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SACEMS with Margin

Posted in Momentum Investing, Strategic Allocation

Is leveraging with margin a good way to boost the performance of the "Simple Asset Class ETF Momentum Strategy" (SACEMS)? SACEMS each month picks winners from the following set of exchange-traded funds (ETF) based on total returns over a specified lookback interval:

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 2000 Index (IWM)
SPDR S&P 500 (SPY)
iShares Barclays 20+ Year Treasury Bond (TLT)
Vanguard REIT ETF (VNQ)
3-month Treasury bills (Cash)

To investigate effects of margin, we augment SACEMS by: (1) initially applying 2X leverage via margin (limited by Federal Reserve Regulation T); (2) for each month with a positive portfolio return, adding margin at the end of the month to restore 2X leverage; and, (3) for each month with a negative portfolio return, liquidating shares at the end of the month to pay down margin and restore 2X leverage. Margin rebalancings are concurrent with portfolio reformations. We focus on gross monthly Sharpe ratiocompound annual growth rate (CAGR) and maximum drawdown (MaxDD) for committed capital as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. We use the 3-month Treasury bill (T-bill) yield as the risk-free rate and consider a range of margin interest rates as increments to this yield. Using monthly total (dividend-adjusted) returns for the specified assets during February 2006 (limited by DBC) through October 2017, we find that:

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