QSector – An Alternative to Traditional Diversification and Investment Styles
Most financial advisors and planners diversify their clients' portfolios according to asset classes, investment styles, or geography in order to improve risk-adjusted performance. There are several problems with these traditional methods for diversifying portfolios by investment fund/advisor styles ("value," "growth," "capitalization") or geography (countries, regions, global):
- Non-stationary correlations: Modern portfolio theories (i.e., Capital Asset Pricing Models and Arbitrage Pricing Theory) assume static (i.e., stationary) correlations (i.e., relationships) between alternative investment options. These static equilibrium models are unrealistic because they assume that historic correlations (sometimes using very long-term periods) are reliable forecasts of future behavior. Static equilibrium models disregard the dynamic nature of the financial markets. Portfolios designed with those underlying steady-state assumptions may under-perform their respective benchmark indexes (on both an absolute and risk- adjusted basis). QSector, portfolios adapt to the underlying dynamic economic factors that drive the financial markets.
- Extended periods of under-performance: Individually, certain asset classes and investment styles may have extended periods of intermediate- and even long-term under-performance as compared to broad market indexes. Government policy variables (trade tariffs, monetary and fiscal policy) and macro-economic variables (inflation, productivity, monetary measures) shift with the business cycle, resulting in favorable conditions for certain asset classes or investment styles. QSector portfolios are adapted to each phase of the US business cycle.
- High downside risk correlations: Individual equities and groups of mutual funds may be highly correlated during periods of high downside volatility, i.e. diversification fails just when you need it most. Over the last decade, global markets and economies have become more closely linked through commodities and currency prices. The recent currency crisis in 1998 is a good example. Almost all geographical country and regional indexes dipped in unison.
QSector's actual results exceed those of its S&P benchmark and closely match the results of its 10-year backtest. Since inception in mid-1997, the QSector portfolio has outperformed its benchmark S&P 500 in both risk-adjusted and absolute terms. See graph which compares relative risk and return performance figures, since inception, for QSector, the S&P 500, and the Fidelity Select Mutual Funds.
* Actual performance is consistent with 10-year backtest of methodology.
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