Strategic Allocation

We have updated monthly allocations and performance data for the Simple Asset Class ETF Momentum Strategy (SACEMS) and the Simple Asset Class ETF Value Strategy (SACEVS). We have also updated performance data for the Combined Value-Momentum Strategy.

We have updated the Trading Calendar to incorporate data for September 2019.

The home page, Simple Asset Class ETF Momentum Strategy (SACEMS) and Simple Asset Class ETF Value Strategy (SACEVS) now show preliminary positions for October 2019. For SACEMS, past returns for ranks two through four are very close, so the second and third places could change by the close. For SACEVS, allocations are unlikely to change.

“SACEMS-SACEVS for Value-Momentum Diversification” finds that the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) are mutually diversifying. Do longer samples available from “SACEVS Applied to Mutual Funds” and “SACEMS Applied to Mutual Funds” confirm this finding? To check, we look at the following three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

1. SACEVS Best Value paired with SACEMS Top 1 (aggressive value and aggressive momentum).
2. SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 3 (aggressive value and diversified momentum).
3. SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

Using monthly gross returns for SACEVS and SACEMS mutual fund portfolios during September 1997 through July 2019, we find that:

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Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, we look at three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

1. SACEVS Best Value paired with SACEMS Top 1 (aggressive value and aggressive momentum).
2. SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 3 (aggressive value and diversified momentum).
3. SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

We also test sensitivity of results to deviating from equal SACEVS-SACEMS weights. Using monthly gross returns for SACEVS and SACEMS portfolios since January 2003 for the first strategy and since June 2006 for the latter two, all through July 2019, we find that: Keep Reading

“Simple Asset Class ETF Value Strategy” (SACEVS) finds that investors may be able to exploit relative valuation of the term risk premium, the credit (default) risk premium and the equity risk premium via exchange-traded funds (ETF). However, the backtesting period is limited by available histories for ETFs and for series used to estimate risk premiums. To construct a longer test, we make the following substitutions for potential holdings (selected for length of available samples):

• Monthly average 3-Month Treasury Bill (T-bill) Secondary Market Rate instead of monthly average 3-Month T-bill Constant Maturity Rate as the risk-free rate and return on Cash.
• Vanguard GNMA Investor Shares (VFIIX) instead of  iShares 20+ Year Treasury Bond (TLT).
• Vanguard Long-Term Investment Grade Investor Shares (VWESX) instead of iShares iBoxx $ Investment Grade Corporate Bond (LQD).
• Vanguard 500 Index Fund Investor Shares (VFINX) instead of SPDR S&P 500 (SPY).

To enable estimation of risk premiums over a longer history, we also substitute:

• Monthly average Moody’s Seasoned Baa Corporate Bond Yields rather than day before end-of-month Baa yields for calculation of the credit risk premium. This substitution ignores a one-day delay in release of daily data.
• Robert Shiller’s S&P Composite Index monthly average levels instead of S&P 500 Index monthly closes. This substitution ignores any delay in posting of Shiller data (but new data are available elsewhere in real time).
• Robert Shiller’s monthly S&P Composite Index (GAAP) earnings instead of S&P Dow Jones S&P 500 operating earnings. We lag the Shiller earnings by four months to ensure real-time availability. In other words, the earnings yield for a month is the S&P Composite Index level for that month divided by index annual GAAP earnings as of four months ago. GAAP earnings are generally lower than operating earnings (see “Stock Market Valuation Ratio Trends”).
• Robert Shiller’s monthly average Long Interest Rates instead of monthly average yields on 10-year Constant Maturity U.S. Treasury notes. This substitution ignores any delay in posting of Shiller data (but new data are again available elsewhere with little delay).

As with ETFs, we consider two alternatives for exploiting premium undervaluation: Best Value, which picks the most undervalued premium; and, Weighted, which weights all undervalued premiums according to degree of undervaluation. Based on the assets considered, the principal benchmark is a monthly rebalanced portfolio of 60% VFINX and 40% VFIIX. Using monthly risk premium calculation data during March 1934 through July 2019 (limited by availability of T-bill data), and monthly dividend-adjusted closing prices for the three asset class mutual funds during June 1980 through July 2019 (39 years, limited by VFIIX), we find that:

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The “Simple Asset Class ETF Value Strategy” (SACEVS) seeks diversification across a small set of asset class exchanged-traded funds (ETF), plus a monthly tactical edge from potential undervaluation of three risk premiums:

1. Term – monthly difference between the 10-year Constant Maturity U.S. Treasury note (T-note) yield and the 3-month Constant Maturity U.S. Treasury bill (T-bill) yield.
2. Credit – monthly difference between the Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield.
3. Equity – monthly difference between S&P 500 operating earnings yield and the T-note yield.

Premium valuations are relative to historical averages. How might this strategy react to changes in the Effective Federal Funds Rate (EFFR)? Using end-of-month values of the three risk premiums, EFFR, total 12-month U.S. inflation and core 12-month U.S. inflation during March 1989 (limited by availability of operating earnings data) through June 2019, we find that: Keep Reading

How lucky would a asset class picker with no skill have to be to match the performance of the Simple Asset Class Momentum Strategy (SACEMS), which each month picks winners from a set of eight exchange-traded funds (ETF) plus cash based on total returns over a specified lookback interval. To investigate, we run 1,000 trials of a “strategy” that each month allocates funds to one, the equally weighted two or the equally weighted three of these nine assets picked at random. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics. Using monthly total (dividend-adjusted) returns and for the specified assets during February 2006 (limited by DBC) through June 2019, we find that:

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A subscriber inquired whether a longer test of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) is feasible using mutual funds rather than exchange-traded funds (ETF) as asset class proxies. To investigate, we consider the following set of mutual funds (partly adapted from the paper summarized in “Asset Allocation Combining Momentum, Volatility, Correlation and Crash Protection”):

1. Vanguard Total Stock Market Index Investor Shares (VTSMX)
2. Vanguard Small Capitalization Index Investor Shares  (NAESX)
3. Fidelity Diversified International (FDIVX)
4. Vanguard Long-Term Treasury Investor Shares (VUSTX)
5. Fidelity New Markets Income Fund (FNMIX)
6. Vanguard REIT Index Investor Shares (VGSIX)
7. First Eagle Gold A (SGGDX)
8. Oppenheimer Commodity Strategy Total Return A (QRAAX) until discontinuation in mid-2016, and PIMCO CommoditiesPLUS Strategy (PCPSX) thereafter
9. 3-month U.S. Treasury bills (Cash)

We rank mutual funds based on total (dividend-adjusted) returns over past (lookback) intervals of one to 12 months. We consider portfolios of past mutual fund winners based on Top 1 and on equally weighted (EW) Top 2 through Top 5. We consider as benchmarks: an equally weighted portfolio of all mutual funds, rebalanced monthly (EW All); buying and holding VTSMX; and, holding VTSMX when the S&P 500 Index is above its 10-month simple moving average (SMA10) and Cash when the index is below its SMA10 (VTSMX:SMA10). Using monthly dividend-adjusted closing prices for the above mutual funds and the yield for Cash during March 1997 through June 2019, we find that: Keep Reading

The Simple Asset Class ETF Momentum Strategy (SACEMS) each month picks winners based on total return over a specified ranking (lookback) interval from the following eight asset class exchange-traded funds (ETF), plus cash:

1. PowerShares DB Commodity Index Tracking (DBC)
2. iShares MSCI Emerging Markets Index (EEM)
3. iShares MSCI EAFE Index (EFA)
4. SPDR Gold Shares (GLD)
5. iShares Russell 2000 Index (IWM)
6. SPDR S&P 500 (SPY)
7. iShares Barclays 20+ Year Treasury Bond (TLT)
8. Vanguard REIT ETF (VNQ)
9. 3-month Treasury bills (Cash)

Based on findings in “SACEMS Portfolio-Asset Addition Testing”, a subscriber proposed adding iShares JPMorgan Emerging Market Bond Fund (EMB) to this set. To investigate, we revisit relevant analyses and conduct robustness tests, with focus on the equal-weighted (EW) Top 3 SACEMS portfolio. Using monthly dividend-adjusted closing prices for asset class proxies and the yield for Cash during February 2006 (when all ETFs in the baseline universe are first available) through June 2019, we find that: Keep Reading

Can investors beat a typical active U.S. equity mutual fund via a small portfolio of periodically re-weighted equity exchange-traded funds (ETF)? In their February 2019 paper entitled “Are Passive Funds Really Superior Investments: An Investor Perspective”, flagged by a subscriber, Edwin Elton, Martin Gruber and Andre de Souza:

1. Determine via cluster analysis a small set of ETFs that captures most of the variation in 69 broad U.S. equity indexes.
2. Explore use of this set to mimic past performances of many active U.S. equity mutual funds via 24-month linear regressions with ETF coefficients scaled to sum to one.
3. Compare next-year (close of first trading day of the year after coefficient calculation to close of first trading day next year) returns of mimicking ETF portfolios and active mutual fund counterparts.

Their target set of 883 active U.S. equity mutual funds are those with at least: three years of data as of January 2003; $15 million in assets; and, 90% of assets allocated broadly to stocks. Using monthly returns for 69 U.S. equity indexes, the small set of passive equity ETFs that capture variation in these indexes and 883 active U.S. equity mutual funds during January 2003 through December 2018, they find that:

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