As was the case with the risk‐based measures in the preceding section, none of these statistics has a threshold value above which an acceptable level of risk‐adjusted return can be identified. Thus, the metrics in this section typically are used to compare one investment against another. However, it is important to note that implicit in all these measures is the notion that there is a simple, linear “exchange rate” between a unit of risk and a unit of return. This is a greatly idealized depiction of reality and, therefore, these metrics can lead to incorrect conclusions if applied blindly.
More Useful Approaches
One measure that can be quite relevant to RMI strategies is Upside/Downside Capture Ratio, which compares the degree to which the investment tracks a market index (e.g., the S&P 500 Stock Index) on its way up to the degree it tracks it on the way down. However, there is a practical limitation to this ratio, as well as with all the metrics thus far discussed, when applied to promising new investments. To be truly meaningful, they should be calculated using data that spans at least one, but preferably more than one, full market cycle. Many investments worth considering have come to market since the crash of 2008‐09, and have therefore existed during only the recovery portion of the cycle. MDD, for example, and even the upside/downside capture ratio are largely useless in this situation.
One way to gauge the efficacy of an RMI strategy that has existed during only the upward phase of a market cycle is to compare it against a benchmark index designed expressly for RMI applications. The Chicago Board Options Exchange publishes several such indexes — the CBOE S&P 500 5% Put Protection Index (PPUT), the CBOE S&P 500 95‐110 Collar Index (CLL), and the CBOE VIX Tail Hedge Index (VXTH) — which were described in our earlier piece Marketplace Review of Risk‐Managed Investments. While awaiting a bear market or market crash to provide a live test of the downside protection afforded by recent‐vintage RMI strategies, these benchmarks provide a very useful way to determine whether the cost of that protection is acceptably low.
There is another approach to even more explicitly assess the cost‐effectiveness of RMI strategies absent a significant market downturn. In our article The Tolerable Cost of Risk‐Managed Investing, we outline a practical way to measure that cost and provide a set of threshold values against which to compare it. This directly addresses the drawbacks in the existing metrics noted above. We believe an approach such as this could form the basis for the investment performance measurement tools of the future, when RMI strategies become even more prominent and important than they are now.
This article was written by Jerry Miccolis, Gladys Chow and Rohith Eggidi of Giralda Advisors, a participant in the ETF Strategist Channel.
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This material is for informational purposes only. Nothing in this material is intended to constitute legal, tax, or investment advice. Investing involves risk including potential loss of principal.
Giralda Advisors, located in New York City, is an asset management firm that focuses on providing riskmanaged exposure to the equity markets with a goal of limiting asset depreciation during both protracted and catastrophic market downturns while allowing substantial asset appreciation in uptrending markets. The Giralda Advisors team welcomes your inquiries. Please call (212) 235‐6801 or visit us at http://www.giraldaadvisors.com/.