We thought we’d continue catching up with the 130 U.S. equity funds which have passed their second anniversary but have not yet reached their third, which is when conventional trackers such as Morningstar and Lipper pick them up. (Technically, they're in the 1.9 year to 2.9 year age bracket.) As Charles has repeatedly demonstrated, the screener at MFO Premium allows you to answer odd and interesting questions. Our screeners are unusually risk-sensitive. That’s because the easiest way to make money, in the long term, is not to lose money in the short-term. The default risk measure in our ratings is the Martin Ratio, which is exceedingly sensitive to downside risk. (Charles can share the details, if you'd like.)
Here's the most disturbing finding of our search for the most risk-sensitive two-year-old funds: they're ETFs. At the very least, all of the ten best funds, measured by Martin Ratio, are ETFs. Here they are, from the safest young equity fund to the 10th safest:
State Street SPDR S&P
500 High Dividend ETF SPYD (Equity Income)
JPMorgan Diversified Return US Equity ETF JPUS (Multi-Cap Core)
ProShares S&P
500 Ex-Financials ETF SPXN (Large-Cap Core)
ProShares S&P
500 Ex-Energy ETF SPXE (Large-Cap Core)
ProShares S&P
500 Ex-Health Care ETF SPXV (Large-Cap Core)
ProShares Russell 2000 Dividend Growers ETF SMDV (Small-Cap Core)
Goldman Sachs ActiveBeta US Large Cap Equity ETF GSLC (Multi-Cap Core)
VictoryShares US Large Cap High Div Volatility Wtd Index ETF CDL (Large-Cap Growth)
Invesco PowerShares S&P
500 Momentum Portfolio SPMO (Large-Cap Core)
Xtrackers Russell 1000 Comprehensive Factor ETF DEUS (Multi-Cap Core)
Likewise, 9 of the best 10 funds measured by Sharpe ratio are ETFs.
Why's that disturbing? Because market-tracking products should have market-like risk, not vastly lower-than-market risk. So, what gives? As Charles pointed out
in his September essay, there simply is
no downside volatility being manifested in the market now which means that our screener has hundreds of US equity funds (rather more than 300) with incalculably high Martin ratios. In a normal market, a Martin Ratio of "3" is virtually unattainable; no U.S. equity fund has a 10- or 20-year Martin ratio that high. The best record for a fund that's been around at least
5 years is
AQR Large Cap Defensive Style (AUEIX) with a lifetime Sharpe ratio of 11. To recap: in the long term, no US equity fund is capable of a Martin ratio of 3 (or even 2) and, in the medium term, 11 is incredibly high.
What about today? The highest calculable one-year Martin ratio we currently have is
Calamos Dividend Growth (CIDVX) at 202,363. The fund's long term Martin ratio is 3.06.
As Charles noted in a recent tweet, the deception gets worse this month as the worst drawdowns from the 2007-09 crash disappear from funds' 10-year records.
Bottom line: common risk metrics, which focus on three year periods, are probably unreliable guides just now. You need to understand a potential investment's risk by (a) looking at the manager's risk-management discussions (if he doesn't have one, run away!) and (b) taking most seriously the risk characteristics in the two recent down markets (2000-02 and 2007-09) or across the whole market cycle, rather than getting lured in by shiny short-term numbers. We'll continue to try to do both for you; that is, we'll take the qualitative and long term quantitative together as we try to make sense of what's on offer.
