Modern Portfolio Theory: The Efficient Frontier [Part 2] by Attain Capital
Contrary to popular belief, The Efficient Frontier isn’t our attempt to write about Star Trek (we can only dream); it’s actually an investment/asset allocation concept put forth by those who believe in Modern Portfolio Theory. If you have no idea what we’re talking about, we covered the concept in depth last year which you can find here, and back in 2010, here. For those wondering how the curve has changed, let’s take a look.
The data from last year’s Efficient Frontier (Jan ’94- Dec ’13) is the purple line and this year’s (Jan. ’94 – Dec ‘ 14) is the blue line:
(Disclaimer: Past performance is not necessarily indicative of future results)
Data Stocks = S&P 500, Bonds = S&P/Citigroup International Treasury Bond Index EX-U.S Index,
Managed Futures = Dow Jones Credit Suisse Managed Futures Index
All around, last year’s returns moved the Efficient Frontier up and to the left, meaning, all portfolio’s increased returns while eliminating volatility (a win-win for everyone). This year’s returns also lifted the (36/24/40) portfolio from 6.44% to 6.68%, while actually slightly decreasing volatility by 0.02%, proving once again to be the most optimum portfolio mix (highest return with lowest volatility) over multiple investment environments in the past {past performance is not necessarily indicative of future results}.
The comparison of these two curves illustrate a unique situation in which Managed Futures was able to increase its returns without increasing its volatility. Some of that may have to do with the lackluster performance the years prior to 2014. Meaning, Managed Futures returns might have caught up to its volatility {past performance is not necessarily indicative of future results}. Meanwhile, the traditional 60/40 portfolio all but stayed the same.
We realize that tacking on a year of returns only offers a small lens of how each portfolio performs over time (even if this is looking at data over the past 20 years). Before the current never ending bull run that we’re now experiencing, the Managed Futures diversified portfolio continued to offer the most optimum portfolio mix. Additionally, a 100% allocation to Managed Futures used to offer the highest return with the highest volatility, while a simple stocks and bonds portfolio only offered the lowest return with medium volatility. You can see that chart posted by CME back in 2008, here {past performance is not necessarily indicative of future results}.
Finally, for the drawbacks of the efficient frontier chart. It’s as simple as risk doesn’t necessarily translate to just volatility. It’s the same issue that most have with the Sharpe Ratio, and doesn’t consider downside volatility and drawdown to name two…). Meaning, these types of charts and ratios treat volatility as a bad thing, when low volatility can be not so smart.
