Providing Investors, the diversification they need, with the downside protection they desire

How do investor’s react to financial market stress?

When the going gets tough investors abandon the notion of traditional diversification, seeking the comfort and safety of cash. This phenomenon can be clearly observed during the last two recessions, as highlighted in the gray areas in the chart on the left. Money market assets as a percentage of mutual fund assets skyrocketed to unprecedented levels in 2003, 2008 and 2009, while the S&P 500 plummeted to below 800, demonstrating the large scale abandonment of portfolio equity and bonds. Stated another way; investors are loss averse rather than risk averse.


What’s been the result of investor’s reaction to market distress?

DALBAR conducted a study of just such behavior for the period January 1, 1991 through December 31, 2010. The study found that the average equity mu- tual fund investor earned a return of 3.83% while the S&P 500 returned 9.14%, an astounding difference of 5.31%. On the fixed income side, the average bond investor earned 1.01% versus 6.89% for the Barclays Capital Aggregate Bond Index. Observed behavioral patterns indicate investor participation in the down- side, while sitting out too long during subsequent market recoveries, leading to dramatic under- performance relative to the market.


Why do investors abandon diversification during market distress?

During times of significant market distress, volatility rises as do correlations among asset classes previously displaying low or no correlation relative to other assets. As correlations rise toward 1.0, loss protections offered through traditional diversification among asset classes deteriorates leaving investorswithout downside protection they assumed would be there to weather the storm. Traditional diversification only delivers protection in normalized markets.


What’s been frequently touted as the standard industry advice through all market conditions?


Is there a strategy that has the potential to participate in up markets and provides protection in down markets?


  1. Built-in Downside Protection
  2. Diversification
  3. Rules-based Discipline

QID develops and distributes strategies with a unique attribute of a built-in downside protection mechanism that provides signaling to raise cash and reduce equity market
exposure during periods it identifies as having a high probability of substantial market loss, a feature absent from buy and hold portfolios. Our belief is that investors are mischaracterized as risk averse when they are actually loss averse.

QID’s strategies provide investors diversification to participate in up or sideways moving markets. The Strategies provide investors with the tools to diversify across and within an asset class. QID’s strategies currently provide investor exposure to global, U.S. and international equity as well as fixed- income and alternative asset classes to develop custom asset allocations. Within each asset class the use of ETF’s provides a secondary level of diversification to avoid the specific risk of any one security. Each ETF typically contains numerous individual securities to provide the asset class exposure desired.

A quantitative signaling engine provides binary (buy/sell) signals on each portfolio position delivering rules based discipline to investment decisions. The algorithms across equity, fixed income, and alternative asset classes are driven by proprietary technical based algorithms.

QID claims compliance with the Global Investment Performance Standards (GIPS®) has been independently verified by ACA Compliance Group.

The Strategy Solution

A Quantitative Engine to Drive Decisions

The quantitative engine driving investment decisions within QID’s portfolio solutions removes behavioral biases from the investment process. The engine utilizes multiple sequences of technical indicators to produce the binary trading signals mentioned in the previous section.

Studies have shown that trading rules based on technical indicators have stood the test of time as one of several noted market anomalies demonstrating predictive power.

—Brock, Lakonishok & LeBaron, 1992

Technical Analysis Applied to U.S. Sector ETFs Appears to Add Value

The graph below illustrates how a strategy based on technical rules can potentially outperform a buy and hold strategy over time. The technical based strategy line (navy blue) tracks evenly with the S&P 500 (orange line) for several years, showing reasonable upside capture. The blue line flattens out in 2008-2009 as a result of technical signals indicating a sale of the underlying portfolio components to cash. Subsequent to this market drawdown period, the distance between the two lines widens and remains that way because of the capital preservation that occurred during the drawdown in the technical rules based strategy.


The QID Quantitative Engine

The quantitative engine aims to identify specific price trends within the actual market price data in an effort to identify instances when the probability of a downturn or upturn of a position seems likely in the near future. In this way the strategy is probabilistic in its approach.

There are times when it is beneficial for the engine to generate signals quickly, and there are times when short term pricing noise should be smoothed and ignored until better information is available. Each strategy signal is based on the strength of the observed data to avoid unnecessary whipsaw trading when possible.

The key to the success of the strategy is the specific sequential arrangement of technical indicators.

Some indicators are used to obtain a preliminary view of price movements and then others follow to confirm or refute information derived from the primary indicators.

Not Just a Defensive Strategy

While one of the primary objectives of the QID quantitative strategies is protection from extreme downside experiences, investors incorrectly assume that a large portion of the upside must be sacrificed as a cost for this protection.

As demonstrated by the charts to the right through a hypothetical back-test of the QID U.S. Equity Sector model, a strategy that is defensive on the downside can also provide reasonable upside participation in bull markets.

In the first chart below the U.S. Equity Sector Model Performs very well during bear markets 12/17/99 to 12/31/2016, and the third chart performs reasonably well during the bull market period of December 30,
2011 through December 2016.

The second and fourth chart below illustrate the defensive nature of the U.S. Equity Sector Strategy model with a much lower standard deviation of returns over the same time period.

The U.S. Equity Sector model strategies perform well in UP as well as DOWN markets as we demonstrate in the table below.

Strategy Highlights

Quantitative Investment Decisions believes its strategies deliver the returns investors seek, with the
downside protection they desire, to stay fully invested through full market cycles (QID makes the cash decision for investors inside the strategy) so that the need for long term growth in wealth may be achieved.

  1. Disciplined Downside Protection — QID develops strategies that focus on downside protection that buy and hold portfolios do not. Our belief is that investors are loss versus risk adverse.
  2. Fully Invested Across Market Cycles — By controlling for extreme losses we believe our strategies can give investors the confidence they need to remain fully invested in our strategies through market cycles.
  3. Targeted Alpha Generation in Up and Down Markets — The model strategies, when back-tested, tend to outperform their indexes, driving alpha through full market cycles.
  4. Diversification & Cost Efficiency — The portfolio construction process and the underlying ETF components provide diversification across the asset class and overall portfolio cost efficiencies in a tactical package.
  5. Asymmetric Risk Profile (an alternative investment profile) — The QID Strategies’ back-tested models’ performance tends to perform well relative to their respective indices on the upside, making them a viable candidate for their respective asset classifications.
    Given their defensive tendencies however, the strategies seem appropriate as a hedge fund exposure displaying a non-normal distribution of returns, asymmetric, with positive skewness and low kurtosis.

A Complete Suite of Tactical Asset Classes

Customizable Tactical Allocated Portfolio Solutions on a Risk or Aged-Based Basis

Disclosures (Click here)