Strategic Allocation

A subscriber asked about a strategy that rotates among equity sectors according to the Leading Economic Index (LEI), published monthly by the Conference Board (see “Leading Economic Index and the Stock Market”). To assess LEI usefulness for sector rotation, we consider the following nine sector Standard & Poor’s Depository Receipts (SPDR) exchange-traded funds (ETF):

Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)

We consider two LEI-based variables: (1) monthly change in LEI; and, (2) 3-month average change in LEI (average of current value, revised value for prior month and twice-revised value for two months ago) for signal smoothing. For each variable and each sector ETF, we consider two tests: (1) correlation of the variable with ETF return each of the next three months; and, (2) average next-month ETF returns across ranked fifths (quintiles) of the LEI variable. The first test looks for linear relationships, and the second test looks for non-linear relationships. Monthly measurements employ closes on LEI release dates, generally after the market open about three weeks after ends of calendar months reported. Using monthly changes in LEI from archived Conference Board press releases and contemporaneous dividend-adjusted daily levels of the above sector ETFs and of SPDR S&P 500 (SPY) from mid-July 2002 (limited by LEI press releases) through mid-November 2021 (233 monthly LEI observations), we find that: Keep Reading

Do quarterly allocation updates for the Best Value and Weighted versions of the “Simple Asset Class ETF Value Strategy” (SACEVS) work as well as monthly updates? These strategies allocate funds to the following asset class exchange-traded funds (ETF) according to valuations of term, credit and equity risk premiums, or to cash if no premiums are undervalued:

3-month Treasury bills (Cash)
iShares 20+ Year Treasury Bond (TLT)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
SPDR S&P 500 (SPY)

Changing from monthly to quarterly allocation updates does not sacrifice information about lagged quarterly S&P 500 Index earnings, but it does sacrifice currency of term and credit premiums. To assess alternatives, we compare cumulative performances and the following key metrics for quarterly and monthly allocation updates: gross compound annual growth rate (CAGR), gross maximum drawdown (MaxDD), annual gross returns and volatilities and annual gross Sharpe ratios. Using monthly dividend-adjusted closes for the above ETFs during September 2002 (earliest alignment of months and quarters) through September 2021, we find that:

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A subscriber asked about performance of Simple Asset Class ETF Momentum Strategy (SACEMS) hedge portfolios, which each month buy the asset class exchange-traded funds (ETF) in the SACEMS universe with the highest past returns and sell (short) those with the lowest. To investigate, we look at three hedge portfolios:

• Top 1 – Bottom 1: long the ETF with the highest past return and short the ETF with the lowest.
• EW Top 2 – EW Bottom 2: long the equal-weighted (EW) two ETFs with the highest past returns and short the two with the lowest.
• EW Top 3 – EW Bottom 3: long the equal-weighted three ETFs with the highest past returns and short the three with the lowest. 

For each portfolio, monthly rebalancing sets the long and short sides to equal dollar amounts. We consider monthly gross portfolio  performance statistics (ignoring any rebalancing and shorting frictions), gross compound annual growth rate (CAGR), maximum drawdown (MaxDD) and gross annual Sharpe ratio. To calculate annual excess returns for the Sharpe ratio, we use average monthly yield on 3-month Treasury bills during a year as the risk-free rate for that year. SACEMS Top 1, EW Top 2 and EW Top 3 SACEMS long-only portfolios serve as benchmarks. Using monthly gross returns for SACEMS ETFs (and cash) by rank during July 2006 through October 2021, we find that:

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Does adding a position take-profit (stop-gain) rule improve the performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) by harvesting some upside volatility? SACEMS each months picks winners from among the a set of eight asset class exchange-traded fund (ETF) proxies plus cash based on past returns over a specified interval. To investigate the value of stop-gains, we augment SACEMS with a simple rule that: (1) exits to Cash from any current winner ETF when its intra-month return rises above a specified threshold; and, (2) re-sets positions per winners at the end of the month. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. Using monthly total (dividend-adjusted) returns and intra-month maximum returns for the specified assets during February 2006 through September 2021, we find that: Keep Reading

Does adding a position stop-loss rule improve the performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) by avoiding some downside volatility? SACEMS each months picks winners from among the a set of eight asset class exchange-traded fund (ETF) proxies plus cash based on past returns over a specified interval. To investigate the value of stop-losses, we augment SACEMS with a simple rule that: (1) exits to Cash from any current winner ETF when its intra-month return falls below a specified threshold; and, (2) re-sets positions per winners at the end of the month. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. Using monthly total (dividend-adjusted) returns and intra-month drawdowns for the specified assets during February 2006 through September 2021, we find that: Keep Reading

“Countercyclical Asset Allocation Strategy” summarizes research on a simple countercyclical asset allocation strategy that systematically raises (lowers) the allocation to an asset class when its current aggregate allocation is relatively low (high). The underlying research is not specific on calculating portfolio allocations and returns. To corroborate findings, we use annual mutual fund and exchange-traded fund (ETF) allocations to stocks and bonds worldwide from the 2021 Investment Company Fact Book, Data Tables 3 and 11 to determine annual countercyclical allocations for stocks and bonds (ignoring allocations to money market funds). Specifically:

• If actual aggregate mutual fund/ETF allocation to stocks in a given year is above (below) 60%, we set next-year portfolio allocation below (above) 60% by the same percentage.
• If actual aggregate mutual fund/ETF allocation to bonds in a given year is above (below) 40%, we set next-year portfolio allocation below (above) 40% by the same percentage.

We then apply next-year allocations to stock (Fidelity Fund, FFIDX) and bond (Fidelity Investment Grade Bond Fund, FBNDX) mutual funds that have long histories. Based on Fact Book annual publication dates, we rebalance at the end of April each year. Using the specified actual fund allocations for 1984 through 2020 and FFIDX and FBNDX May through April total returns and end-of-April 1-year U.S. Treasury note (T-note) yields for 1985 through 2021, we find that: Keep Reading

A subscriber asked about the performance of a strategy that each month has five equal-weighted positions:

• SPDR Gold Shares (GLD) to represent gold if its past 2-month and 12-month returns are both positive, or otherwise iShares 1-3 Year Treasury Bond (SHY).
• iShares MSCI ACWI (ACWI) to represent all-world equities if its past 2-month and 12-month returns are both positive, or otherwise SHY.
• Vanguard Real Estate Index Fund (VNQ) to represent real estate investment trusts if its past 2-month and 12-month returns are both positive, or otherwise SHY.
• iShares Barclays 20+ Year Treasury Bond (TLT) to represent long-term U.S. Treasuries if its past 2-month and 12-month returns are both positive, or otherwise SHY.
• iShares iBoxx $ Investment Grade Corporate Bond (LQD) to represent corporate bonds if its past 2-month and 12-month returns are both positive, or otherwise SHY.

We designate this strategy 2-12 Absolute. As requested, we also consider two variations that substitute Invesco DB Commodity Index Tracking Fund (DBC) for either TLT or LQD, and we compare 2-12 Absolute performance to that of a portfolio that each month allocates 50% to Simple Asset Class ETF Value Strategy (SACEVS) Best Value and 50% to Simple Asset Class ETF Momentum Strategy (SACEMS) equal-weighted (EW) Top 2. We begin tests at the end of March 2009, limited by inception of ACWI. We exclude monthly rebalancing/switching frictions for all strategies. Using monthly dividend-adjusted prices for GLD, ACWI, VNQ, TLT, LQD, DBC and SHY starting March 2009 and monthly gross returns for 50-50 SACEVS Best Value and SACEMS EW Top 2 starting April 2009, all through August 2021, we find that: Keep Reading

When a public pension fund reports beating its benchmark, does that signify a job well done? In his July 2021 paper entitled “Cost, Performance, and Benchmark Bias of Public Pension Funds in the United States: An Unflattering Portrait”, Richard Ennis analyzes net returns of statewide pension funds in the U.S. He calculates both (1) net Sharpe ratio and (2) return versus a matched benchmark constructed via regression as the best-fit combination of the Russell 3000 stock index, the MSCI ACWI ex-U.S. stock index and the Bloomberg Barclays US Aggregate bond index. He compares performance relative to this benchmark and estimated costs for each fund. He then assesses performance of the funds versus the benchmarks they themselves construct and report against. Using self-reported data for a sample of 24 such funds self-reported via the Public Plans Data website during July 2010 through June 2020, he finds that: Keep Reading

In reaction to “Testing the EFA-SPY-TLT-PBBBX EW Strategy”, a subscriber asked about the performance of a strategy that each year rebalances to 25% SPDR S&P 500 (SPY), 10% iShares MSCI Emerging Markets Min Vol Factor (EEMV),  15% Vanguard Total World Stock Index Fund (VT), 25% iShares Barclays 20+ Year Treasury Bond (TLT) and 25% PIA BBB Bond Fund (PBBBX). Annual rebalancing avoids short-term capital gains for taxable accounts. We again compare performance of this alternative to that of a portfolio that each month allocates 50% to Simple Asset Class ETF Value Strategy (SACEVS) Best Value and 50% to Simple Asset Class ETF Momentum Strategy (SACEMS) equal-weighted (EW) Top 2. We begin the test at the end of 2011, limited by EEMV data and the annual rebalancing rule. We ignore rebalancing frictions for both strategies. Using monthly dividend-adjusted prices for SPY, EEMV, VT, TLT and PBBBX starting December 2011 and monthly gross returns for 50-50 SACEVS Best Value and SACEMS EW Top 2 starting January 2012, all through June 2021, we find that:

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A subscriber, hypothesizing that asset classes with weak past returns should revert, requested testing of a strategy that each month holds the equal-weighted three of the Simple Asset Class ETF Momentum Strategy (SACEMS) universe with the lowest cumulative returns over the past 12 months (12-month EW Bottom 3). For comparison, we use the SACEMS EW Top 3 portfolio as specified. We begin the test at the end of February 2007, limited by SACEMS inputs with a 12-month lookback interval. We ignore monthly rebalancing frictions for both strategies. Using monthly dividend-adjusted prices of the nine SACEMS asset class proxies during February 2006 through June 2021, we find that: Keep Reading