Risk over the Short and Long Horizon

Monika Szikszai and Thomas Verbraken

April 21, 2021

Short-horizon risk measures, like that aimed at mitigating one-year drawdown risk, do not take into account market recoveries that could happen during a long investment horizon. To investigate risk on longer horizons, we constructed historically based five-year scenarios from the 1970s until today and assessed their impact on a 60/40 portfolio of U.S. equities and bonds, accounting for quarterly reinvestment of income and rebalancing to the initial allocation. The portfolio experienced the largest initial one-year drawdowns in the scenarios starting in October 1973, April 2008 and October 2000, but even these scenarios generated a positive return (albeit well below the average 8% annualized return over a five-year period).

How to interact with this plot: Select the start dates of the five-year scenarios at the bottom of the chart. Hold Shift to select multiple dates.

The chart shows return paths (colored lines) along with the 5th and 95th percentiles of the distribution (shaded area). The asset allocation was a 60/40 allocation to equities/bonds, with the bond portfolio consisting of 50% U.S. Treasurys, 37.5% U.S. investment-grade corporate bonds and 12.5% high-yield corporate bonds. U.S. Treasurys and high-yield bonds are represented by Markit iBoxx indexes. The equity market is represented by the MSCI USA Index and U.S. investment-grade corporate bonds by the MSCI USD Investment Grade Corporate Bond Index. Based on market data as of Jan. 11, 2021.