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The Importance of Consistency of Returns

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Consistency is King, both in Sports and Investing

Con­sis­ten­cy of returns is an impor­tant dri­ver of over­all invest­ment results, just like in sports and oth­er areas of our lives.

In today’s world of ‘instant every­thing’, investors are like­ly to become myopic. Com­bined with a ten­den­cy to chase returns, it can be dif­fi­cult for many investors to keep their ‘eye on the ball’.

One could learn a lot from the inten­tion­al con­sis­ten­cy sought after by top sports per­form­ers. You can do some­thing once, but can you do it con­sis­tent­ly…?


Why Investors Should Listen to Ken Griffey, Jr.

On July 24th, the great­est ballplay­er I’ve ever seen was induct­ed into the Nation­al Base­ball Hall of Fame with a record-set­ting 99.3% of the vote. Reflect­ing on his career, Ken Grif­fey, Jr recent­ly said:

On the Mariners, we had this phi­los­o­phy in the club­house that we referred to as Base­ball Gods. Maybe it was more of a super­sti­tion than a phi­los­o­phy. When some­one referred to Base­ball Gods, we were acknowl­edg­ing that this game will make you feel human real­ly fast: Nev­er get too high on your­self and nev­er get too low. It was a reminder that you’re nev­er as bad as they say you are and nev­er as good as you think you are.”

What Grif­fey said about base­ball can also be said about the mar­kets: They always have a way of hum­bling you. It’s impor­tant to keep your head on straight when mar­kets are either soar­ing or crash­ing.

Unfor­tu­nate­ly, that’s eas­i­er said than done giv­en the wild ride the mar­kets have been on over the last decade or two. The graph below shows a break­out of annu­al­ized returns for every three-year peri­od between July 1997 and June 2016.

Distribution of 3-year returns S&P 500 - Zephyr | Swan Blog


Return Distribution — A Test of Consistency

A plain Eng­lish descrip­tion of this dis­tri­b­u­tion might be “feast or famine.” The more for­mal, sta­tis­ti­cal descrip­tion is that this is a bi-modal dis­tri­b­u­tion.

Usu­al­ly, a dis­tri­b­u­tion will be clus­tered near the mean, or aver­age result, and then gen­tly slopes off in both direc­tions.

How­ev­er, this dis­tri­b­u­tion has two or maybe even three peaks (tri-modal). A large num­ber of occur­rences clus­ter in 10%-to-18% range, which rep­re­sents a very healthy return.

In addi­tion, there are also a large num­ber of occur­rences where the annu­al­ized three-year returns were in the -8% to -14% range. Even more inter­est­ing, while the aver­age three-year annu­al­ized return for the S&P 500 is 5.65%, there are very few times since July 1997 that the S&P 500 was close to its aver­age — it was typ­i­cal­ly either way above or way below.

Distribution of 10-year returns S&P 500 - Zephyr | Swan Blog

A sim­i­lar, bi-modal dis­tri­b­u­tion appears when look­ing at long-term, ten-year annu­al­ized returns. The largest buck­et rep­re­sent­ing 39.4% of the out­comes is the 6% to 8% range; a per­fect­ly accept­able result for most investors.

Wor­ry­ing­ly though, the sec­ond most fre­quent range of ten-year returns is actu­al­ly neg­a­tive, rang­ing from -2% to 0%. Com­bined with the -4% to -2% buck­et, 22.0% of the obser­va­tions in this range were “lost decades.”

Seeking a Narrow Distribution (or Consistency of Returns)

The Defined Risk Strat­e­gy was designed to mit­i­gate the impact of these out­lier events and pos­si­bly pro­vide a smoother, more reli­able, more con­sis­tent out­come. By active­ly hedg­ing against bear mar­kets, the DRS has a much small­er “left tail” of bad out­comes. Over its 19 year his­to­ry the DRS has weath­ered the two largest bear mar­kets since World War II: the dot-com bust of 2000–2002 and the finan­cial cri­sis of 2007-09. Below we see the dis­tri­b­u­tion of annu­al­ized three-year returns of the DRS com­pared to the S&P 500.


Distribution of 3-year rolling returns of S&P 500 vs. Swan DRS - Zephyr | Swan Blog

By hedg­ing with long-term put options, the DRS has his­tor­i­cal­ly min­i­mized the impact of those bear mar­kets. The dis­tri­b­u­tion of DRS returns is what one hopes to see — the major­i­ty of returns are clus­tered near the aver­age of the dis­tri­b­u­tion.

The long term returns of the Defined Risk Strat­e­gy are much more pre­dictable. There isn’t a sec­ond peak to the dis­tri­b­u­tion out in neg­a­tive ter­ri­to­ry, like there is for the S&P 500.

Of course, by main­tain­ing the hedge at all times, the DRS will lag in up mar­kets. There will be few­er obser­va­tions in the high-teens or over-20% range. How­ev­er, that is a trade-off the DRS has will­ing­ly accept­ed. It has always been Swan’s phi­los­o­phy that avoid­ing loss­es is more impor­tant than cap­tur­ing all of the market’s gains.

The log­ic and jus­ti­fi­ca­tion for this are spelled out in our recent white paper “Math Mat­ters” by Swan’s Direc­tor of Research, Mic­ah Wake­field.

Return Distribution - 5-year rolling returns of S&P 500 vs. Swan DRS - Zephyr | Swan Blog

Com­pared to the S&P 500, the DRS’s annu­al­ized five-year returns look very appeal­ing. Almost two-thirds of the 169 obser­va­tions occurred in the 6% to 10% range. The two most com­mon buck­ets for the S&P 500 were the -2% to 0% and 0% to 2% ranges.

Return Distribution - 5-year rolling returns of S&P 500 vs. Swan DRS - Zephyr | Swan Blog

With a track record of 19 years, the sam­ple size affords a healthy num­ber of decade-long returns to ana­lyze — 109 obser­va­tions, in all. The long-term results of the DRS show a remark­able degree of con­sis­ten­cy. Again, the val­ue of hedg­ing against bear mar­ket loss­es is eas­i­ly illus­trat­ed in this chart.

Con­sis­ten­cy of Returns Address­es Invest­ment Tim­ing Risk

Anoth­er sec­ondary, fin­er point of these charts has to do with tim­ing.

At Swan, we are often asked, “When is the best time to buy the DRS?” If an investor’s pre­vi­ous mar­ket expe­ri­ence has been in some­thing like the S&P 500, it is a per­fect­ly ratio­nal ques­tion to ask.

As we have seen, over the last 19 years one could have expe­ri­enced rad­i­cal­ly dif­fer­ent results, depend­ing upon the time frame in ques­tion. How­ev­er, the DRS almost ren­ders this ques­tion moot as the range of out­comes has been very tight, with a con­sis­ten­cy of returns demon­strat­ed over mar­ket cycles.


When it comes to achiev­ing suc­cess in long-term invest­ing, or at the high­est lev­els of pro­fes­sion­al sports, con­sis­ten­cy is impor­tant.

As Mr. Grif­fey said, it’s impor­tant not to get too high or too low.

Math Mat­ters Series: This post is a con­tin­u­a­tion of the Math Mat­ters blog series, designed to help investors focus on the math behind invest­ment results and empow­er them to avoid emo­tion­al or and irra­tional deci­sions that can derail long-term goals. See our oth­er posts on the pow­er of com­pound­ing, avoid­ing large loss­es, and volatil­i­ty drag.

To learn more about Swan’s DRS invest­ment approach and how this approach has fared in the past, please con­tact Swan at 970–382-8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.



Impor­tant Dis­clo­sures:

Cov­er image source: Yahoo!

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non­qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. All Swan prod­ucts uti­lize the Defined Risk Strat­e­gy (“DRS”), but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS prod­uct offer­ings will have dif­fer­ent per­for­mance results, and com­par­ing results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. Eco­nom­ic fac­tors, mar­ket con­di­tions, and invest­ment strate­gies will affect the per­for­mance of any port­fo­lio and there are no assur­ances that it will match or out­per­form any par­tic­u­lar bench­mark. There­fore, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains.  This analy­sis is not a guar­an­tee or indi­ca­tion of future per­for­mance. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970.382.8901 or vis­it 167-SGI-071116[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

By | 2017-08-21T14:39:24+00:00 October 27th, 2016|Blog|Comments Off on The Importance of Consistency of Returns