positive absolute returns. This strategy delivered positive returns in 69% of months.

Let’s contrast the performance of this 50/50 SAA portfolio with the return to a 100% stock portfolio over the same time frame:

 

/Butler-3-1-5-2012

Source: Butler|Philbrick & Associates, Click on graph for larger image.

Canadian investors have enjoyed two decades of very strong returns, benefitting from the strong U.S. economic expansion of the 1990s and then again from China’s decade- long infrastructure boom during the ‘aughts’ which drove prices for Canada’s commodities to record levels.

Over the past 18 years Canadian stocks delivered a remarkable 9.41% per year including reinvested dividends. To compare, Canadian stocks delivered 1.83 percentage points per year more than US stocks, and 12% per year more than Japanese stocks. Of course, investors still had to endure two near 50% drops, and a 6-year period of zero returns (from 1998 through 2003), which would have wreaked havoc on retirement plans. Further, despite the strong overall performance, stocks only delivered positive returns in 74% of 12-month periods — not a very consistent experience.

While a traditional SAA approach definitely improved results over a pure Canadian equity portfolio, we can improve the performance even more by reconsidering how we think about risk.

True Risk Optimization

While a simple, traditional SAA portfolio with periodic rebalancing delivered much stronger, and more efficient returns over the period tested than did stocks on their own, the simple SAA framework as described still has some very serious drawbacks.

Let’s revisit the true objective of the SAA process: to ensure that an investor achieves the maximum return available at a specified level of risk that is a function of the investor’s risk tolerance. Unfortunately, we know from experience, and a mountain of research, that in real life market risk is constantly changing. When markets are rising in a nice orderly uptrend, market risk (volatility) is generally very low. When markets are falling, or even going sideways, uncertainty and risk (volatility) are generally elevated. (See our article Jekyll or Hyde Markets for more on the market’s multiple personalities.)

If the objective of SAA is to maintain a fixed level of portfolio risk that is commensurate with each investor’s risk tolerance, then shouldn’t we reduce our allocation to each asset class dynamically when we start to experience amplified levels of risk (volatility), and increase our allocation when volatility declines? In this way we can preserve a much more consistent level of risk within the portfolio. Such expansion and contraction in portfolio allocations might be considered at each rebalance period.

If we simply alter the traditional SAA strategy so that at each rebalance date we reduce relative allocations to stocks or bonds when they exhibit relatively risky behaviour (geek note: based on 60 day trailing volatility), and increase allocations when they exhibit low relative risk, we can achieve a much more efficient portfolio, again just with stocks and bonds:

Butler-4-1-5-2012

Source: Butler|Philbrick & Associates, Click on graph for larger image.

Note that the objective of this portfolio is to keep the risk stable by reducing allocations to assets when they are exhibiting risky behaviour (high trailing volatility), and increasing allocations to assets when they are exhibiting low risk behaviour (low trailing volatility). In traditional SAA, the focus is on maintaining a fixed allocation. In contrast, and in keeping with the broader objective of SAA, this risk-weighted approach is focused on maintaining a fixed risk allocation.

It will come as no surprise by now that the volatility weighted rebalancing framework performs much better than the traditional 50/50 approach. Indeed, the relative volatility approach delivered 10.28% annualized returns, maximum drawdown of just 15.3%, and 90% positive rolling 12-month periods. In fact, this simple approach produced a Sharpe ratio over 1.5!

Not bad for a simple and intuitive twist on an old idea. The following chart draws on US data to illustrate how this approach also exposes an investor to a much more consistent portfolio experience as the grey line in the chart below (relative volatility weighted portfolio) tracks well below the black line (SAA 50/50) for most of the past 18 years, indicating much lower and more consistent volatility for the investor. The blue line is beyond the scope of this article, but suffice to say that by explicitly holding risk constant by systematically adding cash, portfolio risk and return characteristics can be improved even more dramatically.

Butler-5-1-5-2012

Source: Butler|Philbrick & Associates, Click on graph for larger image.

 

Opportunities for Action

We have demonstrated that over several market cycles a diversified portfolio substantially outperforms an all-equity portfolio, both in absolute terms and on a risk-adjusted basis. The period studied, from 1993 through 2011 is especially interesting because it includes two record-setting equity bull markets during the 1990s and 2000s, interspersed with two intense bear markets in 2001-2003, and 2008.

While the success of the diversified and rebalanced stock and bond portfolio relative to stocks on their own is not a revelation, many investors might be surprised at just how well this portfolio has done over the past 18 years on both an absolute and risk adjusted basis. Further, while we would in no way espouse this model as an optimal framework, not least of which because the stock / bond diversification framework ignores the myriad opportunities available from other markets and asset classes, this simple portfolio outperformed the average retail investor by 8% per year over the same period (See Dalbar, 2011).

We also demonstrated the conceptual and empirical validity of implementing portfolio allocations based on a true risk target that is commensurate with each individual’s risk tolerance, rather than on static Strategic Asset Allocation percentages. In a traditional SAA approach, a stock/bond allocation is chosen at the inception of the investment process, and the portfolio is altered at each rebalance date to move it back toward its long-term target allocation. In a risk-optimized framework however, the allocation to both equities and bonds depends on the relative risk associated with each asset class based on their relative volatilities at each rebalance date. In this way, portfolio allocations to stocks and bonds will ebb and flow according to their respective risk, holding aggregate portfolio risk near the initial target over time.

Empirically, this simple technique measurably improved absolute returns, but dramatically improved portfolio efficiency: Sharpe ratio improved by 36% and Maximum Daily Drawdown was reduced by 65%.

In closing, we would assert that Advisors and investors should consider an approach to Strategic Asset Allocation that incorporates explicit ‘buffers’ which expand and contract allocations to assets when they are volatile so as to keep aggregate portfolio volatility constant. This approach has merit conceptually, mathematically, and empirically as seen in the associated tests. This type of framework should be robust to asset classes, market regimes, and exogenous shocks, and provide a much more stable return experience for investors.


Links to the complete Rebalancing Resurrected series:

  • Rebalancing Resurrected
  • Rebalancing Resurrected, Part 2: Japan
  • Rebalancing Resurrected, Part 3: Canada

Adam Butler and Mike Philbrick are Portfolio Managers with Butler|Philbrick & Associates at Macquarie Private Wealth in Toronto, Canada.

*Butler|Philbrick and Associates is part of Macquarie Private Wealth Inc.


Disclaimer: This material is provided for general information and is not to be construed as an offer or solicitation for the sale or purchase of securities mentioned herein. Past performance may not be repeated. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please seek individual financial advice based on your personal circumstances. However, neither the author nor Macquarie Private Wealth Inc. (MPW) makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use or reliance on this report or its contents.

No entity within the Macquarie Group of Companies is registered as a bank or an authorized foreign bank in Canada under the Bank Act, S.C. 1991, c.46 and no entity within the Macquarie Group of Companies is regulated in Canada as a financial institution, bank holding company or an insurance holding company. Macquarie Bank Limited ABN 46 008 583 542 (MBL) is a company incorporated in Australia and authorized under the Banking Act 1959 (Australia) to conduct banking business in Australia. MBL is not authorized to conduct business in Canada. No entity within the Macquarie Group of Companies other than MBL is an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Australia), and their obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any other Macquarie Group company. Macquarie Private Wealth Inc. is a member of the Canadian Investor Protection Fund and IIROC


 

Related Articles

Estimating Future Returns by Adam Butler and Mike Philbrick

Rebalancing Resurrected Series by Adam Butler and Mike Philbrick

Articles by Ed Easterling

Recent Investing Blog Articles


This is a cross-post with Advisor Perspectives/dshort.com.

 

Previous Post

China: Entertainment TV Cut Back

Next Post

BOB Doll: GOP Will Sweep in 2012

Related Posts

Gold Versus Bitcoin, Which Is A Better Investment In 2023?
Econ Intersect News

Gold Versus Bitcoin, Which Is A Better Investment In 2023?

by John Wanguba
March 28, 2023
World Bank Cautions Of 'Lost Decade' In Global Growth Without Drastic Policy Shifts
Business

World Bank Cautions Of ‘Lost Decade’ In Global Growth Without Drastic Policy Shifts

by John Wanguba
March 28, 2023
How Is The Banking Crisis Affecting Ripple’s XRP Crypto?
Economics

How Is The Banking Crisis Affecting Ripple’s XRP Crypto?

by John Wanguba
March 28, 2023
Virgin Orbit Extends Employee Furlough, Funding Talks Ongoing – CEO
Business

Virgin Orbit Extends Employee Furlough, Funding Talks Ongoing – CEO

by John Wanguba
March 28, 2023
Lebron James And Several Other Celebs ‘Effectively Wiped Out’ As Fitness App Tonal Loses 90% Value
Business

Lebron James And Several Other Celebs ‘Effectively Wiped Out’ As Fitness App Tonal Loses 90% Value

by John Wanguba
March 28, 2023
Next Post

BOB Doll: GOP Will Sweep in 2012

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Browse by Category

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Browse by Tags

adoption altcoins bank banking banks Binance Bitcoin Bitcoin adoption Bitcoin market Bitcoin mining blockchain BTC business China crypto crypto adoption cryptocurrency crypto exchange crypto market crypto regulation decentralized finance DeFi Elon Musk ETH Ethereum Europe FTX inflation investment market analysis Metaverse mining NFT nonfungible tokens oil market price analysis recession regulation Russia stock market technology Tesla the UK the US Twitter

Archives

  • March 2023
  • February 2023
  • January 2023
  • December 2022
  • November 2022
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • June 2022
  • May 2022
  • April 2022
  • March 2022
  • February 2022
  • January 2022
  • December 2021
  • November 2021
  • October 2021
  • September 2021
  • August 2021
  • July 2021
  • June 2021
  • May 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • August 2010
  • August 2009

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized
Global Economic Intersection

After nearly 11 years of 24/7/365 operation, Global Economic Intersection co-founders Steven Hansen and John Lounsbury are retiring. The new owner, a global media company in London, is in the process of completing the set-up of Global Economic Intersection files in their system and publishing platform. The official website ownership transfer took place on 24 August.

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Recent Posts

  • Gold Versus Bitcoin, Which Is A Better Investment In 2023?
  • World Bank Cautions Of ‘Lost Decade’ In Global Growth Without Drastic Policy Shifts
  • How Is The Banking Crisis Affecting Ripple’s XRP Crypto?

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

No Result
View All Result
  • Home
  • Contact Us
  • Bitcoin Robot
    • Bitcoin Profit
    • Bitcoin Code
    • Quantum AI
    • eKrona Cryptocurrency
    • Bitcoin Up
    • Bitcoin Prime
    • Yuan Pay Group
    • Immediate Profit
    • BitIQ
    • Bitcoin Loophole
    • Crypto Boom
    • Bitcoin Era
    • Bitcoin Treasure
    • Bitcoin Lucro
    • Bitcoin System
    • Oil Profit
    • The News Spy
    • British Bitcoin Profit
    • Bitcoin Trader
  • Bitcoin Reddit

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

en English
ar Arabicbg Bulgarianda Danishnl Dutchen Englishfi Finnishfr Frenchde Germanel Greekit Italianja Japaneselv Latvianno Norwegianpl Polishpt Portuguesero Romanianes Spanishsv Swedish