Backtests Galore (or, beating Mr. Market)

A reader asked if I had updated backtest results for a variety of ETF Replay and Ivy Portfolio strategies.  I track one tactical ETF asset allocation strategy live on Scott’s Investments using data from ETFReplay.com; however, from time to time I will backtest the results and also show how adding different re-balancing rules impact the results.

The Ivy Portfolio strategy’s long/cash signals (background here) are also tracked on Scott’s Investments, but the portfolio is not tracked live. However, it is easy enough to backtest the results using ETFReplay.com.

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Below are backtest results for a relative strength ETF strategy. Returns include dividends but exclude commissions, taxes, and slippage (in other words, real results will differ). The buy/sell strategy for the portfolio is simple: purchase the top  ETFs based on a combination of their 6 month returns, 3 month returns, and 3 month volatility (lower volatility receives a higher ranking) and the average of  the 3 month return, 20 day return, and 20 day volatility.  I refer to these two different sets as “6/3/3″ and “3/20/20″.  The top 2 ETFs in the 6/3/3 ranking and top 2 in the 3/20/20 ranking are purchased each month.

The backtest below is not identical to the ETFReplay strategy I track on a monthly basis. The difference is that the backtest does not always hold 4 ETFs – if the top 2 ETFs in the 6/3/3 and 3/20/20 rankings are the same, then the backtest holds only 2 (or 3) ETFs.   However, the two strategies are similar and there are several months when both the backtested strategy and the one I track will hold identical positions.

It is also important to note that not all 25 ETFs were available at the beginning of 2005. Less than half were available at the start of the test and not until the start of 2009 were all 25 available.

The first backtest are based on a monthly rebalance beginning in 2005:

The second test is based on a semi-monthly rebalance:

While semi-monthly re-balancing appears to bolster returns, keep in mind that returns exclude commission costs and taxes. More frequent re-balancing will tend to increase the costs associated with both.

The next set of tests refer to the Ivy Portfolio strategy detailed in Mebane Faber’s book The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. I also maintain a spreadsheet which tracks these signals daily and also typically write a monthly review (this month’s review is available here).

When a security is trading below its 10 month simple moving average, the position is sold and cash is held until the next month. When the security is trading above its 10 month simple moving average cash is used to invest in the security.  For the purposes of these tests I used a 5 ETF portfolio consisting of AGG, DBC, VNQ, VEU, and VTI and 10 ETF portfolio consisting of AGG, DBC, GSG, RWX, VNQ, TIP, VWO, VEU, VB, and VTI.

(note: For the purposes of this test I substituted AGG for BND due to the fact that AGG had a longer trading history. BND is tracked on my Ivy Portfolio spreadsheet and is closely correlated to AGG).

Below are the results of a monthly re-balance of the 5 ETF portfolio using a 10 month simple moving average system. This test was run from 2007-present with 2007 being selected as the starting date due to DBC’s shorter trade history. All five ETFs were available at the start of this test:

The next test uses the same rules but tests a portfolio of 10 ETFs. Only 7 of the 10 ETFs were available at the start of 2007, making comparisons to the 5 ETF portfolio incomplete:

The Ivy Portfolio system did a good job of avoiding the significant drawdowns of the 2008. In theory the system may miss the early moves of a bull market, potentially limiting total returns in a prolonged bull market but has historically limited drawdowns and volatility.  It could also suffer from whiplash when a position hovers above and below its 10 month moving average for an extended period of time.  Commissions and taxes will also further reduce returns.

6 thoughts on “Backtests Galore (or, beating Mr. Market)”

  1. With a MAR ratio > 1.5 you can’t really complain about a strategy that’s been stagnant for a year. Also it returned +10% in 2011 when SPY was effectively even.
    Scott, I’m assuming the weekly ETF rebalancing didn’t show any improvements and that’s why you’ve omitted it?

  2. Great article, thank you. I would be curious to see the Ivy portfolio back-tested from the mid- to late-80’s if possible. Do the mutual fund counterparts have long enough history? I am guessing your starting point will greatly impact your returns and I do not believe MA strategies work well in strong bull markets like the 1990’s.

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