Expected Return & Volatility
QRPRX has forward-looking return expectations of 6% (or about 4.5 percentage points in excess of cash) and an expected volatility of 8%.** Thus, its Sharpe ratio is similar to QSPRX’s, but with a bit lower return and bit less volatility.
Another difference is that, due to the presence of the trend and risk variance factors, the fund will at times have slightly positive exposure to the equity market (QSPRX is market neutral at all times). Over the long term, however, it is expected to be market neutral.
The bottom line is that QRPRX provides another interesting alternative for investors to consider, as it can offer equitylike forward-looking return expectations with potentially far lower than equity risks.
Most importantly, the fund does so while providing exposure to unique sources of risk and return (factors) with histories of premiums that have been persistent and pervasive, and now in a more tax efficient manner.
The authors of the aforementioned study “Asset Allocation: Risk Models for Alternative Investments” concluded that risk premiums diversify more efficiently than traditional alternative investments.
They also concluded that the returns of an equally dollar-weighted risk premium portfolio are comparable to those of an endowment portfolio (with allocations to venture capital and hedge funds), except with far less risk.
On an interesting note, the authors also cited two studies that found a simple, 1/N diversification strategy (equal-weighting the factors the portfolio diversifies across) was as good as any of the other methods tested. This type of strategy is referred to as “risk parity.”
While diversifying across factors might not be as exciting or glamorous as investing in alternatives, it’s more likely to allow you to achieve your investment goals.
*Discussion of QSPIX, QSPRX and QRPRX is provided for informational purposes only and is not intended to serve as specific investment or financial advice. This list of funds does not constitute a recommendation to purchase a single specific security, and it should not be assumed the securities referenced herein were or will prove to be profitable. Prior to making any investment, an investor should carefully consider the fund’s risks and investment objectives and evaluate all offering materials and other documents associated with the investment.
**Again, it is important to understand expected returns are the mean of a very wide potential distribution of possible returns. Thus, they are not a guarantee of future results. Expected returns are forward-looking forecasts and are subject to numerous assumptions, risks and uncertainties, which change over time, and actual results may differ materially from those anticipated in an expected return forecast. Expected return forecasts are hypothetical in nature and should not be interpreted as a demonstration of actual performance results or be interpreted as a target return.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.