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Each week our investment policy committee meets to discuss different market scenarios and what we are seeing and hearing.
After a strong quarter and a strong start to July we wouldn’t be surprised to see a small selloff here perhaps lasting until mid month with a low on the S&P 500 at 1919. This could be driven in part by the fact that the market is overbought and the changing Fed narrative where we keep hearing hints of the possibility of a faster exit than previously thought. Intermediate and long term we maintain our bullish view and expect the market to end the year higher.
Bonds still don’t seem to want to die even though everybody has been writing their obituary. One reason could be the fact that interest rates around the world are also low. We often talk about how money goes where it is treated best, this applies across and within markets. There are a number of investors that have to buy bonds and for bond buyers there is still not much out there more attractive than the US.
How to Evaluate Smart Beta—or any Investment Strategy
Smart Beta (or whatever you want to call it) is the hottest new trend on Wall Street. On the whole I think it is a great idea as there is no rule that market cap weighted indices are the best way to go. However, whenever you see a flood of new products most are probably going to be more hype than anything else, so how do you evaluate this stuff?
Past performance doesn’t predict future results, this applies to Smart Beta also. No new strategy is going to be launched without a backtest showing that the strategy beats its relevant index. There are some things you would want to pay attention to on any backtested returns:
1. Are the returns too good? There are two ways to backtest, you can take a premise that should work going forward and see how it would have worked in the past—the right way. Or, you can use your knowledge about what happened in the past to construct an awesome backtest—the wrong way. If the returns are too good there is a chance the sponsor used his 20/20 hindsight to come up with the strategy.
2. What are the drawdowns vs. the benchmark. Past performance is fairly meaningless for the future but past risk has some predicative ability for future risk. Take a look at the drawdowns and calculate the MAR ratio (average annual return/maximum drawdown). The strategy might have outperformed the benchmark but did it have a better MAR?