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1 May 2015

What to do with your equity allocation

For those invested in developed market equities the last few years, performance has been very good. For example in the 6 years since January 2009 the S&P500 returned 17% per year including dividends to the end of 2014. Those investors who were not significantly exposed to equities during this time may feel some regret. Those who are invested may well be wondering how long it can last.

There is a Chinese proverb that says the best time to plant a tree was 20 years ago and the second best time is today. Perhaps one can say the same thing about equity investing. Over the last 20 years the S&P 500  annualised total return was 9.5% versus 3% for USD cash and about 2% inflation. However, these returns came with plenty of stress: volatility was 19% and there were two periods of drawdowns of around -50%.

So what are the options now for those still searching for equity-like returns but who fear the equity volatility and drawdown risk? QLAB’s answer is to plant that tree and invest in equities but with a robust risk management process in place to actively manage the equity exposure in order to reduce the stress.

The QLAB Dynamic Allocation (QDA) strategy[1] can hold up to 105% US equities, rotating between sectors, but it can also hold no equities at all and also hold US government bonds, commodities, currencies and cash. Risk is managed by taking dynamic exposure to an underlying asset allocation strategy with 6% volatility applying a variable amount of leverage up to x3. The process is systematic and driven by a strict risk budget approach with resulting volatility of up to 15% and a worst drawdown of -13%. Annual performance since going live over 4 years ago has been 9.7% with realised volatility 11%.

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

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.

Find out more at 


[1] http://www.qlabi.com/qda & QLABQDA on Bloomberg live since 1-Jan-2011, simulated returns shown prior

Close disclaimer

DISCLAIMER: This document does not constitute an offer, a solicitation, an advice or a recommendation to purchase or sell any investment products associated with the material described herein. The purpose of this document is to describe the principles, research and ideas behind the QLAB Invest strategy indices. Prior to an investment in any product tracking a strategy index, you should make your own appraisal of the investment risks as well as from a legal, tax and accounting perspective, without relying exclusively on the information provided by QLAB Invest. Investment products tracking the indices must be issued or/and marketed by a regulated company. This document is strictly for informative purpose. The single source of the underlying asset data is Thomson Reuters Datastream and QLAB Invest cannot guarantee the correctness of the underlying asset data and cannot be held legally responsible in this regard. Any references made to historical performance up to the official live inception do not reflect actual live performance and can be subject to selection, curve fitting and other statistical biases. Performance in investment products linked to the indices may be reduced by the effect of commissions, fees or other charges in excess of those already factored into the index calculations. The level of the indices will fluctuate due to the volatility of the underlying exposures and past performance or volatility is not necessarily indicative of future results.