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Until the debt ceiling is taken care of it will continue to dominate the markets. We continue to believe that there will be some sort of resolution to this crisis and would treat any selloff as noise, not a trend change, and a potential buying opportunity. In the meantime it will likely be a rocky ride as the markets react to every snippet of news and we should probably get used to partisan infighting like this for the foreseeable future.
I am frequently asked about what benchmarks we use for our strategies and why. Unfortunately, there is no easy answer to this question because there is no real agreement on what the right benchmark for a tactical money manager should be.
In our public disclosures I use the S&P 500 and Barclays Aggregate Index. As a GIPs compliant firm I need to have a benchmark for each strategy and I need to justify it. Since these are the industry standards I use them to comply with GIPs. However, I understand comparing a dynamic strategy to a passive index is far from ideal.
I often attend conferences for ETF Strategists and there is always a discussion of what benchmarks to use. There are always ideas, but no great answers. Some of the best ideas are:
1. Other tactical managers—-On the surface this would make a lot of sense but there are all different types of tactical managers—partially tactical, fully tactical but undiversified, and fully tactical and diversified. Comparing a fully tactical and diversified manager like us to a partially tactical manager would be like comparing a Large Cap Value Manager to an Emerging Market Stock Manager, there would be some similarities but more differences.
2. Absolute Returns—This makes a lot of sense to me as a tactical manager should be able to generate positive returns regardless of the market direction. From a public perception standpoint though this is problematic as clients will often demand relative returns (vs. the S&P 500) when the market is going up and absolute returns when the market is going down.
3. Drawdowns—This also makes a lot of sense to me as we believe that if you can avoid the downside the upside will take care of itself. Maximum drawdown targets could be perhaps combined with upside capture ratios to create a complete benchmark.
Regardless of what the right answer is, benchmarks need to be used appropriately, looked at in the wrong way they can be dangerous. Methodologies will always go in and out of favor. From a Modern Portfolio Theory point of view market leadership can cycle around growth and value and large and small cap. Different tactical methodologies can also cycle in and out of favor. For example, trend following can do very well in a straight up or down market but won’t do well in a choppy market. It can be very tempting to rotate money from an asset class or methodology that has recently underperformed a benchmark into one that has outperformed. Sometimes this can be the right decision but often times it is done at exactly the wrong time.