The ETF Portfolio Strategist: Risk Management Strategies Update
James Picerno | Mar 08, 2021 01:04AM ET
Global markets delivered a mix of gains and losses last week, as mentioned previously, but our two proprietary strategies were essentially unchanged. The performances are fractionally behind the benchmark, Global Beta 16 (G.B16), which edged up 0.1% for trading week through Friday’s close (Mar. 5). But given the turbulence in risk assets recently, holding steady is tolerable at the moment.
But deeper cracks may be forming. Global Managed Volatility (G.B16.MVOL) and Global Managed Drawdown (G.B16.MDD) are trailing G.B16 year to date by 60 basis points and 160 basis points, respectively. In other words, the jury’s still out on whether the two risk-managed strategies will add near-term value over the raw, largely unmanaged beta of G.B16, which defines the opportunity set for all three portfolios. For details on strategy rules and risk metrics, see this summary.
Over the longer term, G.B16.MVOL and G.B16.MDD have outperformed G.B16. G.B16.MVOL’s edge is clearly seen in the trailing three-year return, for instance, 13.4% annualized total return vs. 8.6%. G.B16.MDD’s advantage arises mostly from a risk perspective. The maximum drawdown for G.B16.MDD over the past five years, for instance, is a relatively light -7% vs. G.B16’s hefty -29%. True, those advantages had a price tag of substantially higher trading and so, on an after-tax/after-cost basis, the advantages are considerably smaller.
Given the renewed turbulence in markets this year another question looms: Will the impressive histories on a gross basis hold in 2021? History offers reason for optimism, but for 2021 to date it’s not yet clear that a repeat performance is fate.
Speaking of risk management, G.B16.MDD’s risk-off signals retreated on Friday to one slice of the ETF opportunity set—broadly defined, equally weighted commodities via WisdomTree Continuous Commodity Index Fund (NYSE:GCC). The strategy’s brief, one-week flirtation with risk-off for US investment-grade corporates—iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSE:LQD)—and Treasuries—(NASDAQ:IEF) shifted back to risk-on at last week’s close. A bit of noise, it seems; par for the course at times in the art/science of attempting to mine alpha from the raw material of beta.
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By contrast, there were no changes in G.B16.MDD’s risk profile. Twelve of the 16 target funds remained in a risk-off posture, leaving shares in Africa—VanEck Vectors Africa Index ETF (NYSE:AFK), commodities—(GCC) and US and foreign REITs/real estate as the ongoing front lines for risk-on for this strategy.
Finally, a visual comparison of the two strategies relative to the benchmark since the start of 2020 continues to show G.B16.MVOL with a wide performance lead. G.B16.MDD’s relatively smooth ride is also conspicuous. It’s unclear if these histories are set for out-of-sample pressure this year, but the mixed numbers year-to-date suggest it’s premature to rule out the possibility.
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