The algorithm has definitely worked this time

Have you heard about indexes that use algorithms or mathematical formulas to guide their asset allocation? No human money manager. A formula determines the current composition of a changing portfolio.

Indexes using this technique are available within several insurance companies' Fixed Index Annuity (FIA) product lines. The index is used as the tracking vehicle for interest calculations- you do not invest directly in an index within an annuity.

If you are unfamiliar with how a Fixed Indexed Annuity works (principal protection with interest tied to an index's performance) you can find a quick tutorial with this link FIAs Explained

Each of the many algorithm-driven indexes have their own mathematical formula (algorithm) that determines how money is allocated at any time. In addition to unique algorithms these indexes have different asset classes that make up their potential portfolio.

It always helps to see an example. Of course, results will vary between indexes.

Let's use an index from Credit Suisse. Here is how Credit Suisse describes this index:

The Credit Suisse Momentum Index is a rules-based global multi-asset index that implements a unique and flexible momentum-driven strategy.

Index Features:

Diversification: The Index’s underlying components are diversified across four regions and three asset classes in an effort to generate consistent returns over time.

Momentum: the trend following strategy of the Index is intended to gain exposure to components that exhibit the strongest trends while reducing exposure to components with weaker trends.

Risk-Adjusted Weightings: Index components are weighted inversely to their risk in an attempt to build a risk-balanced allocation.

Risk Control: The Index targets an annualized volatility of 5% or less to help stabilize returns.

The three asset classes mentioned under Diversification are Stocks, Bonds and Commodities (Gold and Oil). The stocks and bonds are large-cap and investment grade respectively and have global diversification.

2022 is a good year to test an index like the Credit Suisse Momentum Index.

In a really rough year, how has this risk controlled, momentum driven approach worked using Stocks, Bonds, Gold and Oil?

For some perspective:

YTD the S&P 500 is down 19%, the 10-Year Treasury is down 18%, gold is down 10% and oil is up around 15%.

The Credit Suisse Momentum Index is off 5.4% year to date. Relatively strong when compared to the performances of stocks, bonds and gold.

The relative performance of the index was aided by another attribute not mentioned above. The index can "short" asset classes and potentially benefit from falling prices. Recent allocation data shows a 12% short position in the Euro-Bund Futures Index (bonds backed by the German government).

It's fair to say the algorithm has worked so far in 2022.

Two important points worth mentioning here and probably worth their own blog post:

1. An account that is down 19% needs to appreciate by 23% to get back to even. An account down 6% needs to go up just 6.4% to return to even. Tesla's stock down 36% YTD needs an increase of 56% to reach January 1st levels.

2. Fixed Indexed Annuities sometimes use a "Participation Rate" to provide more than 100% of the index's return. More than 100% of a return is also referred to as leverage. What makes leverage desirable within a FIA is that it only applies to positive returns. There are no negative returns with a Fixed Indexed Annuity- just years when you earn nothing.