Should We Optimize For Sharpe Ratio?

Franklin Templeton is an ETF provider that gets very little attention. They do some interesting things and they also have model portfolios to support their funds. 

It's a 10/90 but it's not intended to be a standalone portfolio. As I take it, it could be used as a fixed income replacement along the lines of ProShares Hedge Fund Replication (HDG) or NY Life Hedge Multi-Strategy Tracker (QAI) as suggested by Claude. 

First is how Franklin model compares to HDG and QAI.

IUSB is similar to AGG but a little broader and has done slightly better that I will plan on using for blogging purposes going forward instead of AGG. The model took a less volatile path to a similar result as both HDG and QAI. A quick note, I switched out ARB from the model in favor of MNA to be able to go back a little further. If you look at the performance numbers, they fair worse than what I got because I am only able to grab what is in the model now, not track the changes it made along the way. 

Building the model out to a 40% weighting with 60% to equities, certainly helps the growth rate versus putting the 40% in IUSB but doesn't help much with volatility. Other than the 2020 Pandemic Crash though, the model has consistently done better in drawdowns. 

Here's a four minute excerpt from a podcast featuring Cliff Asness. The key line from Cliff was "you need to be able to short sell to create an uncorrelated return." QLEIX below is long biased, MERIX is market neutral and BTAL is short biased.

MERIX is client/personal holding the Merger Fund and ok, that might be the correlation but take a look for yourself, I would say it looks nothing like the stock market. It's by no means negatively correlated but regardless of the stats, having held the fund since the Financial Crisis, for my money it does not behave like the stock market even a little bit. 

Cliff also talked risk parity weighting of assets without using the term risk parity. He talked about leveraging up to even out the risk taken between assets with low/un/negative correlations. 

The holdings are SPY for equities, IUSB for bonds, AQMIX for managed futures and GLD.

It is very amusing that the way to optimize risk adjusted return (Sharpe Ratio) is to have no AGG-like bond exposure. Interestingly, if we replace IUSB with MERIX, the Optimized Sharpe Ratio recommendation was 25% each to SPY and AQMIX, 30% to MERIX and the rest in gold. 

Other than the Pandemic Crash, Optimized with MERIX has been a very smooth ride.

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