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Market Risk And The Sharpe's Ratio: Comments On Chris DeMuth's Article

|Includes: iPath S&P 500 VIX Short-Term Futures ETN (VXX), XIV

Hi Chris:

My attention was drawn to your statement in your recent article:

3 Ways to Expose Yourself to Today's Market at

"Risk is always and everywhere a function of price, not volatility. However, there is a significant part of the market that is arbitrarily adverse to volatility because it is frequently used as a (quite flawed) proxy for risk analysis. Your explanation of the XIV and VXX was the clearest I have come across in some time.

It brings mind the Sharpe's Ratio: overall return of a portfolio is compared with a risk free return, by dividing by the Standard Deviation of the Portfolio return over a set period of time.

It is a tool utilized by many professional investors in comparing and selecting money managers. Over certain periods of time, for example, a wealth preservation - building strategy, like the period of high interest rates in municipal bonds with tax free turns over 8-10% during the 1980's, an equity based approach would be inferior for many investors during such a time. Insurance companies perceived that early on in the 1980's, and became huge buyers of municipal bonds.

It is noteworthy that 85% of mutual fund managers were not able to outperform the Standard and Poor's 500 Index during the period of sustained bull market in the 1980's up to 1987 that incidentally coincided with the expansion of 401-k and IRA accounts. For many investors seeking shelter from risk but desiring participation, an Indexed S&P fund with no load was the preferred vehicle if you recall, that's when financial firms such as Vanguard had their exponential growth with the American public:

A Quick Simple Hypothetical Example: a Money Manager reports a net 35% return with a Standard Deviation of 25%, while a tax free municipal bond nets 8% tax free equivalent to approximately 10% taxable return.

Comparing: 35%-10 %/25% SD= 1.00 same overall risk.

I personally assisted individuals in assembling a tax-free AAA rated municipal bond portfolios during that time. Many were business owners that were generating cash surplus, and demanded a risk free strategy. I was working at an investment banking firm as a younger executive seeking to open retail accounts at that time.

In conclusion, I agree with you that it's important to keep one perspective on individual goals and actions in participating in the market. Your discussion of the challenges facing market participants is very helpful.

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