After a stellar run higher, the Global Market Index’s risk-adjusted performance reversed in January, based on the trailing 3-year Sharpe ratio, a measure of return adjusted by volatility. The downturn was dramatic, but no less expected after the hefty increase in previous months. As noted in last month’s risk profile, “History suggests that upward spikes in GMI’s Sharpe ratio are quickly reversed, which implies that choppy market activity lies ahead.”
After GMI’s Sharpe ratio surged to 1.29 in December (the highest in more than four years), gravity finally prevailed last month and this risk-adjustment performance metric dropped to 0.97. The catalyst: widespread losses in the major asset classes during January.
Despite the setback, GMI’s Sharpe ratio remains relatively high for this unmanaged, market-value-weighted portfolio that holds all the major asset classes (except cash). History suggests that a Sharpe ratio at or near 1.0, much less above that mark, is unsustainable for a passive mix of the world’s major asset classes. As a result, expecting risk-adjusted performance to ease in the near-term future is a reasonable guesstimate.
In line with the reversal in Sharpe ratio, GMI’s drawdown deepened last month, dropping to -4.6%, the lowest since May 2020. Despite the slide, the portfolio’s current drawdown is mild by historical comparisons.
GMI represents a theoretical benchmark for the “optimal” portfolio. Using standard finance theory as a guide, this portfolio is considered a preferred strategy for the average investor with an infinite time horizon. Those assumptions are, of course, unrealistic in the real world. Nonetheless, GMI is useful as a baseline to begin research on asset allocation and portfolio design. GMI’s history suggests that this benchmark’s return will be competitive with active asset-allocation strategies overall, especially after adjusting for risk, trading costs and taxes.
The table below presents additional risk metrics for GMI and its underlying asset classes, based on a trailing 10-year window through last month.
Here are brief definitions of each risk metric:
Volatility: annualized standard deviation of monthly return
Sharpe ratio: ratio of monthly returns/monthly volatility (risk-free rate is assumed to be zero)
Sortino ratio: excess performance of downside semivariance (assuming 0% threshold target)
Ulcer Index: measure of downside risk based on drawdown over a specific period
Maximum Drawdown: the deepest peak-to-trough decline
Calmar Ratio: ratio of annualized return/maximum drawdown
Beta: measure of volatility relative to a benchmark (in this case GMI)