Matching VTS strategies to appropriate benchmarks

VTS Community,

Matching VTS Strategies to appropriate benchmarks 

- If you're a stock market investor buying individual stocks, would you measure your performance against gold?  No, that would be a totally meaningless comparison right? 

- If you were a crypto trader, would you compare numbers against the global bond market?  Of course not.  The risk profile of a bond investor is radically different from someone who trades Bitcoin. 

When analyzing performance, if we want to draw the most meaningful conclusions and actually improve our investing, it's very important that we always try to compare apples to apples.

It's the same concept within our diversified VTS Total Portfolio Solution.  Each individual strategy uses different asset classes, they have different rates of return, varying degrees of drawdown, and overall just different long-term goals.  If we want to make an accurate assessment of performance, we have to match the risk profile to the appropriate benchmark.

Looking at the big picture, given that the vast majority of investors in the world hold portfolios that closely track the performance of a 60/40, I've always used the Vanguard VBINX  (60% stocks 40% bonds)  as our benchmark.  Head to head, we're crushing the growth rate of most investors.

Apples to apples benchmark matching using correlation

Correlation is just a basic measure of directional movement of one security in relation to another, and you'll typically see it represented either as a percentage or a number:

-1 or -100% means the two securities always move in opposite directions

+1 or +100% means the two securities always move in the same direction

Since nothing will ever be perfectly positively or negatively correlated, we will always see these numbers on the spectrum. 

VTS strategies with higher S&P 500 correlation

Tactical Volatility Strategy video

Defensive Rotation Strategy video

Strategic Tail Risk Strategy video

All three of our systematic rules based strategies show higher correlation to the S&P 500.  Now they are all still quite low, given they each have a mechanism to move to safety or actually take inverse market positions, but the correlations are all positive.

Given they are all strategies designed for high absolute performance, we can isolate just these three strategies and match the performance against the S&P 500 which is also an aggressive portfolio position.

1/3 allocation for each systematic VTS strategy vs S&P 500

Every investor will have a different risk tolerance.  There may be some people who really can sustain higher drawdowns if it means a higher long-term rate of return and perhaps they could target higher returning strategies.  There's other investors though who simply can't watch their net worth drop by 33% and still stay the course, in which case they would be looking for diversification opportunities.

Most people overestimate their risk tolerance

It's not for me to decide how much financial pain you can sustain.  What I will say though is that in my experience, the vast majority of investors massively OVER-estimate their own risk tolerance.  When looking at a long-term chart, it's easy to see the progression from where it started to where it currently is and think sure, I would have held on because look at that great return.  The issue there is, you can already see that it eventually recovered right?  There's no emotions involved, it's just a numbers game in hind sight.

In real time though, when emotions are high and there's uncertainty as to whether things will actually recover, many people find out they didn't actually have the risk tolerance they thought they did.

That's what diversification is for 👇

VTS strategies with no S&P 500 correlation

Iron Condor Strategy video

Volatility Trend Strategy video

Both of our discretionary Options strategies are designed to move completely independently of the market, and both show no correlation what so ever to stocks.  In fact, the correlation is even negative which during a bull market is extremely difficult to come by.

* Side note, zero or negative correlation strategies are often frustrating to follow because there are plenty of times when the market is doing well and the strategy isn't.  Sound familiar?  The key thing to focus on though is, there's just as many times the market isn't doing well and the strategy is.  Only the long-term comparison matters.

Bonds and gold have shown only a small positive correlation to the stock market in the last 12 years, making them a far better benchmark to compare results of our zero correlation strategies against.

50% allocation for each Options based VTS strategy vs Bonds / Gold

People who look purely at rate of return may not fully appreciate the benefit of having market neutral negatively correlated strategies that smooth out performance over time.  I do, which is why my investable assets are in the VTS Total Portfolio Solution.

I've been investing now for over 18 years and I've gone through all the emotions of taking larger drawdowns due to excessive risk taking.  I wasn't always so focused on consistency and risk management. 

Perhaps you've even seen my video where I talked about my biggest trading loss ever, where I lost over 70,000 USD in a single month.  Truth be told, it was more like a week because it happened pretty quickly.  A loss like that teaches you the importance of risk management pretty quickly!

Click here:  My Biggest Trading Loss Ever

Personally, that's no longer within my risk tolerance to put myself through that so I focus on the diversified Total Portfolio Solution.