U.S. Sector ERC Portfolio Overtakes SPY

by: Anonymous Investor..

Last week I presented the concept of equally-weighted risk contribution (ERC) portfolios and showed that this risk-based indexation methodology can deliver alpha compared to classical benchmarks like the S&P 500. I want to give readers a quick update on the recent performance.

After a light pullback in the first half of April, the US stock market recovered nicely until month-end and reached new highs for the year. The SPDR S&P 500 (NYSEARCA:SPY) gained 2.90% and the SPDR Dow Jones Total Market (TMW) gained 2.76% while all basic ERC Portfolios also delivered strong gains. The US Sector ERC Portfolio even overtook its benchmark during the month of April for the first time this year.

The US Sector ERC Portfolio, which consist of the nine sector SPDRs (XLY, XLP, XLE, XLF, XLV, XLI, XLB, XLK, XLU), gained 3.55% during April and outperformed its benchmark by 65bps. On a risk-adjusted basis, the US Sector ERC Portfolio outperformed the SPDR S&P 500 clearly over the last year with a Sharpe Ratio of 1.02 compared to 0.84 for the benchmark. In addition, its information ratio is currently at 0.76, which is very good for a passive index strategy. Furthermore, the portfolio's daily Value-at-Risk is just at -2.87% compared to 3.23% for the SPDR S&P 500.

Both the US Equities ERC Portfolio, which consist of SPY, IJH and IJR, and the US Style ERC Portfolio, which consist of IVW, IVE, IJK, IJJ, IJTand IJS, delivered strong returns during April. The US Equities ERC Portfolio's gain of 2.76% matched the benchmarks performance, while the gain of 2.72% of the US Style ERC portfolio fell just 4bps short off the benchmark's month-end gain. However, both portfolios still clearly outperform their benchmark over a mid- to long-term view on an absolute comparison as well as on a risk-adjusted basis. Both portfolios exhibit currently an information ratio of 0.59 and a Treynor Ratio of 0.22 over the last year, despite their slightly higher volatility and VaR compared to the benchmark. Furthermore, both portfolios exhibit a beat below 1.

Given the steadily rising equity markets during the month of April, the volatility (the VIX Index) went gradually lower until month-end, despite its volatility hiccup on April 18, which turned out to be a sharp reversal day. Given the easing volatility, all hedged portfolios with volatility instruments underperformed their un-hedged versions as well as their respective benchmarks on an absolute basis.

The US Sector ERC Portfolio Hedge gained 2.74%, which brings its return over the last year to +12.83% with a volatility of 11.71%. Given the much lower volatility compared to the benchmark, its Sharpe Ratio at 1.07 is still much higher than the Sharpe Ratio of 0.84 of the SPDR S&P 500.

The US Equities ERC Portfolio Hedge gained 2.02% which brings its gain over the last year to 15.16%, with a volatility of 15.36%. Its Sharpe Ratio of 0.97 is still above that of the SPDR Dow Jones Total Market.

The US Style ERC Portfolio Hedge gained 1.99%, which brings its return to +15.10% with a volatility of 15.37%. Given its Sharpe Ratio of 0.97 it still outperforms its benchmark from a risk-adjusted point of view.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.