Investor experience is often only part of the long term return path, that typically does not look like the total path. Investors may face a bell-shaped curve over time. However, the long-term symmetrical bell-shaped curve is actually made up of many smaller nearer term non-symmetrical distributions. Some are negatively skewed and some positively skewed.
As investors move away from longer term investing into the nearer term, in search for better ways to invest, it becomes more challenging to be successful. Being successful requires understanding where one is in the market cycle, some grounded analysis about what to expect going forward.
Valuation analysis involves identifying periods where market prices deviate from fundamental values, and positioning for adjustment. Dynamic rebalancing seeks to capture volatility and correlation properties among portfolio components, by opportunistically selling into gains and buying into losses. Other forms of analysis of market conditions can help determine if those conditions favor near-term upside, so as to position a portfolio accordingly.
Understanding Near-Term Distributions with the Upside Potential Ratio (UPR)
Dr. Frank Sortino’s work in the area of analyzing asymmetrical distributions has always been groundbreaking. His latest research has been with the Upside Potential Ratio (UPR), defined as the ratio of upside potential to downside risk. It may offer more forward-looking insight than the popularized Sortino Ratio. Can an investor use UPR analysis of the distribution over the last three years to provide useful insight about the next year? Dr. Sortino’s latest work suggests an investor can more often than not, https://pmpt.me/2017/06/24/the-cost-of-assuming-symmetry-in-a-skewed-world/
The charts below illustrates what Upside Ratio analysis of selected asset classes and ETFs over the last three years would tell us today about the next year. According to the charts done at the end of August, only US Large Cap and the total US Stock Market Index have UPRs greater than 1.0 for a 6% portfolio return target. This means only US Large Cap and the total US Stock Market Index have meaningful likelihoods of returning over 6% in the next year – more upside potential than downside risk. Or, to put this another way, 29 out of 31 world indices have more downside risk than upside potential, a strong signal for caution.