Morningstar Advisor - February/March 2012 - (Page 29)

The short answer is yes, though to a disappointing extent. We measured the maximum drawdown of each tactical fund during the May 1–Aug. 21, 2011, period and then sorted by decile, with funds that suffered the largest drawdowns in the 10 th decile and those with the smallest in the 1st decile (Exhibit 2). We found that around 40 of the 112 tactical funds experienced smaller drawdowns than Vanguard Balanced (negative 9.46%). However, that means more than half of the tactical funds fell more than the Vanguard fund; what’s more, the negative 11.08% median drawdown was about 10 percentage points larger than one would have suffered hunkered down in investmentgrade U.S. bonds during the period. This last finding should give pause to those who are considering tactical funds as a form of “tail insurance” against extreme negative events. While some of these funds have proved more resilient when the stock market is falling, we found it’s far from a sure thing. Indeed, only 14 of the 81 tactical mutual funds in existence since October 2007 posted lower downside-capture ratios during the 2008 financial crisis, and the spring/ summer 2010 correction, as well as the recent European debt-related downturn. In other words, there was a less than one-in-five chance that the insurance would consistently pay off versus what one could achieve through a simple balanced fund (Exhibit 3). Of course, one could argue that the only truly extreme episode was the financial crisis itself and, on that score, tactical funds acquitted themselves far better—44 of the 81 tactical funds existing at the start of the crisis came through it capturing less downside than the Vanguard fund. But that protection came at a steep cost, as only six of the 44 funds captured at least as much upside as Vanguard Balanced Index in the subsequent months, with the typical fund in that cohort capturing a meager 46% of the upside versus 62% for the Vanguard fund. (This likely overstates the upside capture of this group, as Exhibit 1 Risk vs. Return: Most of the tactical funds gained less than Vanguard Balanced, were more volatile and prone to downside, or both. Aug. 1, 2010–Dec. 31, 2011 Standard Deviation (%) Higher Sharpe, Lower Drawdown Higher Sharpe, Higher Drawdown Lower Sharpe, Lower Drawdown Lower Sharpe, Higher Drawdown Vanguard Balanced Index 20 15 10 5 0 –5 –10 –15 –20 0 Annual Return (%) 5 10 15 20 25 Exhibit 2 Drawdowns by Decile Group: More than half of the tactical funds fell more than Vanguard Balanced during the market’s sharp correction. May 1, 2011–Aug. 21, 2011 Decile Group Vanguard Balanced 30 10 th 0 –5 –10 –15 –20 Drawdown (%) 9 th 8 th 7 th 6 th 5 th 4th 3 th 2nd 1st Note: Graph shows the median drawdown for each decile. Exhibit 3 Number of Tactical Funds With Lower Downside Capture Than Vanguard Balanced Starting Population: 81 Tactical Funds That Existed as of October 2007 50 40 30 20 10 Financial Crisis ...and 2010 Correction ...and 2011 Correction MorningstarAdvisor.com 29 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

Morningstar Advisor - February/March 2012

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