Many people ask how risky this approach is and what is the correlation to equities. Well, given the leverage is on a low risk portfolio, even at maximum exposure the risk is no greater than that of equities and usually a lot less, especially in terms of drawdown risk. Further, the leverage is dynamic, not fixed, as shown below.
Figure 1 - The dynamic leverage over time
Figure 1 shows the leverage (LH scale) over time with the performance of the strategy shown together with the S&P500 total return (RH scale). The leverage is quickly reduced during times of equity market decline, such as in 2001 and 2008 but also responds defensively in times of high risk or uncertainty as happened in 2010 at the height of the Eurozone crisis and in 2011 when the US credit rating was downgraded.
Figure 2 shows the realised volatility measured over a 1 year rolling period. Note how more stable the volatility of the QDA strategy is compared to the S&P500. The average volatility of QDA is 12% versus over 19% for the S&P500 over this period. More importantly when the S&P500 volatility increases, the volatility of QDA actually decreases due to the dynamic decline of leverage and the underlying asset allocation becoming more defensive at the same time.
Figure 2 - One year rolling volatility of QLAB Dynamic Allocation versus the S&P500
Figure 3 shows the correlation of monthly QDA returns to equities over a 1 year rolling period. It is highly variable tending to show strong correlation when equities increase and weak or even negative correlation when equities decline. On average the correlation is low at 0.35. The variable nature of the correlation is a result of the underlying asset allocation shifts into better performing assets when equities decline.
Figure 3 - One year rolling correlation of QLAB Dynamic Allocation to the S&P500
Finally Figure 4 shows the drawdowns which are just a fraction of the equity market due to the active asset allocation and the dynamic de-leveraging of exposure. Such low drawdowns give investors the peace of mind to stay invested through the market cycle and earn good returns over the long run.
Figure 4 – Drawdowns of QLAB Dynamic Allocation and the S&P500
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QLAB Dynamic Allocation is thus positioned as a good candidate to replace equity holdings or for those not holding equities, a way to gain exposure in a safer way than investing in ETFs or other benchmark products.
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