Historical Drawdowns & Recoveries of the Salient Risk Parity V15 Index

Transcription

1 Historical Drawdowns & Recoveries of the Salient Risk Parity V15 Index July 1, 2013 Lee Partridge, CFA Rusty Guinn

2 This information is being provided to you by Salient Index Management, LLC. It is intended solely for educational purposes. No other distribution or use of these materials has been authorized. The opinions expressed in these materials represent the personal views of the professionals of Salient Index Management, LLC and is based on their broad based investment knowledge, experience, research and analysis. It must be noted, however, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future Index results. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Please note that the returns presented in this paper are the result of a hypothetical investment framework. Backtested performance is NOT an indicator of future actual results and do the results above do NOT represent returns that any investor actually attained. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. Certain assumptions have been made for modeling purposes and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the assumptions. Changes in these assumptions may have a material impact on the backtested returns presented. This information is provided for illustrative purposes only. Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity, and may not reflect the impact that certain economic or market factors may have had on the decision-making process. Further, backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtested performance. The backtested results do not include the effect of backtested transaction costs, management fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation. The Salient Risk Parity V15 Index represents hypothetical performance since the Index does not reflect any particular investment program and may, therefore, have certain inherent limitations, some of which are described below. Since this is Index performance, it does not represent the performance of any investment account or the results of actual trading, and no representation is being made that any account using the Index as a benchmark will experience performance similar to the Index s performance. In fact, it is not uncommon for investment programs targeting a particular index to have performance that diverges materially from the performance of the relevant index. In addition, hypothetical performance does not involve financial risk, and no hypothetical performance record can completely account for the impact of financial risk that exists in an investment program that is actually trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results. The Index has been retrospectively calculated and did not exist prior to March Accordingly, the index performance shown for periods prior to March 2013 has been developed with the benefit of hindsight. Certain futures contracts and credit default swap instruments comprising the underlying asset classes were not available at inception of the retrospective Index performance calculation beginning in January Futures contracts unavailable at Index inception were included in the underlying asset classes as available. Credit default swaps comprising the Global Credit asset class were included beginning February Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. The Salient Risk Parity Index Committee selects, maintains, and reviews the list of futures contracts and credit default swap indices making up the Salient Risk Parity Index and oversees the computation of Index weights for each asset. The Salient Risk Parity Indices are the exclusive property of Salient Index Management, LLC, which has contracted with NASDAQ OMX Group, Inc. to administer and calculate the Index. NASDAQ OMX Group, Inc. shall have no liability for any errors or omissions in calculating the Index. Information provided by Salient Index Management, LLC, a wholly owned affiliate of Salient Partners, L.P. Salient is the trade name for Salient Partners, L.P., which together with its subsidiaries provides asset management and advisory services. 2

3 The Salient Risk Parity V15 Index (the Index ) has been challenged by prevailing market conditions in the second quarter of Based on these Index developments, we thought it appropriate to share some information about the historical performance to provide some context on this environment. Recent Performance The Index was down 12.56% for the month of June. This extends a drawdown in the Index that began in May to a total of 17.84%. 1 In addition to the magnitude, recent performance stands out in large part because all of the asset classes utilized in the Index, which we consider to be core market exposures, have declined in value. Each of equities, rates, commodities and momentum have contributed to the month s performance. Return (%) 0% -2% -4% -6% -8% Exhibit 1: Salient Risk Parity V15 Index June 2013 Performance Attribution by Asset Class -1.83% -2.52% -3.13% -5.07% While discussion of return drivers has justifiably focused on rates, the rise in correlations among the various asset classes has in fact been the primary change relative to prior periods. In particular, the rise in correlation between equities and rates has been a significant contributing factor to the underperformance of the Index. -10% -12% -14% % Commodities Momentum Equities Rates TOTAL Asset Class Attribution refers to the contributions of sub-components of the Index to aggregate Index performance in a particular period. Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. The percentages represented here have been rounded to the nearest tenth and are for illustrative purposes only. Current Positioning During the second quarter of 2013, we have witnessed rising correlations across both risky and safe haven assets and heightened risk across all liquid markets. These rising risk and correlation levels have resulted in more volatile returns for the Index. Because our Index model is responsive to these changes, we will likely lower our aggregate exposures to markets over the months ahead as we continue to target a consistent level of portfolio risk regardless of market conditions. By doing this in a systematic manner, we attempt to remove the emotional element of fear and greed from the equation. As shown in the figure on the following page, large down moves and large up moves in the Index often occur together, and we believe investors attempts to time these movements are unlikely to generate favorable results. The performance of the Index on June 20, 2013 is represented by the last observation in the lower right hand corner of the chart on the following page. 1 Index returns are unaudited and subject to change without notice. 3

4 Exhibit 2: Daily Salient Risk Parity V15 Index Returns with ±1 and ±2 Standard Deviation Bands (January 1, 1990 June 30, 2013) Standard Deviation Bands identify levels which are one or two standard deviations above or below zero based on observed daily volatility since inception of the Index. Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. Historical Comparisons While the current drawdown for the Index is significant, we believe that it is helpful to compare it to prior drawdowns for the Index and to those of other indices. As shown in Exhibit 3 below, the Index historically experienced four drawdowns deeper than what the Index has experienced thus far in May and June As shown below, historical Index drawdowns have been relatively brief in length, and have typically recovered with reasonable speed. Four of the five deepest drawdowns recovered in less than a year, and the deepest drawdown recovered in less than two years. Exhibit 3: Historical Salient Risk Parity V15 Index Drawdowns Greater than 15% (January 1, 1990 June 30, 2013) Drawdown Length Recovery Peak Valley % /29/ /31/ % /30/1998 7/30/ % /31/1994 6/30/ % /31/1989 4/30/ % 2 N/A 4/30/2013 N/A % /31/2001 9/28/2001 Drawdown refers to the amount that the Index is below its prior peak level. A drawdown begins when an index falls below its prior peak level and ends or recovers when it exceeds its prior peak level. Current drawdown is measured through 6/30/13. All other drawdowns represent month-end returns. Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. The percentages represented here have been rounded to the nearest tenth and are for illustrative purposes only. 4

5 It is likewise instructive to consider a comparison with drawdowns from other well-known indices. Below we present the largest historical drawdowns experienced by the S&P 500 Index and by a traditional balanced allocation of 60% to the S&P 500 Index and 40% to the Barclays Aggregate Bond Index. 2 We believe the conclusion to draw from the data below is that equities typically experience deeper, more frequent drawdowns. In addition, we also note that the time-to-recovery for the Index has been, on average, briefer than drawdowns for either the S&P 500 or the lower volatility 60/40 portfolio. Exhibit 4: Historical S&P 500 Drawdowns >15% (December 31, 1969 June 30, 2013) Drawdown Length Recovery Peak Valley % /31/2007 2/28/ % /31/2000 9/30/ % /31/1972 9/30/ % /31/ /30/ % /31/1969 6/30/ % /30/1980 7/31/ % 2 3 6/30/1998 8/31/1998 Exhibit 5: Historical 60/40 Drawdowns >15% (December 31, 1989 June 30, 2013) Drawdown Length Recovery Peak Valley % /31/2007 2/28/ % /31/2000 9/30/2002 Source: Bloomberg, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. The percentages represented here have been rounded to the nearest tenth and are for illustrative purposes only. While we do not know how rapidly the Index will recover from this drawdown, we believe that the paths of historical recoveries form a consistent narrative. We note in particular that, with the exception of 2008, most Index drawdowns experience much of their underperformance during the first three months of the drawdown. Exhibit 6, on the following page, identifies the path experienced by the largest drawdowns in the Index s history. We also believe that it is worthwhile to consider that historical drawdowns of varying lengths have been frequent events throughout the history of the Index. The compelling long-term return profile of the Index reflects performance achieved in spite of these drawdowns. Exhibit 7, on the following page, presents the historical compounded returns of the Index against the drawdowns experienced over that history. 2 The indices referenced herein are broad-based securities market indices and used for illustrative purposes only. They have been selected as they are well known and are easily recognizable. Broad-based securities indices are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly into an index. Past performance is no guarantee of future results. Descriptions of each index can be found at the end of this paper. 5

6 80% 60% 40% Drawdown 2008 Drawdown 1999 Drawdown 1994 Drawdown 1990 Drawdown 2001 Exhibit 6: Historical Drawdown & Recovery Paths for the Salient Risk Parity V15 Index Current Drawdown Return (%) 20% 0% -20% -40% Source: Salient Index Management, LLC, July 1, Current drawdown is April 30, 2013-June 30, The dates of other drawdown periods can be found in Exhibit 3. Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. Exhibit 7: Salient Risk Parity V15 Index Level & Drawdowns (January 1, June 30, 2013) % % % Growth of $100 (Log Scale) Drawdown Index Trend Line 5% -5% -15% -25% Drawdown % 12/29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/ /29/2012 Date Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. 6

7 As shown in Exhibit 8 below, in the year after the five worst annual returns for the Index, returns were considerably higher, on average. Likewise, in no calendar year after one of these worst years has the following year s return been negative. There can be no guarantee that this Index experience will persist into the future, but we believe that it reflects the how responsive the Salient Risk Parity V15 Index can be to changing economic and market regimes. Exhibit 8: Salient Risk Parity V15 Index Performance Before & After (January 1, 1990 June 30, 2013) 5 Worst Calendar Years Return Return in Preceding Return in Following Year Year 12/31/ % 31.33% 15.66% 12/31/ % 25.37% 33.18% 12/31/ % N/A* 21.75% 12/30/ % 74.35% 52.80% 12/31/ % 13.79% 25.37% Worst % 13.79% 15.66% Average -5.43% 36.21% 29.75% *The analysis begins on 1/1/90; hence there was no preceding year. Worst represents the worst annual performance over the analysis period. Average provides the average of the performance for each of the 10 years presented in the table. Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. The percentages represented here have been rounded to the nearest tenth and are for illustrative purposes only. The performance following significant drawdowns has likewise tended to be stronger. In some cases, near-term performance continued to be weak but typically recovered over the next 1-2 years. Exhibit 9: Salient Risk Parity V15 Index Performance After > 15% Drawdowns (January 1, June 30, 2013) Drawdowns > 15% Depth of Drawdown (Annualized) 4/30/ % 13.97% 29.90% 25.07% 3/31/ % -0.43% 13.45% 35.08% 5/31/ % 13.47% 34.43% 17.90% 9/28/ % 8.10% 25.38% 35.52% 9/30/ % -3.11% 5.74% 21.97% Worst % -3.11% 5.74% 17.90% Average % 6.40% 21.78% 27.11% Performance after drawdowns assumes investment at month-end of period where drawdown first reached 15%. Source: Salient Index Management, LLC, July 1, Note that an investor cannot invest directly into an index. Past performance is no guarantee of future Index results. The percentages represented here have been rounded to the nearest tenth and are for illustrative purposes only. Summary Our analysis indicates that the Index s record would have been achieved in conjunction with relatively frequent and occasionally meaningful drawdowns, such as the one experienced in May and June However, we observe, based upon our analysis, that these drawdowns would have been briefer 7

8 than those experienced by both equity and traditional balanced 60/40 strategies over the same time periods, and would typically have recovered more quickly. Index Definitions S&P 500 Total Return Index: A stock market index based on the common stock prices of 500 top publicly traded American companies. Barclays Aggregate Bond Index: A U.S. Aggregate index that covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes government securities, mortgage-backed securities, asset-backed securities and corporate securities all with a maturity of greater than one year. 8