# Strategic Allocation

Is there a best way to select and weight asset classes for long-term diversification benefits? These blog entries address this strategic allocation question.

**May 26, 2022** - Strategic Allocation

A subscriber suggested review of “Accelerating Dual Momentum [ADM] Investing”, which allocates all funds to U.S. stocks, international (ex-U.S.) small-capitalization stocks or long-term U.S. Treasury bonds, as follows:

- Each month, calculate for each of the two equity assets the sum of its 1-month, 3-month and 6-month past returns.
- If both sums are negative, buy U.S. Treasury bonds.
- If both sums are not negative, buy the equity asset with the higher sum.

To investigate, we apply these rules to three exchange-traded funds (ETF):

- SPDR S&P 500 (SPY) to represent U.S. stocks.
- iShares MSCI EAFE Small-Cap ETF (SCZ) to represent international small stocks.
- iShares 20+ Year Treasury Bond (TLT) to represent long-term U.S. Treasury bonds.

Using end-of-month dividend-adjusted prices of these ETFs during December 2007 (limited by SCZ) through April 2022, *we find that:* Keep Reading

**May 23, 2022** - Strategic Allocation, Volatility Effects

Can investors use leveraged exchange-traded funds (ETF) to construct attractive versions of simple 60%/40% (60/40) and 40%/60% (40/60) stocks-bonds portfolios? In their March 2020 presentation package entitled “Robust Leveraged ETF Portfolios Extending Classic 40/60 Portfolios and Portfolio Insurance”, flagged by a subscriber, Mikhail Smirnov and Alexander Smirnov consider several variations of classic stocks/bonds portfolio as implemented with leveraged ETFs. They ultimately focus on a monthly rebalanced partially 3X-leveraged portfolio consisting of:

- 40% ProShares UltraPro QQQ (TQQQ)
- 20% Direxion Daily 20+ Year Treasury Bull 3X Shares (TMF)
- 40% iShares 20+ Year Treasury Bond ETF (TLT)

To verify findings, we consider this portfolio and several 60/40 and 40/60 stocks/bonds portfolios. We look at net monthly performance statistics, along with compound annual growth rate (CAGR), maximum drawdown (MaxDD) based on monthly data and annual Sharpe ratio. To estimate monthly rebalancing frictions, we use 0.5% of amount traded each month. We use average monthly 3-month U.S. Treasury bill yield during a year as the risk-free rate in Sharpe ratio calculations for that year. Using monthly adjusted prices for TQQQ, TMF, TLT and for SPDR S&P 500 ETF Trust (SPY) and Invesco QQQ Trust (QQQ) to construct benchmarks during February 2010 (limited by TQQQ inception) through April 2022, *we find that:* Keep Reading

**May 16, 2022** - Strategic Allocation

A subscriber requested evaluation of a streamlined version of the Simple Asset Class ETF Momentum Strategy (SACEMS) that considers only three exchange-traded funds (ETF):

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

To evaluate, we test a strategy that each month picks the one of these ETFs with the highest total return over a set momentum ranking (lookback) interval. We call the strategy Very SACEMS (VSACEMS) Top 1. We consider lookback intervals of one to 12 months. We then select one of these lookback intervals and generate performance statistics similar to those for SACEMS. We consider three benchmarks:

- SPY – buy and hold SPY.
- SPY:SMA10 Cash – Hold SPY (3-month U.S. Treasury bills) when SPY is above (below) its 10-month simple moving average (SMA10) at the end of the prior month.
- SPY:SMA10 TLT – Hold SPY (TLT) when SPY is above (below) its SMA10 at the end of the prior month.

Using monthly dividend-adjusted prices for the above three assets during July 2002 (limited by TLT and LQD) through April 2022, *we find that:* Keep Reading

**April 29, 2022** - Fundamental Valuation, Strategic Allocation, Technical Trading

The “Simple Asset Class ETF Value Strategy” (SACEVS) allocates across 3-month Treasury bills (Cash, or T-bill), iShares 20+ Year Treasury Bond (TLT), iShares iBoxx $ Investment Grade Corporate Bond (LQD) and SPDR S&P 500 (SPY) according to the relative valuations of term, credit and equity risk premiums. Does applying a simple moving average (SMA) filter to SACEVS allocations improve its performance? Since many technical traders use a 10-month SMA (SMA10), we apply SMA10 filters to dividend-adjusted prices of TLT, LQD and SPY allocations. If an allocated asset is above (below) its SMA10, we allocate as specified (to Cash). This rule does not apply to any Cash allocation. We focus on gross compound annual growth rates (CAGR), maximum drawdowns (MaxDD) and annual Sharpe ratios (using average monthly T-bill yield during a year as the risk-free rate for that year) of SACEVS Best Value and SACEVS Weighted portfolios. We compare to baseline SACEVS as currently tracked and to the SMA rule applied to a 60%-40% monthly rebalanced SPY-TLT benchmark portfolio (60-40). Finally, we test sensitivity of main findings to varying the SMA lookback interval. Using SACEVS historical data, monthly dividend-adjusted closing prices for the asset class proxies and yield for Cash during July 2002 (the earliest all funds are available) through March 2022, *we find that:*

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**March 23, 2022** - Momentum Investing, Strategic Allocation, Technical Trading

“SACEMS with Momentum Breadth Crash Protection” evaluates in depth the potential of a simple momentum breadth rule to improve performance of the Simple Asset Class ETF Momentum Strategy (SACEMS). This rule forces the model to all cash when fewer than some threshold of the non-cash SACEMS assets have positive returns over a specified lookback interval. Do major findings of that evaluation still hold? To update, we repeat some of the analyses with the minor changes since made to SACEMS plus recent data. We focus on compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) for the Top 1, equal-weighted (EW) Top 2 and EW Top 3 SACEMS portfolios. We look at all possible momentum breadth thresholds for the baseline SACEMS lookback interval. We then consider lookback intervals ranging from one to 12 months for a specific momentum breadth threshold. Using monthly dividend-adjusted closing prices for SACEMS assets and the T-bill yield during February 2006 through February 2022, *we find that:*

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**March 14, 2022** - Strategic Allocation

A subscriber proposed adding Utilities Select Sector SPDR Fund (XLU) to the Simple Asset Class ETF Momentum Strategy (SACEMS) asset universe based on the relatively low correlation of XLU with the broad U.S. stock market. To investigate, we:

- Expand the SACEMS asset universe to include XLU.
- Generate performance data for this expanded universe for the SACEMS Top 1, equal-weighted (EW) Top 2 and EW Top 3 portfolios.
- Compare results to those for baseline SACEMS portfolios.

Using inputs during February 2006 (inception of DBC as a proxy for commodities) through February 2022, *we find that:* Keep Reading

**February 28, 2022** - Equity Premium, Momentum Investing, Strategic Allocation

A subscriber asked whether the optimal momentum ranking (lookback) interval for the “Simple Asset Class ETF Momentum Strategy” (SACEMS) shrinks during bear markets for U.S. stocks. To investigate, we compare SACEMS monthly performance statistics when the S&P 500 Index at the previous monthly close is above (bull market) or below (bear market) its 10-month simple moving average. We consider Top 1, equal-weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners for the baseline SACEMS lookback interval. We focus on monthly return, monthly volatility and compound annual growth rate (CAGR) as key performance metrics. In a robustness test for the EW Top 2 and EW Top 3 portfolios, we consider lookback intervals ranging from one to 12 months. Using monthly total (dividend-adjusted) returns for SACEMS assets since February 2006 and monthly S&P 500 Index level since September 2005, all through January 2022, *we find that:*

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**February 22, 2022** - Strategic Allocation

What is the overall best way to weight stock portfolios? In their February 2022 paper entitled “Weighting for the Right One: Weighting Scheme Design for Systematic Equity Portfolios”, Wei Dai, Namiko Saito and Gigi Wang compare eight stock portfolio weighting schemes frequently used in systematic strategies, five that ignore prices and three that do not, as follows:

- Weighting schemes that ignore prices are:
- Equal weighting – assign all stocks the same dollar weight.
- Rank weighting – separately rank all stocks from large to small, growth to value and low to high profitability, and then re-rank and weight based on averages of individual ranks.
- Z-score weighting: separately calculate z-scores (number of standard deviations from average) for each firm’s market capitalization, relative price and profitability, transform the z-scores into a value between 0 and 1, and weight in proportion to the product of the three standardized z-scores.
- Inverse volatility weighting: weight each stock in proportion to the inverse of its daily return volatility over the last 60 trading days.
- Fundamental weighting: weight each stock in proportion to the sum of book equity, sales and cash flow per share during its latest fiscal year.

- Weighting schemes that incorporate prices are:
- Rank x mcap: weight each stock in proportion to the product of its rank weighting (as defined above) and its market capitalization.
- Z-score x mcap: weight each stock in proportion to the product of its standardized z-scores (as defined above) and its market capitalization.
- Integrated core: separately sort all firms by market capitalization, relative price and profitability into groups with similar characteristics; within each group, weight firms in proportion to their market capitalizations; and, further weight each group in proportion to its aggregate market capitalization times a multiplier capturing its overall size, value and profitability premiums as modified for interactions among them.

They rebalance each portfolio semiannually. They consider stock universes with and without microcaps (bottom 4% of market capitalizations). Their approach focuses on the importance of accounting for current market prices that reflect the latest news and market expectations. Using data as described for all U.S. common stocks (excluding REITs, tracking stocks and investment companies) during July 1974 through December 2019, *they find that:*

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**February 15, 2022** - Calendar Effects, Strategic Allocation

A subscriber asked whether the Simple Asset Class ETF Momentum Strategy (SACEMS) exhibits monthly calendar effects. In investigating, we also look at the Simple Asset Class ETF Value Strategy (SACEVS)? We consider the Best Value (most undervalued asset) and Weighted (assets weighted by degree of undervaluation) versions of SACEVS. We consider the Top 1, equally weighted (EW) Top 2 and EW Top 3 versions of SACEMS, which each month equally weights the top one, two or three of nine ETFs/cash with the highest total returns over a specified lookback interval. We further compare seasonalities of these strategies to those of their benchmarks: for SACEVS, a monthly rebalanced 60% stocks-40% bonds portfolio (60-40); and, for SACEMS an equally weighted and monthly rebalanced portfolio of the SACEMS universe (EW All). Using monthly gross total returns for SACEVS since August 2002 and for SACEMS since July 2006, both through January 2022, *we find that:*

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**February 14, 2022** - Economic Indicators, Strategic Allocation

Using quarterly data in their April 2013 paper entitled “Analyzing Federal Reserve Asset Purchases: From Whom Does the Fed Buy?” Seth Carpenter, Selva Demiralp, Jane Ihrig and Elizabeth Klee find that some categories of investors appear to sell U.S. Treasuries to the Federal Reserve and rebalance toward riskier assets (corporate bonds, commercial paper, and municipal debt). Are stocks, proxied by for SPDR S&P 500 (SPY), a part of this process? To investigate, we relate weekly, monthly and quarterly U.S. stock market returns to changes in the Federal Reserve’s System Open Market Account (SOMA) holdings, comprised of U.S. Treasury bills, U.S. Treasury notes and bonds, U.S. Treasury Inflation-Protected Securities (TIP) and Mortgage-Backed Securities (MBS). The Federal Reserve reports these holdings as of Wednesday, typically with a 1-day lag. Using weekly (Thursday close) dividend-adjusted prices for SPY and weekly total SOMA holdings during early July 2003 through January 2022, *we find that:*

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