Originally published in February 1, 2013 Commentary

Under normal market conditions, the Strategic Income Fund seeks to achieve its investment objective by investing at least 80% of its total net assets…in the Asia region. ASIA: Consists of all countries and markets in Asia, including developed, emerging, and frontier countries and markets in the Asian region.

Fund manager Teresa Kong references two benchmarks: HSBC Asian Local Bond Index (ALBI) and J.P. Morgan Asia Credit Index (JACI), which cover ten Asian countries, including South Korea, Hong Kong, India, Singapore, Taiwan, Malaysia, Thailand, Philippines, Indonesia and China. Together with Japan, these eleven countries typically constitute the Asia region. Recent portfolio holdings include Sri Lanki and Australia, but the latter is actually defined as Asia Pacific and falls into the 20% portfolio allocation allowed to be outside Asia proper.

As shown in following table, the twelve Asian countries represented in the MAINX portfolio are mostly republics established since WWII and they have produced some of the world’s great companies, like Samsung and Toyota. Combined, they have ten times the population of the United States, greater overall GDP, 5.1% GDP annual growth (6.3% ex-Japan) or more than twice US growth, and less than one-third the external debt. (Hong Kong is an exception here, but presumably much of its external debt is attributable to its role as the region’s global financial center.)

Very few fixed income fund portfolios match Matthews MAINX (or MINCX, its institutional equivalent), as summarized below. None of these alternatives hold stocks.

 Aberdeen Asian Bond Fund CSBAX and WisdomTree ETF Asian Local Debt ALD cover the most similar geographic region with debt held in local currency, but both hold more government than corporate debt. CSBAX recently dropped “Institutional” from its name and stood-up investor class offerings early last year. ALD maintains a two-tier allocation across a dozen Asian countries, ex Japan, monitoring exposure and rebalancing periodically. Both CSBAX and ALD have about $500M in assets. ALD trades at fairly healthy volumes with tight bid/ask spreads. WisdomTree offers a similar ETF in Emerging Market Local Debt ELD, which comprises additional countries, like Russia and Mexico. It has been quite successful garnering $1.7B in assets since inception in 2010. Powershares Chinese Yuan Dim Sum Bond ETF DSUM (cute) and similar Guggenheim Yuan Bond ETF RMB (short for Renminbi, the legal tender in mainland China, ex Hong Kong) give US investors access to the Yuan-denominated bond market. The fledgling RMB, however, trades at terribly low volumes, often yielding 1-2% premiums/discounts.

A look at life-time fund performance, ranked by highest APR relative to 3-month TBill:

Matthews Strategic Income tops the list, though of course it is a young fund. Still, it maintains low down side volatility DSDEV and draw down (measured by Ulcer Index UI). Most of the offerings here are young. Legg Mason Western Asset Global Government Bond (WAFIX) is the oldest; however, last year it too changed its name, from Western Asset Non-U.S. Opportunity Bond Fund, with a change in investment strategy and benchmark.

Here’s look at relative time frame, since MAINX inception, for all funds listed:

Charles, 25 January 2013

From the Mutual Fund Observer discussion board, January 2013

After last discussion, A Look at Risk Adjusted Returns, I wanted to explore further the issues of under performance and substantial down years for even top ranked risk adjusted funds. Building on a tip from MikeM:

I used to do my own risk analysis by just calculating the probability of what a fund could make or loose in any given year. Probability is just a calculation using the funds average returns and its standard deviation. Using 1x stdev would give you a probability confidence value of 68%. 2x stdev would be 95%.

Instead of standard deviation STDEV, however, I focused on the down side and draw down deviations that represent the denominators in Sortino and Martin ratios, respectively. The Sortino denominator is the annualized downside deviation DSDEV, which uses only monthly returns falling below TBill average. The Martin denominator is the Ulcer Index (UI), which is the square root of the mean of the squared percentage draw downs in value.

I imposed a threshold on these two measures to protect against substantial down year performance. The threshold assumed a simple, four fund portfolio – one fund in each broad type (equity, asset allocation or “balanced,” fixed income, and money market), each holding equal share.

For pain threshold, I used 15% loss for the portfolio in a down year. Nominally, this translates to a maximum tolerable loss of 30% in the equity fund, 20% in asset allocation fund, 10% in the fixed, and zero for money market.

Accounting for a 3x deviation down side occurrence (more conservative than MikeM’s example), the attendant thresholds become 10% for equity funds, 7% for asset allocation, and 4% for fixed income, in round numbers.

First off, it is extraordinary just how many equity funds fail to meet this 10% down side threshold on either DSDEV or UI! Here is a summary of funds evaluated, all oldest share class:

Once the funds were screened for down side volatility, I simply sought top returning funds for each type, relative to SP500 for equity and asset allocation, and TBill for fixed income and money market. This step protects against selecting an under performing fund that may have a very high risk-adjusted rate of return. Below is the result, by fund inception date:

Some observations:

• Worst performing year (highlighted in red) was 2008, of course, with the 15+ age group portfolio down the most at -13.7%, but still within the -15% pain threshold.
• Overall portfolio lifetime returns (green) appear very respectable for all age groups, most even beating SP500 (blue), despite the healthy cash holding.
• Great returns are achievable without high volatility, evidenced by some seriously good funds included on this list, like Sequoia SEQUX, Vanguard Wellesley Inc Investor VWINX, Mutual Quest Z MQIFX, Oakmark Equity & Income I OAKBX, Osterweis Strategic Income OSTIX, and Yacktman Svc YACKX.
• The 25+ age portfolio produced 9.7% APR versus 8.9% for SP500. It includes stand outs Vanguard Health Care Investor VGHCX, T. Rowe Price Cap Appreciation PRWCX, and PIMCO Total Return Institutional PTTRX.
• The 5+ age portfolio produced 7% APR versus 1.7% for the SP500. It includes MainStay Marketfield I MFLDX and PIMCO Income A PONAX. – In the 40+ age group, only one money market fund existed, so that was included by default, even though it has a negative lifetime Sharpe.

Of the fifteen fixed income funds in the 50+ age group, none met the less the 4% down side volatility criteria. I’m pretty impressed with the result actually. The simple approach imposed a 10-7-4 down side volatility screen, then sought top returning APR, un-adjusted. Now, if I could only figure out how to ensure it works going forward…

Here is link to original thread.

From the Mutual Fund Observer discussion board, January 2013

A recent thread by hank, catch22, bee, MikeM, and Investor got me thinking about risk adjusted returns. Here is a link to their discussion: How To Calculate Risk-Adjusted Rate of Return.

With same database of oldest share class fund performance from Funds That Beat The Market, I ranked funds by Sharpe, Sortino, and Martin (or so-called Ulcer Performance) indices then compared against relative APR rankings.

For this comparison, Sharpe is defined as fund annualized percentage return (APR) minus 90-day TBill APR divided by fund annualized standard deviation STDEV, all over the same period, which is lifetime of fund (or back to January 1962). Here is the formula used:

Sortino is same as Sharpe except its denominator is the annualized downside deviation, which only uses monthly returns falling below TBill average, as shown here:

Finally, Martin, which uses same numerator as Sharpe and Sortino, excess return relative to TBill, but it uses the Ulcer Index (UI) for the denominator, which is the square root of the mean of the squared percentage draw downs in value. Here is link to good article: Ulcer Index – An Alternative Approach to the Measurement of Investment Risk & Risk-Adjusted Performance. Here is how I applied its formula:

OK, a few comparisons that I found insightful:

Mutual Shares Z MUTHX is the top performer in APR relative to SP500 and tops all risk adjusted return (RAR) indices in the 50 year equity category. Still, in 2008, it drew down 38%, just like the SP500. American Funds American A AMRMX, on the other hand, one of top three funds picked up by Martin Ratio had a more tempered loss. All top RAP funds in this category in fact had hefty losses in 2008, except AMRMX.

Here’s an example where I think RAR indices really tell the story. Fidelity Magellan FMAGX has best life time APR, but it loses to Sequoia SEQUX in every RAR category. SEQUX produced only a moderate draw down in 2008. Of course, SEQUX may be the best mutual fund of all time…and it shows in the RAR indices.

The stark comparison between First Eagle Global A SGENX and Vanguard Wellesley Income Inv VWINX is another good example of the power of RAR indices. In fact, every top performer in this modest asset allocation class suffered losses of more than 20% in 2008, except VWINX, which has highest Sharpe, Sortino, and Martin ratios, as well as lowest downside deviation and Ulcer Index.

Ditto here for the 30 year equity category. While Fidelity Select Health Care FSPHX produced the highest returns relative to SP500, Mutual Quest Z MQIFX would be my fund of choice, topping all RAR indices. It is the only top fund that lost less than 30% in 2008 – notice its DSDEV and UI values are also lowest.

Berwyn Income BERIX is top risk adjusted performer over Bruce BRUFX…and T. Rowe Price Capital Appreciation PRWCX, Morningstar’s top allocation fund this year, does well also.

Finally, here is an example that shows how RARs can be too protective. Gabelli ABC AAA GABCX certainly takes top honors for risk adjusted returns in the 15 year equity category, but it also produced low absolute returns.

Some takeaways:

• Risk adjusted performance indices can indeed provide stark distinctions in fund selection, especially for those sensitive to downside risk.
• Sortino and Martin indices are most reflective of downside risk, but Sharpe nonetheless is better than just looking at APR.
• A limitation to RAR indices is that they are useful only in relative sense, since their absolute values change with market. Their utility is in comparing funds over same time period.
• Top performing RAR funds may under perform in absolute returns, and worse, they can still have substantial down years.

Here is link to original thread.