Reminder
Three portfolios in CHF, EUR and USD, 50% invested in the local equity market and 50% in local government treasury bonds (3-7 years). They are rebalanced once a year, on the last working day. There is a 0.2% annual fee, which includes the cost of two transactions per year, as well as custody fees.
Why "dumb"?
They are called "dumb" because there is no need to do a lot of thinking to design them, and also "dumb" because buying government bonds with negative or zero yield doesn't make much sense nowadays.
With qualities
However, even "dumb", they have three fundamental qualities that must be the basis of any good portfolio management. They are disciplined, systematic, and they optimize costs (ETFs +1 buy and 1 sell transactions per year).
For what purpose?
It is a simple measure of quality. It can be used, for example, as a tool to monitor one's risk budget, and compare the performance per unit of risk of the managed portfolios against that of the "dumb". They should be easy to beat now that the rates are negative or close to zero. In Swiss Franc, for example, the average yield of the SBI Domestic Government 3-7 ETF is -0.73%. Knowing that this instrument paid a dividend of 1.04% in 2020, on which Swiss residents are taxed in addition to wealth tax, the cost of holding such a position is close to -2% per year. What rational investor would want to allocate 50% of his portfolio to such a costly asset? This illustrates the exceptional "post-financial crisis" environment, reinforced by the deflationary shock of the Covid crisis
Results
Below are the performances of the "dumb portfolios" for the period 2016-2020. This can be considered as an investment cycle that more or less corresponds to the time horizon of an investor who would have chosen a portfolio with a " medium " risk budget.
"Dumb portfolios" embody passive management with passive investment vehicles (passive-passive). It has often been said that the recent period favored this type of portfolio management because markets were characterized by a lack of volatility. However, with the exception of 2019, the years under review have all experienced episodes of significant volatility. Therefore, this cannot be used as an excuse for poor results when compared to “passive-passive” portfolio management.
Volatility: daily volatility in 2020, annualized
ETFs in the portfolios:
Portfolio management professionals, or even clients who have discretionary accounts, can easily compare their performance to the above results. This is a task that everyone can do, as one can see below.
A community of investors
Thanks to the excellent independent site Performance Watcher (www.performance-watcher.ch), it is possible to have a fairly accurate idea of the average performance for private clients. Performance Watcher is a community of private investors and management professionals who share anonymously their returns. It is important to note that it is the platform that (re)calculates the performances, so it is not possible to "cherry pick" by only sharing the portfolios that would have the best results. For each period, depending on the volatility and the result achieved, a weather visual allows you to immediately know the quality of the performance.
For reasons of space, only the average performances collected by Performance Watcher are shown here. Of course, a more detailed analysis would be required that takes into account the risk and its evolution over time, which the platform enables to do.
2020 volatilities suggest that the risk profiles are similar between the medium risk Performance Watcher index and the “dumb portfolios”. As one can see, over the last five years, the average performance of professionals has barely been any better than the “dumb portfolios”. It is important to emphasize that the net performance of management professionals includes higher fees, without it being possible to know exactly what the average cost of active management is, prices can differ significantly from one institution to another.
Conclusion
The reasons for disappointing risk adjusted return is usually a mix of lack of disciplined investment process, high turnover, and poor implementation, using inappropriate investment vehicles and high costs.
In many organizations, what is called "flexible”, “agile", “timely” or “personalized” portfolio management is too often a source of underperformance because it is emotionally driven. This does not mean that portfolio management should not be customized to the specific needs of each client, but it should be done according to clear guidelines and protocol, like when one prepares to take off an airplane.
For those whose segregated accounts would not reach PW's average performance (for a similar risk budget), corrective measures are urgently needed. Premyss can help (jsp@premyss.ch). There are concrete and effective steps to put in place to achieve consistent long-term results.
In the years to come, "dumb portfolios" should be easy to beat, since government bonds will no longer be able to play their role as shock absorbers in volatile phases, as we saw in March 2020 for CHF and EUR portfolios.
Happy New Year 2021!