Risk-Adjusted Returns for the DTRS Model Portfolios using the Sharpe Ratio:
The impetus behind creating the data-driven DTRS method was to provide better investment returns using higher-yield U.S. equities. When developing the method, it was assumed that the method would carry more risk than investing in a larger blend of equities such as the 30 stocks comprising the Dow Jones Industrial Average (DJIA) or the 500 stocks included in the S&P500 Index. Consequently, we classified the relative risk associated with each portfolio as either “high risk” or “medium-to-high risk” based upon the number of equity holdings in a particular portfolio. Portfolios holding fewer than 5 equities were labeled as “high risk”. Portfolios holding approximately 5 to 10 equities were labeled as “medium-to-high risk”.
While this assessment of risk may reflect the diversity in equity holdings, it ignores the balance and stability that was incorporated into the development of the method. This was achieved by creating multiple screen criteria so that stocks were not selected based upon yield alone. Our model portfolios use 5 to 6 investment screening parameters to generate the equity proportioning. Putting aside the qualitative risk assessment based solely upon the number of equity holdings, we decided looked at a quantitative measure of the risk-adjusted returns based upon past performance.
To measure risk-adjusted return, the Sharpe Ratio was calculated for each portfolio over various periods using historical total return data. These values were then compared to the Sharpe Ratios for the DJIA and S&P500 Indices over the same periods. With exception of the 1-year period for 2017, risk-adjusted returns for the DTRS portfolios typically exceeded those of both indices. For calculation purposes, the risk-free return was assumed to be the 10-year Treasury rate. In order to adjust for the wide range in interest rates over the last 45 years, excess returns were calculated annually relative to the average 10-year Treasury rate for each year. Specifically, the Sharpe Ratios were calculated as follows:
Sharpe Ratio = Average (%ROR – Risk free rate) / Std. Dev. (%ROR – Risk free rate)