With QQQ, TLT and IWM, Amount Matters

Investment advisors have a lot at stake based on how their client portfolios are invested. 

That was perhaps never as clear as in 2022, when stocks and bonds fell together. That had not happened since the 1970s. But then it did happen. In investing, never say never is one of the golden rules. That's why words like "guarantee" and "certainty" drive compliance departments crazy. 

Advisors, as well as self-directed investors, have skated by for well over a decade in one important respect: position sizing hasn't mattered as much as it does now. In other words, with all the attention in investment discussion circles about what to own, the far bigger concern should be how much of it you own. Whatever "it" happens to be. 

The Math of Positioning 

Some simple math will help bring that point home. If an exchange-traded fund is 5% of a client portfolio, and it crashes by 20%, it has an impact on the total portfolio of 1%, since 20% of 5% equals 1%. But if that position had been 25% and meets that same fate (20% loss), that dings the total portfolio by 5%.  

That's a big enough difference to not only affect a practice's revenue and cash flow from the investment losses, but it might also compound the problem by risking client relationships. Because in bear markets, things like "owning great companies" and "time in the market, not timing the market" tend to fall on deaf ears. 

QQQ, IWM and TLT Drawdowns 

There are cold hard facts behind this, as it relates to the current market climate. I ran an analysis of "maximum drawdown" for three exchange-traded funds that have been particularly volatile in recent years, including the Invesco QQQ Trust (QQQ), the iShares Russell 2000 ETF (IWM) and the iShares 20+ Year Treasury Bond ETF (TLT).  

Using data from YCharts, I produced a table that answered the question, "for every 12-month period ending at the end of each month, what was the most that the ETF fell from peak to trough during that period?" 

The results: on average, QQQ had a maximum drawdown of 24% in a 12-month period. For IWM, it was 22%, and for TLT, it was 14%. These covered the period from inception through the end of last month for each ETF. QQQ made its debut in 1999, IWM in mid-2000 and TLT in the summer of 2002.  

TLT is a special case that requires more information, given that it is now down more than 40% from its all-time high, set back in 2021. Since May 31 of that year, if you held TLT for 12 months, the best case was that you "only" endured a drop of 26% at some point. The worst case was 39%. Remember, it's a bond ETF! 

Over in the equity market, where we expect volatility, 27% of the periods studied QQQ had a max drawdown within a 12-month period of at least 33%. In other words, there was a chance of seeing a one-third cut of the position. 

IWM has incurred only a 33% decline over 12 months 17% of the time. It is way off its all-time high, however, and has spent most of the periods since 2018 in a deep hole. 

Some Takeaways 

That's a lot of data to process. So, what are the implications and takeaways for advisors and investors right now? Position size matters more than ever. It is tempting to look at the declines in all three of these prominent ETFs and conclude that what is down must go up and soon. And that might be exactly what happens.  

But the risk of that not happening is where the rubber must meet the road. Dipping one's toe into battered ETFs and market segments is one thing. Trying to be a hero and calling the bottom with big chunks of a portfolio's allocation is another.  

Every advisor or investor sets the allocation structure for portfolios. If there were ever a time to be tempted to swing for the fences, it would be now.  

But with recession still in the picture, a noncommittal Federal Reserve, inflation stabilizing more than receding and government and consumer credit in a state of crisis, "asset allocation" in whatever form one defines should be priority one. 

What you own is important, but how much you own may have a greater impact in the long run.