Friday, February 26, 2016

Using visuals to tell the return to risk story

Everyone talks about the retune to risk trade-off, but it is a concept that is at times hard to visualize.  A simple tool is to form return to risk boxes with well-known benchmarks. The return to risk boxes represent the area of higher return and lower relative to some benchmark. If you are in the box, you have a better return to risk trade-off. If you are outside the box, your return to risk is inferior. You can look at a large number of managers or indices in one graph through the box approach. 

In the graph above, we have included global macro and managed futures indices as well as the S&P 500 index (green circle) and Barclays Aggregate bond index (green square) for the last 12 months of return and 36 months of volatility. The triangles represent the major managed futures and global macro indices. We have not labeled them to make the graph a little cleaner. The other green circle is the MSCI world index. 

The graph tells a very interesting story. All but one index shows a better return to risk than the S&P 500 even though the returns were flat or slightly negative. Relative to the bond index, managed futures and global macro did not do as well. Most indices were inferior with only one adding return value. These numbers will change over any period, but this graph shows a bond-macro combination was superior to a bond/equity combination. 

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