# 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.

**March 22, 2019** - Momentum Investing, Strategic Allocation

Subscribers have questioned selecting assets with negative past returns within the “Simple Asset Class ETF Momentum Strategy” (SACEMS). Inclusion of Cash as one of the assets in the SACEMS universe of exchange-traded funds (ETF) prevents the SACEMS Top 1 portfolio from holding an asset with negative past returns. To test full dual momentum versions of SACEMS equally weighted (EW) Top 2 and EW Top 3 SACEMS portfolios, we add two more copies of Cash to the universe, thereby preventing both of them from holding assets with negative past returns. The SACEMS universe thus becomes:

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)

3-month Treasury bills (Cash)

3-month Treasury bills (Cash)

We focus on the effects of adding two copies of Cash on compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) of SACEMS EW Top 2 and EW Top 3 portfolios. Using monthly dividend adjusted closing prices for the asset class proxies and the yield for Cash during February 2006 (the earliest all ETFs are available) through February 2019, *we find that:* Keep Reading

**March 15, 2019** - Calendar Effects, Momentum Investing, Strategic Allocation

Is there a best time of the month for measuring momentum within the Simple Asset Class ETF Momentum Strategy (SACEMS)? This strategy 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, we compare 21 variations of the strategy based on shifting the monthly return calculation cycle relative to trading days from the end of the month (EOM). For example, an EOM+5 cycle ranks assets based on closing prices five trading days after EOM each 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 for the specified assets during mid-February 2006 (limited by DBC) through mid-February 2019, *we find that:* Keep Reading

**March 13, 2019** - Strategic Allocation

Subscribers asked whether the monthly winner (Top 1) of the Simple Asset Class ETF Momentum Strategy (SACEMS) is more prone to mean reversion than momentum, thereby justifying its exclusion from or lower weight within SACEMS portfolios. SACEMS each month picks winners from the following universe of eight asset class exchange-traded funds (ETF), plus cash:

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, we review relevant past research and conduct in-depth robustness tests of SACEMS monthly returns and volatilities across all ranks 1 through 9 and ranking (lookback) intervals one to 12 months. Limited by availability of DBC (inception February 2006) and a 12-month lookback interval, we start the comparison with March 2007. Using monthly dividend adjusted closing prices for the asset class proxies and the yield for Cash during February 2006 through February 2019, *we find that:* Keep Reading

**March 11, 2019** - Big Ideas, Equity Premium, Momentum Investing, Size Effect, Strategic Allocation, Value Premium, Volatility Effects

How should investors feel about factor/multi-factor investing? In their February 2019 paper entitled “Alice’s Adventures in Factorland: Three Blunders That Plague Factor Investing”, Robert Arnott, Campbell Harvey, Vitali Kalesnik and Juhani Linnainmaa explore three critical failures of U.S. equity factor investing:

- Returns are far short of expectations due to overfitting and/or trade crowding.
- Drawdowns far exceed expectations.
- Diversification of factors occasionally disappears when correlations soar.

They focus on 15 factors most closely followed by investors: the market factor; a set of six factors from widely used academic multi-factor models (size, value, operating profitability, investment, momentum and low beta); and, a set of eight other popular factors (idiosyncratic volatility, short-term reversal, illiquidity, accruals, cash flow-to-price, earnings-to-price, long-term reversal and net share issuance). For some analyses they employ a broader set of 46 factors. They consider both long-term (July 1963-June 2018) and short-term (July 2003-June 2018) factor performances. Using returns for the specified factors during July 1963 through June 2018, *they conclude that:*

Keep Reading

**March 8, 2019** - Calendar Effects, Momentum Investing, Strategic Allocation

“Optimal Monthly Cycle for SACEMS?” investigates whether using a monthly cycle other than end-of-month (EOM) to pick winning assets improves performance of the Simple Asset Class ETF Momentum Strategy (SACEMS). This strategy 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)

In response, a subscriber asked whether sticking with an EOM cycle for determining the winner, but delaying signal execution, affects strategy performance. To investigate, we compare 23 variations of SACEMS portfolios that all use EOM to pick winners but shift execution from the contemporaneous EOM to the next open or to closes over the next 21 trading days (about one month). For example, EOM+5 uses an EOM cycle to determine winners but delays execution until the close five trading days after EOM. We focus on gross compound annual growth rate (CAGR) and 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 daily dividend-adjusted opens and closes for the asset class proxies and the yield for Cash during February 2006 (limited by DBC) through January 2019, *we find that:* Keep Reading

**February 28, 2019** - Momentum Investing, Strategic Allocation, Technical Trading

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 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 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 (limited by DBC) through January 2019, *we find that:* Keep Reading

**February 27, 2019** - Momentum Investing, Strategic Allocation, Technical Trading

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 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 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 (limited by DBC) through January 2019, *we find that:* Keep Reading

**February 22, 2019** - Momentum Investing, Strategic Allocation

Subscribers have asked whether substituting leveraged exchange-traded funds (ETF) in the “Simple Asset Class ETF Momentum Strategy” (SACEMS) might enhance performance. To investigate, we execute the strategy with the following eight 2X leveraged ETFs, plus cash:

DB Commodity Double Long (DYY)

ProShares Ultra MSCI Emerging Markets (EET)

ProShares Ultra MSCI EAFE (EFO)

ProShares Ultra Gold (UGL)

ProShares Ultra S&P500 (SSO)

ProShares Ultra Russell 2000 (UWM)

ProShares Ultra Real Estate (URE)

ProShares Ultra 20+ Year Treasury (UBT)

3-month Treasury bills (Cash)

We consider portfolios of Top 1, equally weighted (EW) Top 2 and EW Top 3 past winners. We include as benchmarks: an equally weighted portfolio of all ETFs, rebalanced monthly (EW All); buying and holding SSO (SSO); and, holding SSO when the S&P 500 Index is above its 10-month simple moving average (SMA10) and Cash when the index is below its SMA10 (SSO:SMA10). Using monthly adjusted closing prices for the specified ETFs and the yield for Cash over the period January 2010 (the earliest month prices for all eight ETFs are available) through January 2019, *we find that:* Keep Reading

**February 15, 2019** - Momentum Investing, Strategic Allocation, Volatility Effects

Subscribers asked whether risk parity might work better than equal weighting of winners within the Simple Asset Class ETF Momentum Strategy (SACEMS), which each month selects the best performers over a specified lookback interval from among the following eight asset class exchange-traded funds (ETF), plus cash:

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, we focus on the SACEMS Top 3 portfolio and compare equal weighting to risk parity weights. We calculate risk parity weights at the end of each month by:

- Calculating daily asset return volatilities over the last 63 trading days (about three months, as suggested). This step includes Cash, which has very low volatility.
- Picking the volatilities of the Top 3 momentum winners.
- Weighting each winner by the inverse of its volatility.
- Scaling winner weights such that the total of the three allocations is 100%. This step essentially puts the entire portfolio into Cash when any of the Top 3 is Cash.

We use gross compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) to compare strategies. We check robustness by trying lookback intervals of one to 12 months for both momentum ranking and volatility estimation (increments of 21 trading days for the latter). Using monthly dividend-adjusted closing prices for asset class proxies and the yield for Cash during February 2006 (when all ETFs are first available) through December 2018, *we find that:* Keep Reading

**February 8, 2019** - Momentum Investing, Strategic Allocation

In response to “Robustness of SACEMS Based on Sharpe Ratio”, a subscriber asked whether Martin ratio might work better than raw returns and Sharpe ratio for ranking assets within the Simple Asset Class ETF Momentum Strategy (SACEMS), which each month selects the best performers over a specified lookback interval from among the following eight asset class exchange-traded funds (ETF), plus cash:

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, we focus on the SACEMS equally weighted (EW) Top 3 portfolio and compare outcomes across lookback intervals ranging from one to 12 months for the following three asset ranking metrics:

- Raw return – cumulative total return over the lookback interval.
- Sharpe ratio (SR) – average daily excess return (asset return minus T-bill return) divided by standard deviation of daily excess returns over the lookback interval, with months approximated as 21 trading days. We set SR for Cash at zero (though it is actually zero divided by zero).
- Martin ratio (MR) – average daily excess return divided by the Ulcer Index calculated from daily returns over the lookback interval, with months again approximated as 21 trading days.

We employ gross compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) to compare ranking metrics. Using monthly dividend-adjusted closing prices for asset class proxies and the yield for Cash during February 2006 (when all ETFs are first available) through December 2018, *we find that:* Keep Reading