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Stock Index Shows Losses After 10 Years… But Not if You Missed Downside

Over the past decade, the S&P 500 Stock Index has lost -17.97%. That’s a annualized loss of -1.96% over the past 10 years. CLEARLY, a passive buy and hold strategy hasn’t been profitable. Below we show the 10 year trailing return (or lack thereof) for this popular index and its 4 different formats. The most commonly quoted capitalization weighted index, the Total Return (includes dividends), the Equal-Weighted (all 500 stocks are weighted equally, rather than based on size), and the Equal-Weighted Total Return. None of them has achieved a positive return of the past decade.

S&P 500 Stock Index (4/28/2000 – 4/28/2010)

INDEX

Gain/Annum

%Gain Total

S&P 500 Stock Index

-1.96%

-17.97%

 

S&P 500 Total Return (4/28/2000 – 4/28/2010)

INDEX

Gain/Annum

%Gain Total

S&P 500 Total Return

-0.16%

-1.54%

 

S&P 500 Equal-Weighted Index (4/28/2000 – 4/28/2010)

INDEX

Gain/Annum

%Gain Total

S&P 500 Equal-Weighted Index

-2.65%

-23.53%

 

S&P 500 Equal-Weighted Total Return Index (4/28/2000 – 4/27/2010)

INDEX

Gain/Annum

%Gain Total

S&P 500 Equal-Weighted Total Return Index

-0.12%

-1.17%

 

Relative Return managers,  money managers whose objective is to track and outperform an index like the S&P 500 often make statements like "Time – not timing – is on your side" or “It’s not timing the market, but time in the market.” They use a one-sided study showing that missing the best days (the largest daily gains) of the stock index leads to poor returns. While that is obviously true, that is a misuse of data and it’s only one side of the story. First, we could probably win the lottery twice in a year easier that we could miss the 10 largest gaining days in the stock market on a annual basis. Second, what they don’t tell you is that missing the downside creates the kind of positive imbalance between profits and losses that we want. Since we’re talking about the past decade, missing the 10 worst down days was the only way to achieve a positive return… and the more down days we missed, the more positive the outcome.

Missing Best and Worst Days Decade

This is just one of many examples that we will share that explains the logic behind why we employ our active risk management systems. Yes, I know, not managing risk would be illogical. Isn’t it fascinating that the very people who presume that all investment decisions are made with logic are the same people who believe that markets are efficient? So they believe all they need to do is buy and hold a index like the S&P 500. And, relative return managers whose objective is to try to beat a benchmark index don’t manage absolute risk either. Instead, their idea of risk isn’t the loss of money at all. For a relative return manager, risk means "tracking error". For example, a manager whose benchmark is the S&P 500 could hold all the 500 stocks in the index at the exact same weight of the index and would consider that no risk. That is, as long as they hold the stocks in the index, they will track the benchmark and have no risk of tracking error. Stock indexes are fully invested at all times. That necessarily means an index is fully exposed to the possibility of loss with all the capital, all the time. Therefore, a Relative Return manager whose objective is relative performance vs. a benchmark stock index would actually consider it a risk if he or she held 10 or 20% of the portfolio in cash. That is because their risk is not tracking the benchmark. It has nothing to do with losing money. When these managers don’t track close to their benchmark, they call it ‘tracking error risk" or "style drift". Therefore, when the indexes decline a lot, so will they.

I’m just pointing out a few "illogical inconsistencies". If you’ve ever wondered why the vast majority of investment managers closely track the daily moves of the stock indexes, now you know. This is in sharp contrast to our strategy at Shell Capital. Instead of a market-based strategy that tracks the moves of a stock market index, our first priority is capital preservation. Because I can control my risk, that allows me to focus on the momentum in our profits. We believe that most logical investors are risk averse. Investors perceive downside volatility worse than upside volatility. We believe that is logical and wise because of the exponential nature of losses. Now, risk control shouldn’t be confused with the elimination of all risk. If we neutralize all risk there would be no reward. We must take "some" risk in order to go for profits. The difference in our method is that we know what our risk is, and we control it, so our focus is on creating a risk/reward profile that meets our investors objectives. Clearly, that cannot be accomplished with a passive strategy or a relative return strategy…