Low Risk Fund Portfolios In A High Risk Environment

Jun. 14, 2020 6:53 PM ET

by: Charles Bolin

Summary

With the uncertainty of the economy and markets, investors should remain conservative.

Mutual Fund Observer is used to update Top Fund and Category Performance.

A "Very Conservative" Model Portfolio is created for short term funds in addition to the three Conservative Model Portfolios.

Introduction

According to the National Bureau of Economic Research, the U.S. economy entered a recession in February of this year. The S&P 500 is down about 5 percent for both the week and year to date. I don't believe that the full impact of the slowdown or continuing risk of COVID-19 is fully priced into the markets. There are plenty of potential disruptions in the near term including the political rhetoric associated with the election. This article describes a conservative investment approach using Mutual Fund Observer to measure risk (Ulcer Index) and Risk Adjusted Return (Martin Ratio) using the author's Ranking System.

Chart #1: S&P 500 Late Stage of the Business Cycle Performance (Volatility)

Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion. – Jesse Livermore

Rules Based Investing

I use an Investment Model as shown below to determine how much risk to take in investments following the philosophy of Howard Marks. The solid blue line is a theoretical stock to bond allocation with a minimum allocation of 20% along the guidelines of Benjamin Graham (who used a minimum allocation of 25%). The Model started to show improvement in late 2019 prior to the impact of COVID-19 on the markets. The red line shows the percent of the indicators that are negative and the downturn in the economy is wide spread.

Chart #2: Investment Model

Source: Created by the Author

Chart #3 shows the total return performance of the S&P 500 (green), Vanguard Wellington (red) which represents a traditional 60/40 stock to bond allocation, the Vanguard Wellesley (blue) which is a more conservative 40/60 stock to bond allocation, and the Fidelity Japan Fund (orange) for the past 22 years. For someone nearing retirement, this time period represents an approximate average life expectancy for a 65 year old. I expect a conservative allocation to perform as well or better than more aggressive allocations over the next decade or two due to slower population growth, aging population, current recession, and high debt and deficits, among other reasons. Much of the gain over the past decade is the result of quantitative easing. I show the Fidelity Japan Fund as a market which has had similar problems.

Chart #3: Twenty Year Baseline Fund Performance

Source: Portfolio Visualizer

Table #1 shows the performance for the base line funds in the previous chart. As someone nearing retirement, managing risk is more important than higher returns. The Sortino Ratio which measures the risk free return divided by the downside deviation is one measure of risk-adjusted returns. As shown below, when adjusted for risk, the Vanguard Wellesley Income Fund has had the highest return compared to the risk taken.

Table #1: Fund Performance since 1998

Portfolio	Return	Max. Drawdown	Sortino Ratio
Vanguard Wellesley	7.0%	-18.8%	1.3
Vanguard Wellington	7.7%	-32.5%	0.9
Fidelity Japan	4.7%	-63.8%	0.4
Vanguard 500	7.1%	-51.0%	0.6

Source: Portfolio Visualizer

Risk Managed Portfolio

I have been using Mutual Fund Observer Premium Services for the past year or two to build risk adjusted portfolios in my own accounts. Earlier this year, I built three model portfolios to use as guidance to build low turnover portfolios that I would be content to hold through recessions with few adjustments. The two year return of these portfolios are shown as red triangles compared to the risk taken as measured by the Ulcer Index which measures the depth and length of drawdowns. The blue circles are baseline funds. A small account is held in a Charles Schwab Intelligent Portfolio which is a Robo-Adviser account. Schwab makes periodic adjustments to these portfolios so it is not a fair comparison to say the Intelligent Portfolio would have been static for the past two years. I used two years because it is the age of the youngest fund in my portfolios. The Fidelity Conservative and Moderate Portfolios are higher performers on a risk adjusted basis.

Chart #4: Return vs Risk (Two Years)