As elaborated in "What Works Best?", a strategic allocation involving perhaps five to ten equally weighted asset classes available via low-fee exchange-traded funds (ETF) or mutual funds, with periodic rebalancing, is a simple way for individual investors to harvest uncorrelated volatility over the long term. For investors seeking an active (tactical) edge, there is evidence supporting exploitation of intermediate-term momentum of these asset class proxies. Holding a few top-performing funds (rather than just the top fund) combines continuous diversification and momentum.
Specifically, "Simple Asset Class ETF Momentum Strategy" indicates that switching each month to the top-performing asset class (proxied by an ETF) adds value to simple asset class diversification over recent years, and that this strategy outperforms momentum strategies focused on U.S. stock sectors and styles (even when the latter have crash protection). "Simple Asset Class ETF Momentum Strategy Robustness/Sensitivity Tests" suggests that a five-month historical ranking interval may be optimal for the performance of a momentum strategy applied to a small set of asset class proxies. Also, "Alternative Asset Class ETF Momentum Allocations" shows that portfolios of the equally weighted two or three best-performing asset classes have attractive performance characteristics.
For the set of strategies presented here, we allocate at the end of each month all funds to the top one (Top 1), the equally weighted top two (EW Top 2) or the equally weighted top three (EW Top 3) asset class ETFs from a set of nine, based on total return over the past five months.
The following chart shows the gross cumulative values of $100,000 initial investments in Top 1, EW Top 2 and EW Top 3 portfolios since the end of August 2006 (when all ETFs considered are first available). The chart includes two benchmarks: buying and holding SPDR S&P 500 (SPY); and, an equally weighted, monthly rebalanced portfolio of all ETFs considered (EW All), indicative of simple diversification benefits.
Momentum Signal for May 2013 (Final)
Momentum ETF Winner
Second Place ETF
Third Place ETF