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Is the market the best performance indicator for post-ER portfolios?
Old 08-27-2009, 03:17 PM   #1
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Is the market the best performance indicator for post-ER portfolios?

In response to my assertion that index funds tend to outperform actively managed funds on average, a friend asked me: 'Why is that an important metric?'

While reading Otar's book, I revisited that thought. For a post-ER (i.e. withdrawal portfolio), the really important attribute is how the selected funds help with portfolio longevity given your, hopefully, safe withdrawal rate.

For eg: an equity fund that has lower volatility than the index, but with slightly lower returns, could provide better portfolio longevity than the index fund.

Has anyone else thought along these lines? If so, are there any metrics available to measure this?

Ofcourse, the usual 'past performance is not a predictor of future performance' applies, but if all funds are compared with a performance metric that is specially suited for withdrawal portfolios, it would provide important information.
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Old 08-27-2009, 03:26 PM   #2
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risk adjusted return, ie sharpe's ratio?
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Old 08-27-2009, 03:46 PM   #3
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Thank you.
Does Sharpe's ratio differentiate between positive and negative volatility? I'll have to check.
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Old 08-27-2009, 05:02 PM   #4
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Thank you.
Does Sharpe's ratio differentiate between positive and negative volatility? I'll have to check.
I don't think so. The Sharpe ratio is simply the Excess Return / Standard Deviation of Excess Return.

I think you'll also find that most actively managed funds have lower Sharpe ratios than the index, making them losers on this count too.

But even if you find an active manager who consistently produces higher risk adjusted returns, you run into the same problem you have with managers that consistently produce high absolute returns . . . past performance is no guarantee of future results.
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Old 08-27-2009, 05:49 PM   #5
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Instead of an equity fund with lower volatility, why not just increase fixed-income?
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Old 08-27-2009, 08:31 PM   #6
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LOL!, ...YTG,
All valid points, but I do not feel they address my question.

Is there a better way (metric) to analyze mutual funds or ETFs for their suitability to post-ER portfolios? So far, Sharpe has been mentioned, but as YTG says, it measure SD with no advantage given to positive volatility.

The needs of a withdrawal portfolio are different from an accumulation portfolio. Aside from annuities, I haven't seen any research done to determine if there are attributes of mutual funds that can increase portfolio survival at a sensible withdrawal rate.

I'm sticking with index funds and a few low cost active funds that I've owned for a long time.
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Old 08-27-2009, 08:38 PM   #7
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The needs of a withdrawal portfolio are different from an accumulation portfolio. Aside from annuities, I haven't seen any research done to determine if there are attributes of mutual funds that can increase portfolio survival at a sensible withdrawal rate.
I've just finished reading Milevsky's "Are you a stock or a bond?". He makes the case for looking at the withdrawal phase as being less about maximizing returns and more about minimizing risk (of negative returns), particularly early in retirement. He recommends sticking with current asset allocation, more or less, but argues in favour of (wait for the chorus of howls) annuities as a portfolio class accounting for 10-15% of the portfolio, with different types for different purposes, e.g. defined time period to cover early retirement bear markets, and single payment life later if you envisage living for a long time. I recommend reading his discussion.
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Old 08-27-2009, 09:13 PM   #8
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I've just finished reading Milevsky's "Are you a stock or a bond?".
At my last megacorp, I was safe like a bond, but I wanted better returns.

So I left to help found a couple of startups. Yes, I became like a stock.

My stock turned out to be more like a dot-com stock.

So, I went back to being a bond (working part-time). And now, my bond is getting called.
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Old 08-27-2009, 09:30 PM   #9
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You could experiment with a Monte Carlo simulation and try out different return/standard deviation combinations. I don't think less volatility compensated much for lower gains. FundAdvice.com's "Ultimate Buy-And-Hold Portfolio" paper covers this a little bit with respect to asset classes instead of individual funds, as does FIRECalc.

Of the funds I have looked at, oakbx stood out as one with a good return and low volatility. According to Oakmark, they know many people use it as their only fund.

Beyond that, you probably need to download fund return information into a spreadsheet and try it for yourself.
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Old 08-28-2009, 12:40 PM   #10
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I've just finished reading Milevsky's "Are you a stock or a bond?". ...I recommend reading his discussion.
thanks for the suggestion.
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Old 08-28-2009, 04:06 PM   #11
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Originally Posted by walkinwood View Post
In response to my assertion that index funds tend to outperform actively managed funds on average, a friend asked me: 'Why is that an important metric?'

While reading Otar's book, I revisited that thought. For a post-ER (i.e. withdrawal portfolio), the really important attribute is how the selected funds help with portfolio longevity given your, hopefully, safe withdrawal rate.

For eg: an equity fund that has lower volatility than the index, but with slightly lower returns, could provide better portfolio longevity than the index fund.

Has anyone else thought along these lines? If so, are there any metrics available to measure this?

Ofcourse, the usual 'past performance is not a predictor of future performance' applies, but if all funds are compared with a performance metric that is specially suited for withdrawal portfolios, it would provide important information.
The index vs managed fund performance seems to be a separate issue from the portfolio survivability and performance-volatility issues. It could very well be that I am not following the question well.

Index out performs managed funds means you make more money in an index fund. That is why it is important.

The worth in performance terms of reduced volatility is an interesting topic. I did some trial and error with monte carlo type portfolio survivablity software and I came up with a rule of thumb that one percentage of yield is worth about 2.5 standard deviations (SD). I varied the SD and the estimated return to achieve the same percentage of portfolio survivability. I wonder if other have tried this sort of thing? Perhaps there is something better that is published?

I have not read Otar's book.

I hope this help.

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