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Reduce Portfolio Volatility

Portfolio VolatilitySince the S&P 500’s recent high on 9/20/2018, the S&P 500 has lost 8.47%. However, smart investors have options to reduce portfolio volatility, as there are many strong funds and stocks in sectors which:

  • Are attracting safety conscious investors
  • Have less volatility than the broad market
  • Are not highly correlated to the S&P 500
  • Funds are inherently diversified (Individual stocks are too risky for this analysis)

The remainder of this article describes the use of FastTrack tools to find these attractive, low volatility, diversified funds to reduce portfolio volatility (risk) and increase return of a portfolio which is losing value in current markets (Increase risk adjusted return).

Defining an Investment Universe

Defining a universe of candidates with FastTrack requires the Sieve. We start start with all no-load, low-fee, oldest share class, open end funds, plus all ETFs not including ETNs.
Use sieve to remove all bond funds. Bias toward all equities.

  1. Use sieve to remove all Short (bear) funds. No market timing gimmicks.
  2. Use the FastTrack spreadsheet to remove all funds with correlation >90% to the S&P 500. Bias toward reducing exposure to a broad bear market.
  3. Use Spreadsheet to remove funds with less than 1-year of daily history.
  4. Use the spreadsheet to remove all funds with recent volatility greater than the S&P 500 OR less than half the S&P. Bias toward less risk.

Analysis – Reduce Risk, Increase Return

We’re looking for funds that would increase return and reduce volatility of the S&P 500 index. First, ranking the 207 issues in the selected universe for the trailing one year (11/24/2017- 11/26//2018). Using a metric risk and return metric called NCAlpha, we picked three diverse funds from in the top 10 funds ranked by NCAlpha:

  • PSL – Invesco DWA Consumer Staples Mom ETF
  • PDFDX – Perkins Discovery
  • IHF – iShares US Healthcare Providers ETF

Below is a chart the shows a 33% / 33% / 34% mix of PSL / PDFDX / IHC rebalanced quarterly.

Returns
YTD
1 year
3 year
5 year
10 year
RDV$
22.8%
27.6%
45.9%
73.3%
392.0%
SP-DA
2.1%
5.1%
36.4%
63.9%
271.8%
Stats
Rtn
Ann
SD
UI
Corr
RDV$
73.3%
11.6%
3.9%
5.9
83.1%
SP-DA
63.9%
10.4%
3.7%
3.3
100.0%
DrawDown Stats
Max Draw
Length
Recovery Length
Peak Date
Valley Date
RDV$
(21.6%)
6
14
8/5/15
2/11/16
SP-DA
(13.1%)
7
2
7/20/15
2/11/16

Result – Reduced Volatility

The new portfolio found funds that backtested consistently better than the S&P 500 over many years, and had less drawdown than the S&P 500 for the period 9/20/2018 to 11/25/2018. While, the final portfolio was less diverse than the S&P 500. The top-ranked funds benefit from successful fund manager and index construction and the recession-proof nature of the health industry.

Next Step

Since the portfolio is optimized for down-trending markets, it will require reallocation to take full advantage of a bull market. Step 5 above should be changed to have a bias toward more risk.

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FT4Web Spreadsheet of Top Ranked Funds

FastTrack-Spreadsheet Top Ranked Funds