Last March, Dow Jones began publishing the Dow Jones RBP Index Series. The series consists of nine indexes that draw from the Dow Jones Wilshire Large Cap 750 (DJW 750) universe with weightings assigned on the basis of RBP Probability. The nine indexes include various permutations of growth, value, high RBP and low RBP.
The performance of the indexes in 2008 gives great insight in to the potential profitability of an RBP strategy. Particularly during a market that, for all intents and purposes, was in complete chaos, the RBP strategies did exceedingly well.
Long/short investment strategies in 2008 oftentimes just didn’t operate correctly, as traditional assumptions for market behavior failed in the face the unforeseen “black swan” events among financials. It was a rough year to be an institutional money manager. But remarkably RBP was still able to do what it is supposed to do.
All three RBP 130/30 indexes outperformed the DJW 750. The outperformance was not huge, but substantial enough to warrant closer inspection. However what I notice is that there appears to be substantial alpha to be extracted from the RBP numbers.
For instance, the DJ RBP Large-Cap Value 130/30 index returned -34.41% in 2008 versus the DJ Wilshire Large Cap Value Index (the universe from which this RBP index is drawn) which returned -38.81%. In other words, the RBP 130/30 approach beat the market by 4.4%, but of course the absolute return is still very negative since the index is net 100% long.
So the problem was that a 130/30 strategy is not market neutral and the market tanked last year. But what if we employed a strictly long/short, net zero-beta strategy in which we went long the high RBP companies (the “leading 30”) and shorted the low RBP companies (the “lagging 30”)?
The DJ RBP US Large-Cap Value Leading 30 produced a -30.30% return in 2008 while the DJ RBP US Large-Cap Value Lagging 30 returned -47.05% The difference, the spread, is a whopping 16.75% and indicates the return (before transaction costs) to an investor who had maintained a market neutral portfolio in this way.
Let me put this in perspective by citing the returns to some hedge fund indexes. The Dow Jones Hedge Fund Strategies Benchmark (DJHFSB) Equity Long/Short Index and DJHFSB Equity Market Neutral were discontinued in November, but had lost 10.82% and 4.32% respectively in 2008 up to that point.
A popular alternative hedge fund index is the HFRX Equity Hedge Index, which was down a painful 25.45% in 2008. Its counterpart, the HFRX Equity Market Neutral Index was down 1.16% in 2008.
That’s right, the typical market neutral hedge fund lost 1.16% last year, whereas the market-neutral, hedge-fund type RBP strategy I describe above would have produced a positive 16.75% return, beating its benchmark by 17.91%.
There really seems to be something to the RBP strategies. And with the new products to be launched based on these strategies soon they will be available to investors. It should be an interesting ride.