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Major Asset Classes | November 2021 | Risk Profile

Summary:
If genius is a bull market, it’s been easy to look smart in recent years by holding a multi-asset-class portfolio. That’s been true in total-return terms and the profile holds up after adjusting for risk. But there are hints that the bull run for risk-adjusted performance may be peaking for globally diversified strategies. As one example, consider the Sharpe ratio for the Global Market Index (GMI). Although this metric remains elevated, it continues to show signs of cresting. GMI is an unmanaged, market-value-weighted portfolio that holds all the major asset classes (except cash). GMI’s Sharpe 3-year Sharpe ratio dipped to 1.02 in November, well below the 1.12 print for the previous month (red line in chart below). The current reading is still a strong profile for risk-adjusted

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If genius is a bull market, it’s been easy to look smart in recent years by holding a multi-asset-class portfolio. That’s been true in total-return terms and the profile holds up after adjusting for risk. But there are hints that the bull run for risk-adjusted performance may be peaking for globally diversified strategies.

As one example, consider the Sharpe ratio for the Global Market Index (GMI). Although this metric remains elevated, it continues to show signs of cresting. GMI is an unmanaged, market-value-weighted portfolio that holds all the major asset classes (except cash).

GMI’s Sharpe 3-year Sharpe ratio dipped to 1.02 in November, well below the 1.12 print for the previous month (red line in chart below). The current reading is still a strong profile for risk-adjusted performance, but the downshift may signal a softer trend for the foreseeable future. The trailing 10-year Sharpe ratio, by contrast, held steady at 0.95 last month (black line).

Major Asset Classes | November 2021 | Risk Profile

Meanwhile, drawdown for GMI has been persistently low/nil in recent months. There was a slight red print in November: the index’s peak-to-trough decline was a mild -1.8% following a zero drawdown in the previous month.

Major Asset Classes | November 2021 | Risk Profile

GMI represents a theoretical benchmark for the “optimal” portfolio. Using standard finance theory as a guide, this portfolio is considered a preferred strategy for the average investor with an infinite time horizon.

Those assumptions are, of course, unrealistic in the real world. Nonetheless, GMI is useful as a baseline to begin research on asset allocation and portfolio design. GMI’s history suggests that this benchmark’s performance is competitive with active asset-allocation strategies overall, especially after adjusting for risk, trading costs and taxes.

For extra context, readers can use the risk profile for GMI alongside the current monthly updates on performance and expected return for the benchmark and its components. In addition, total return forecasts are updated monthly via three models at The ETF Portfolio Strategist.

The table below presents additional risk metrics for GMI and its underlying asset classes, based on a trailing 10-year window through last month.

Major Asset Classes | November 2021 | Risk Profile

Here are brief definitions of each risk metric:

Volatility: annualized standard deviation of monthly return

Sharpe ratio: ratio of monthly returns/monthly volatility (risk-free rate is assumed to be zero)

Sortino ratio: excess performance of downside semivariance (assuming 0% threshold target)

Ulcer Index: duration of drawdowns by selecting negative return for each period below the previous peak or high water mark

Maximum Drawdown: the deepest peak-to-trough decline

Beta: measure of volatility relative to a benchmark (in this case GMI)


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By James Picerno


James Picerno
James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers. Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg Markets, Mutual Funds, Modern Maturity, Investment Advisor, Reuters, and his popular finance blog, The CapitalSpectator.

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