Though not unexpected, most of us were surprised by the spike in volatility that we saw in the beginning of February 2018. The fallout hit some big-name players and hedge funds that were on the wrong side of the volatility bet. Most interesting to me was the hit that befell the LJM Preservation and Growth Fund (LJMIX). Not so much because its chart shows it falling off the definitive “cliff,” though that is certainly interesting, but because of what the word “Preservation” in its name implied. Not many people would have guessed that a fund with the word “preservation” in its name could fall 80% in the blink of an eye.
This unusual circumstance led me to think about the use of other marketing words used in other fund names. Most names used in ETFs and mutual funds are pretty bland, but they often imply a key characteristic; whether that characteristic follows perhaps is another story. I have a personal interest in the use of the word “moderate” because that is usually considered “middle ground” where most people would reside in a normal distribution curve. It might even be where the average investor might set their “default” investment strategy. I set out to see how the use of the word “moderate” might imply certain characteristics.
I used the SEC EDGAR database to search for all mutual funds and ETFs with the word “moderate” in its name. I came up with 459 mutual funds, including all share classes but not including funds used within variable annuity contracts. Surprisingly, there was only one ETF, the iShares Core Moderate Allocation ETF (AOM). I scrubbed this list to exclude funds with other descriptive words in it like “growth” or “income”, included only class A shares for the sake of consistency when measuring returns, and excluded bond funds. I then wanted to include only funds that had a history longer than 5 years (I am assuming there is some decent “survivorship” bias here). The list shrunk to only 22 funds, including the 1 iShares ETF.
The following listing includes offerings from some of the largest investment managers, but does not include anything from Vanguard or Fidelity (because their fund names usually add another descriptive term like “growth” or “income”). In fact, there are many, many other funds that have investment characteristics similar to this list; it is just that the word “moderate” is not in the name telegraphing a message. Most (but NOT all, see SXMAX below) of these funds fall into the Morningstar 50-70% Equity Category classification.
Analytics Source: portfoliovisualizer.com
As can be see from the above table, for the 6.1 years ended January 31, 2018 (chosen since it includes all the funds in the data set), the average compound annual growth rate (OTCPK:CAGR) for all the funds was 8.46%, average standard deviation was 6.17%, and the average maximum drawdown was -7.97%. Red highlighted cells show the worst stats and yellow highlights show the best. Risk and return profiles for SPDR S&P 500 Trust (SPY) and iShares Core Total U.S. Bond Market (AGG) are shown for comparison. This time frame is a bit fortuitous since it included the low volatility/high return period of 2017 and an overall bull market with generally less volatility than seen historically. Return profiles are clustered between 8-9% CAGR and standard deviation of returns is around 6% and Sharpe ratios are quite high averaging 1.33. Aside from a few outliers, the majority of funds provide similar amounts of excess return per unit of risk (Sharpe ratio).
The following chart shows the return profile presented as the compound value of $1,000. You can see the clustering of the majority of funds in the middle and the major outliers including SPY (the top green line), AGG (the bottom red line), and SXMAX (a dark blue line just below SPY). Though clustered, there is a material difference between the bottom and the top and, in general, the difference is explained by the increased risk (equity content) taken in each fund (per below).
Data source: portfoliovisualizer.com, Excel chart
The current risk profiles looked surprisingly mild given what we had become used to historically, so I expanded the time horizon to see how a longer-term horizon might impact the results. As expected, expanding the time horizon from 3-, to 5-, to 10-year horizons showed that the most recent periods greatly minimized the standard deviation of return metrics. Per the table below, the average standard deviation of return grew from 6.11% for a 3-year horizon to 10.29% for a 10-year horizon. Though the 6.11% looked low, the 10.29% looked high; ultimately, though, reversion to the mean will likely result in higher risks for these strategies than shown currently.
As expected, most of the risk profile comes from the equity weightings that each fund maintains. Per data from Morningstar, the average equity weighting for these funds is 55% (U.S. and International combined) with the balance in bonds, cash, and other. There are some outliers, of course, and understanding the rationales from each fund prospectus helps explain the positioning. For example, the SEI Moderate Strategy Allocation Fund (SXMAX) is intended to be coupled with other funds as “one component of a broader strategy” so its overweight in equities at 80% (!) overstates its standalone “moderate” name. Just another reason that you can't judge a fund by its name, or "book by its cover" (alternative title for article!)
I am happy to note that the “moderate” nomenclature in the funds studied above reflects similar, but not interchangeable, investment vehicles. Best to read the prospectus and match to your goals before investing; but you all knew that!
P.S. I couldn’t help but notice some of the interesting ticker symbols above. For example, I am not sure what “IMO” (IMOAX) says to an investor when it comes to portfolio management decisions? I would like a little more strength in tone. Also, “JDTAX” must be a “doctor of tax” and “MRMAX” reads like Mr. Max for “maximum return”? Finally, “PLUSX” reminds me of my days doing black and white photography with Kodak film!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.