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Value Investing Strategy (Strategy Overview)

Allocations for April 2020 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for April 2020 (Final)
1st ETF 2nd ETF 3rd ETF

Simple Asset Class ETF Momentum Strategy (SACEMS)

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 relative momentum of asset class proxies.

The Simple Asset Class ETF Momentum Strategy (SACEMS) seeks diversification plus a monthly tactical edge by holding a few top-performing ETFs. We consider three versions of SACEMS, which at the end of each month allocate 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 diversified set of nine, based on total return over recent months.

Supporting research includes (items may at times be unavailable for a few days during updates and may use an old strategy vintage):

Some investors may want to follow one of the alternatives tracked here. Others may want to adapt them with modifications suited to their individual goals and constraints. Still others may want to apply the analysis approaches to test other strategies. Something to keep in mind is that adding complexity to a strategy increases the number of ways to optimize it in backtests and thereby elevates potential for data snooping bias.

The next section summarizes historical (backtest) performance data.

Historical Performance

The following chart shows the gross cumulative values of $100,000 initial investments in SACEMS Top 1, EW Top 2 and EW Top 3 since the end of June 2006 (based on availability of ETF data). The chart includes three benchmarks: (1) an equally weighted, monthly rebalanced portfolio of all ETFs in the SACEMS universe (EW All), indicative of simple diversification; (2) buying and holding SPDR S&P 500 (SPY); and, (3) SPY:SMA10, a simple timing strategy that holds SPY (Cash) when the S&P 500 Index is above (below) its 10-month simple moving average.

Results indicate that SACEMS is attractive, but has setbacks.

For perspective, we look at an array of performance metrics.

The following table summarizes some monthly statistics for these same strategies over the available sample period. Return/Risk is average return divided by standard deviation. Maximum (peak-to-trough) drawdowns are based on monthly measurements over the sample period. 

The next table summarizes annual/annualized returns for these strategies over different intervals commonly used to describe performance of funds. The annualized returns are compound annual growth rates (CAGR). Only the longest measurement intervals include a major equity bear market. For Sharpe ratio, to calculate excess annual return, we use average monthly yield on 3-month Treasury bills during a year as the risk-free rate for that year.

The next section offers a discussion of this performance.

Performance Assessment

Results at this point suggest:

  • EW All is not attractive.
  • Outperformance of SACEMS EW Top 2 and EW top 3 relative to the simple SPY:SMA10 is material with respect to both returns and Sharpe ratios. SACEMS seeks to access the resilience of multiple asset classes efficiently. SPY:SMA10 is essentially a one-asset class (two, viewing cash as an asset class) timing strategy, with a lookback interval somewhat comparable to that of SACEMS. A possible interpretation of results is that the momentum strategy gives many noisy choices when times are good for U.S. stocks, but that buying and holding SPY and SPY:SMA10 do not give enough choices when times are bad.
  • Overall, SACEMS outperforms SPY, especially in terms of Sharpe ratios. However, in recent intervals, SPY easily wins.

There are longer backtests of relevant strategies in the second list of links at "What Works Best?", which mostly weigh in on the side of considering multiple asset classes, but these backtests generally have biases.

Pairing SACEMS with a value strategy to offset its setbacks while retaining nearly all performance appears to be attractive.

What one picks as the best strategy should take into consideration: investment horizon; risk tolerance; taxes; and, beliefs about future financial environments. For example:

  • How likely is another deep bear market for U.S. stocks? What will be the future bull/bear mix?
  • The available sample period is largely disinflationary (probably favorable to stocks, bonds and real estate). Is a sustained rise in the inflation rate plausible, and what would it do to the different asset classes?
  • How might the geopolitical environment evolve and affect U.S. versus non-U.S. stocks?

The next section describes aspects of the strategy in detail.

Momentum Signal for April 2020 (Final)

Winner ETF

Second Place ETF

Third Place ETF

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