“When you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling.” – David Swensen, Yale Endowment Chief Investment Officer
We are currently going through the compliance gauntlet to post our composite returns to the Pure Portfolios website. In our quest to knock down the walls of secrecy of the investment industry, we wonder why more firms do not post their investment track record (future blog post in the making).
The process of posting performance involves running the performance and risk calculations across our ETF models. To be candid, our performance has been solid in 2017. However, we don’t put much stock in limited track records. In fact, it would take magical skill to lose money in this market environment. Most every financial asset with a ticker symbol has posted a positive return this year.
As we combed through the data, what surprised us was the rock bottom risk (volatility) numbers, to the point we thought the output was incorrect. This begs the question; how does asset class volatility in 2017 stack up with recent history?
Standard Deviationis a statistical measurement; when applied to the annual rate of return of an investment, it sheds light on the historical volatility of that investment. The greater the standard deviation of a security, the greater the variance between each price and the mean, indicating a larger price range. Source: Investopedia
We measured annualized standard deviation from 4/1/09 – 12/31/16 across 14 different asset classes. We used ETFs to represent each asset class. U.S. Equities (Blue), Fixed Income (Gray), Foreign Equities (Yellow), Other (Peach).
The above data set is post financial crisis. All of the asset classes posted positive returns, except commodities. Note the annualized standard deviation figures in the far right column. From an academic standpoint, we prefer assets to show high return characteristics with low standard deviation.
Now look at the below annualized standard deviation for 2017 (as of 12/8/17).
Let's ignore the return numbers for now. Compare the annualized standard deviation figures between the two tables. Across every asset class, standard deviation is dramatically lower in 2017.
The lack of any meaningful volatility leaves us ~670 days and counting without a 10% correction (S&P 500).
Source: Bespoke Research
Observations using 2017 returns compared with annualized standard deviation from the first data set:
The Vanguard Total Stock Market ETF produced a return of 19.95% with ~20% less risk than the municipal bond ETF.
The Vanguard FTSE All-World ETF(foreign stocks) up 24.38% with less risk than a U.S. Treasury Inflation Protected Securities ETF (TIPS).
The Vanguard Total Bond Market ETF posted similar returns in both data sets, ~3.5%.
However, the underlying price movements have been ~50% less in 2017. This was supposed to be a chaotic time to be a bond investor with the Fed increasing interest rates. Not so much.
In our opinion, the lack of volatility is troubling as it desensitizes investors to risk. We worry about overconfidence and extrapolating positive returns into the future (see Tis the Season for Wall Street Forecasting).
If you believe markets are mean-reverting, higher returns and lower volatility today may equal the opposite in the future. We will enjoy the quiet while it lasts, but in our view the current environment is not sustainable.