Investment Management: Why You Need A Complete Rethink. Part 4 – Active Asset Management. Further Steps To RVAR Improvement.

In Part 4 I will show what I believe is the path to further improvements to RVAR through making a shift to Active Asset Management with tactical allocation models.

The case for a further improvements in RVAR from Active Asset Management can be shown from even a simple Active Asset Management system, which can be applied to a very long history of data.

Our current monetary system dates back to 1971, when the fixed price of gold in US dollar terms was abandoned. So, to maximize relevant data, over 40 years of information can be used from that date. Then just 3 main asset classes can be considered with a very simple selection rule. This should provide some useful insight.

Here it is, with all the results shown and summarized below.

Simple Active Management System (called “Trend System” below)

“Three asset classes: Stocks, bonds, gold.

Invest equally in whatever is going up (defined as 3 month SMA > 10 month SMA).

That’s it.”

As the results show below the Trend System outperforms all the other individual asset classes, with lower volatility and Max Drawdown,  and also a higher sharpe ratio.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Past returns are no guarantee of future returns, and all these back tests are provided for educational and illustrative purposes only, because I believe this illustrates a very useful approach. Any investor should do their own further research and seek advice before implementing any similar approach. No method, software, or advisory services guarantee any return or could ever be regarded as risk free or in any way perfect as a risk management system. No returns should ever be guaranteed, and all methodologies carry risks as well as benefits. The information and charts are provided to illustrate how they can help construction of portfolios, and be a useful guide for decision making and for testing methodologies and illustrating how portfolio construction could change the dynamic of risk management.  Analysis provided by any investment services, whether Tradestops or Stansberry Research has it’s limitations and may result in the loss of capital.The purpose of providing the information contained in this note is as an illustration only to help investors understand some aspects of the investment process. The statistics mentioned are accurate to my best knowledge but only a snapshot at the time of writing and should also be regarded as illustrative only.

 

The example above shows a significant improvement in return from each of the asset classes alone and average annualized returns of over 3% above an equal weight passive allocation to the three asset classes combined.

So this example suggests that for even a very simple repeatable Active Management system RVAR can improve.

Next Stages of Active Asset Management. Further ideas for RVAR improvement

Naturally, there are infinite ways to develop active asset management systems, even beyond just trend based systems of the type described above. However, the more complicated the system and the less data there is, the more unreliable backtested results can become. Furthermore, backtested results always need special care concerning how repeatable any results could be.

Nevertheless, multiple systems, with multiple methodologies can be developed that suggest further RVAR improvement. Once this is achieved then combinations of Active Management systems can take RVAR improvement to an even higher level. Particularly when:

1. Active Management Systems are uncorrelated.

2. Active Management Systems focus on different sectors.

3. Active Management Systems focus on different time cycles/horizons.

4. Active Management Systems can be combined in a balanced and universal aggregate system. In this way, a whole portfolio can be constructed that will automatically adapt to many different investment environments.

Summary

This concludes the four part series of completely rethinking investment management. From the beginning it is important to ask the right questions about what constitutes clearly superior long term investment performance. Once this is deeply considered a very different enquiry then follows from switching from just past returns to RVAR, Repeatable Volatility Adjusted Returns.

Armed with this new metric, though, a whole series of new developments arise which can take RVAR results to many further and more optimal levels.

1. In part 1, in addition to demonstrating how dangerous it can be to focus just on past returns, it was shown that Static Allocation can be adjusted towards the All Weather system and long term improvements in RVAR.

2. In part 2 the weaknesses of the widespread use of stock/bond allocation strategies were exposed. Highlighting that:

a) There is simply no clear historical basis for the stock/bond passive allocation strategy.
b) The theoretical basis for a stock/bond passive allocation strategy is nonsense!

c) This is now the worst time in history to adopt a 60% equity/40% bond passive     allocation strategy.

3. In part 3 the key importance of Money Management Systems was introduced. Money Management Systems alone can improve RVAR. Furthermore, deeper analysis of these techniques suggest that long term returns can even be increased by techniques that simultaneously lower risk!

4. In part 4 the further improvements in RVAR from Active Management Systems were considered. Then, in addition, multiple Active Management Systems can extend these RVAR benefits to a whole portfolio as described above.

Overall, the line of thinking outlined in these 4 parts can transform an investor’s risk and return outlook and peace of mind.

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