Studies of Life

Learning by doing.

Strategy Test 2015 – 1: January 15

17 January 2015 by Jim

Here’s our first update of the year for the strategy test I announced hereSTrategy test

As we can see, the current results are quite spectacular already. “X” refers to my own portfolio (a combination of TV and a 30% bond + gold piece) which has performed admirably in the past two weeks but it is pretty volatile as well.
Here’s the ranking of the strategies by their Sharpe ratios:
    • AAA (0.99)
    • Perm (0.79)
    • Parity (0.66)
    • DM (0.50)
    • TV (0.28)
    • 60/40 (0.20)
We are getting a sharpe of almost 1 with the AAA (Adaptive Asset Allocation) strategy! Looking at the chart, it’s quite astonishing to compare the strategy with the worst Sharpe (the 60/40 stock and bond portfolio) to the best one (AAA).

stocks bonds january
AAA january
As you can see, AAA’s curve is extremely smooth. I’ve actually never seen any portfolio or asset combination that is so smooth myself, and that’s precisely what the Sharpe ratio expresses: there are no sharp losses or wins, just a steady climb upwards.
Also note that while the PP (Permanent Portfolio) and the Risk Parity portfolios are getting a boost due to gold, which has begun rising in price in 2015, there is no gold in AAA, so the extremely smooth upwards trend cannot be explained by that.
The ranking by total return is:
  • Perm (4.3%)
  • Parity & TV (both 3.4%)
  • AAA (3.1%)
  • DM (2.7%)
  • 60/40 (1.9%)

I don’t think total return should be the main measure we look at, because we already know that among all asset classes, stocks are supposed to be the riskiest and those with the best total return (for the past decades this has been true, even if it’s not true every year). Instead, I wanted to look for something that is not as easy to find: a low-volatility portfolio. Low volatility is beneficial because it is very easy to stick with such a portfolio, since it should not suffer as much as other portfolios when the road gets bumpy.

I expect both the AAA and DM to do well even if the environment changes, because they are both reevaluated regularly and switch into the best-performing asset classes of the past 6 months, so if stocks take a hit, they should be able to move away from them and into other assets, which the Permanent Portfolio, Trending Value and Risk Parity do not do.

I am really excited about the AAA strategy at this point, because it looks so very atypical in how smooth it is. Risk Parity is close to that same Sharpe range, due to the fact that it also tries to allocate risk intelligently. Finally, the very simple Permanent Portfolio strategy looks like a real winner right now – mostly due to the strong upwards trend of gold – but it’s impressive regardless.

And the current performance of the portfolio strategies can not be explained by general enthusiasm on the markets, because they have been choppy in the past two weeks. Just have a look at the German DAX and the SP500 compare to my AAA portfolio:

DJI and SP500 beginning of 2015

If the evidence grows stronger in their favour, I might decide mid-2015 to allocate a big chunk of my personal portfolio to one or two of these strategies, which could greatly reduce its volatility based on what we see here.

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