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The Drawdown Risk and Portfolio Concentration of Sector ETFs

Dr. Tim Leung1 min read

Illustrative

A drawdown measures the distance (in %) of the portfolio value from its peak, reflecting its downside risk. If a portfolio had previously reached a peak of $100 and subsequently dropped to $90, then the portfolio experienced a 10% drawdown.

Drawdown risk is relevant to all stocks and portfolios. Investor should care about not only the magnitudes of drawdowns but also their durations.

We examine the drawdown risk sector by sector through a series of Sector ETFs. As we see below, drawdown risk may vary greatly across sectors.

As a comparison, we look at the drawdown charts for the QQQ ETF, S&P500 ETF (SPY) and the Financial Sector ETF (XLF). It’s visible that XLF tends to take longer to recover to previous peaks than SPY.

Drawdown line chart for QQQ, 2010–2020, with shaded periods of 5%+ drawdown; the deepest comes in 2020
Drawdown line charts for SPY and XLF, 2010–2020, 5%+ periods shaded; XLF’s shaded stretches are wider, showing slower recoveries
Drawdown time series (y-axis: -0.1 means 10% drawdown) for QQQ, SPY and XLF. The shaded areas indicate the periods where the drawdown is greater than or equal to 5%. The wider the shaded area the longer the drawdown duration.

Other sectors that have shown higher drawdown risk include Materials (XLB) and Real Estate (IYR).

Drawdown line charts for Materials (XLB) and Real Estate (IYR), 2010–2020, with long shaded 5%+ drawdown periods and deep drops in 2020

Extreme drawdown risk can be seen in the Biotech (XBI) and Energy (XLE) sectors.

A summary of work first published on medium.com.

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