Previously, we saw Rob Arnott call the kettle black, and evaluated the performance of his top fundamental indexation fund.
Arnott is also on the gravy train of a $35 billion fund at PIMCO. The genius of this fund is that it invests in other PIMCO funds, just to keep it all in the family.
In his April essay, Arnott addressed the poor performance of the fund:
Q: Should I be concerned that the strategies have been lagging? What is your view of stocks?
Arnott: We’ve never played the game of picking market tops and bottoms. Rather, we seek to “average in” once markets are priced to give us solid long-term prospective returns, and to “average out” when markets are fully priced. We have no interest in picking up the last few dimes and quarters in front of a steamroller; we leave that game to others.
The rest of the essay is sad, but classic.
Suppose we are invested in Rob’s attempt at asset allocation, the PIMCO All Asset Fund (PASDX). Are we getting good bang for the buck?
First, strip out dividends. There is no need to pay someone to collect dividends for us. We also don’t want to reward a fund manager for skill if all he did was buy dividend-paying stocks and junk bonds. We level the dividend playing field. Use price-only data that we can get anywhere.
The worst month was -13%. The maximum 12-month rolling loss is -26.67%, too close to failing the -30 yardstick test.
Second, calculate standard deviation. This is a fundamental, yet useful statistic for our purposes because every sales pitch is based on “we are better than the other guy” or “we are better than the benchmark index”. The WealthCop Investor knows about the myth of beating the market, and won’t fall for that trick again.
The standard deviation metric is independent of the underlying strategy, amount of leverage or benchmarks. It is its own benchmark, of how big of a roller coaster, because a wild ride deprives us of steady compounding. Consistency is king.
We generally use the 3-year standard deviation, but you can use a longer period if you like. Compared to the S&P 500 Index (without dividends), PASDX is less volatile.
Third, calculate bang for the buck. We always take income AND expense into account to calculate earnings. In baseball, we look at hits divided by at bats. Yet somehow, most investors think about “performance” in terms of reward, NEVER ABOUT RISK.
The WealthCop Investor divides the return by the risk to arrive at the Reward for Risk ratio. It goes without saying that a fund or a strategy which features more risk than reward is not for us, no matter how well it does in any given year.
We generally divide the 3-year return by the 3-year standard deviation, but you can use a longer period if you like. By this measure, the S&P 500 Index produced 1.5836 units of reward per unit of risk while PASDX delivered 0.5142 units of reward per unit of risk.
The good news: PASDX is not very volatile, which is helpful for compounding returns efficiently.
The bad news: risk is twice the reward, and on top of that, the three-year return before dividends is only 7.48% (repeat, three-year).
Considering the total annual operating expenses for the PIMCO All Asset Fund (1.365%) is 12 times more than the SPDR® S&P 500® ETF (0.1102%), which fund would you choose?