Overcoming the Trailing Returns of Active Management
Posted on: 01/05/2015
By Chuck Self
A number of year-end 2014 articles have bemoaned the fate of active management. In one of them, Standard & Poor’s indicates that only 39% of the large cap mutual funds beat the S&P 500 Index last year. Also, few hedge funds outperformed the Index in 2014.
Of course, actively managed mutual funds have to overcome the 1%+ expense ratio most of them charge. Even before fees, active management does relatively well in down years but seems to have a hard time in up years. Hedge funds have to take active positions in all market environments due to their high fees. Our research has found that in order to outperform benchmarks over long periods of time, you have to have the ability to take leveraged positions in the good years and not be fully invested in the bad years. If performed successfully, downside risk can be reduced, while taking on enough risk over time to beat the benchmarks.
Both of the iSectors® Post-MPT Allocations are intentionally structured to increase the chance of outperformance over long periods of time. The Post-MPT Growth Allocation has owned leveraged sector ETFs contributing to outperformance of its S&P 500 index benchmark in 2014 (past performance does not guarantee future results.) The Post-MPT Moderate Allocation, which has a benchmark of 60% stocks, 40% bonds, was 80%+ invested in stocks for most of the year. Moderate also outperformed its benchmark.
Post-MPT Growth will have a 10-year track record on January 31, 2015, the longest of all iSectors Allocations. From its February 1, 2005 inception through December 31, 2014, the Allocation has outperformed the S&P 500, net of fees, through some of the best and worst equity markets in US history. For the most part, the Allocation has been leveraged in the best times and significantly underinvested in stocks during the worst times. Of course, properly determining equity investment levels is just a contributor to the three-fold process leading to the Allocation’s success:
- It uses the best ingredients (sectors),
- The recipe has been rigorously tested (objective, mathematical models solving for the minimization of downside risk),
- The preparers follow the recipe meticulously and efficiently (low cost, sector ETF portfolios resulting from the model’s output, not human judgment).