All posts by oyenscott

Market Reads

Below are investment-related articles I am reading this (wild!) week:

From The Reformed Broker:

My Little Trick for Coping with a Correction
Why the stock market has to go down

Advertisement: Algorithmic Trading System Prospers from Market Collapse

Pragmatic Capitalism:

What The Hell is Going on
What’s Your Max Pain Point?
The Cost of Getting Scared out of Stocks in 1998

Alpha Architect:

Combining Value and Momentum in Stock Selection and Market Timing
Avoid Buying Put Insurance When You are Most Afraid
Crisis Alpha: Surprising Ways to Hedge Stock Portfolio Risk

ETF.com:

Swedroe: Debunking Gold Mythology
Swedroe: Parallels Of Betting & Investing
Understanding ETF ‘Flash Crashes’

And Others,

Timing the Markets with Value and Trend – Meb Faber
How to deal with market uncertainty? Adam Grimes
What Do People Hear? The Irrelevant Investor
Crash Rules Everything Around Me – A Wealth of Common Sense
5 Investments Best Held in an IRA – Charles Sizemore

 

More on this topic (What's this?)
My Stock Watch List for August 2015
Tradeking – Best Broker For New Dividend Investors
Read more on Max, Investment Brokerage - National at Wikinvest

Sunday Reads

Below is my Sunday night investment reading list:

From the Reformed Broker:

The MLP Myth Blown to Smithereens
The Positive Feedback Loop is Broken
The Coolest Portfolio Tool on the Web

Confusing What Just Happened With What Happens Next – Bloomberg

Are Stocks Overvalued? A Survey of Equity Valuation Models – Research Affiliates

Top 10 Trump Rules – The Big Picture

Bring Data – Dual Momentum

Two Centuries of Momentum and What is the difference between Relative Strength and Trend Following?– Newfound Research

Is More Information Making Us Worse Investors? Pragmatic Capitalism

Is Managed Futures Secret Weapon Coming Back? Attain Capital

From Alpha Architect:

Avoiding the Big Drawdown: Is Downside Protection Helpful or Heresy?
Private Equity Replication with Leveraged Small-Cap Value Stocks

From A Wealth of Common Sense:

A False Sense of Security
20 People You Don’t Want to Invest With

From The Irrelevant Investor:

Is Momentum Misunderstood?
Does This Time Feel Different?

From ETF.com:

Swedroe: Battle Of New Factor Models
Swedroe: The Carry Trade Defies Theory
Swedroe: When Bonds Act Like Stocks
3 ETF Predictions For Rest Of 2015

Dual Momentum August Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum.  Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk, also details Dual Momentum as a total portfolio strategy.

My Dual ETF Momentum spreadsheet is available here and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”.

Relative momentum is gauged by the 12 month total returns of each ETF. The 12 month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of iShares Barclays 1-3 Treasury Bond ETF (SHY). In order to have an “Invested” signal the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns.

An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3, 6, and 12 (“3/6/12″) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have an average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF.

Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12″).  The test results were posted in the 2013 Year in Review and the January 2015 Update.

Below are the four portfolios along with current signals:

dual momo

As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions and the terms of their commission-free ETFs could change in the future.

Dividend Champion Portfolio August Update

The High Yield Dividend Champion Portfolio is a publicly tracked stock portfolio on Scott’s Investments.  Its goal is to capture quality high yield stocks with a history of raising dividends.

The screening process for this portfolio starts with the “Dividend Champions” as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years.  Stocks from the Dividend Champion list are then ranked on yield, payout ratio, P/E, and 3 year dividend growth rate.

Stocks are sold on the re-balance date (generally around the 5th of the month) when they drop out of the top 15 (to limit turnover) and are replaced with the next highest rated stock.

The top 15 stocks  are below and displayed in order of their overall ranking (figures are July month-end):

Name Symbol Yield Payout 3-yr P/E
Helmerich & Payne Inc. HP 4.76 42.24 116.13 8.87
Chevron Corp. CVX 4.84 46.83 10.86 9.68
ExxonMobil Corp. XOM 3.69 43.84 13.43 11.89
Emerson Electric EMR 3.63 49.47 7.04 13.62
Eagle Financial Services EFSI 3.39 38.28 2.26 11.29
Community Trust Banc. CTBI 3.54 48.82 1.60 13.78
Universal Health Realty Trust UHT 5.23 64.65 1.29 12.37
Sonoco Products Co. SON 3.39 52.43 3.36 15.46
Wal-Mart Stores Inc. WMT 2.72 40.08 10.98 14.72
Black Hills Corp. BKH 3.89 56.25 2.23 14.47
Universal Corp. UVV 3.65 53.75 2.04 14.74
Old Republic International ORI 4.42 60.66 1.41 13.71
Tompkins Financial Corp. TMP 3.11 48.41 4.99 15.58
Questar Corp. STR 3.79 65.63 6.55 17.30
First Financial Corp. THFF 2.95 38.13 1.41 12.91

EFSI is not eligible for purchase due to its low liquidity.

There is turnover in one position this month.  Cincinnati Financial (CINF) will be sold for a capital gain of 5.64% and original purchase date of 3/6/15.  It will be replaced by Emerson Electric (EMR) which currently yields 3.63%.

The current portfolio is below:

Position Shares Average Purchase Price Initial Purchase Date Percentage Gain/Loss Excluding Dividends Current Allocation
CVX 218 103.1835 12/6/2012 -17.42% 9.55%
EMR 425 49.64 8/4/2015 -0.02% 10.84%
ORI 1145 16.22 4/4/2014 3.14% 9.85%
UVV 348 47.3 4/8/2015 22.56% 10.37%
TMP 429 44.46 8/6/2014 21.01% 11.86%
CTBI 682 36.55 5/5/2014 -3.80% 12.33%
XOM 196 89.01 4/5/2013 -13.34% 7.77%
HP 238 90.57 10/6/2014 -35.42% 7.16%
STR 860 22.8 3/6/2015 -4.25% 9.65%
UHT 398 55.27 4/8/2015 -11.76% 9.98%

 

I also have  a second portfolio using similar metrics as the High Yield Dividend Champion portfolio. The primary difference is it only requires 10 years of dividend increases and it also hedges the portfolio during unfavorable market conditions. Hedging requires margin, but the portfolio can also be implemented without the hedge.

The portfolio is available on Portfolio123, search for ‘Scott’s Dividend Champ Portfolio Hedged’ in the Ready-to-Go section.

ETFReplay.com Portfolio – August Update

The ETFReplay.com Portfolio holdings have been updated for August 2015.  I previously detailed here and here how an investor can use ETFReplay.com to screen for best performing ETFs based on momentum and volatility.

The portfolio begins with a static basket of 14 ETFs. These 14 ETFs are ranked by 6 month total returns (weighted 40%), 3 month total returns (weighted 30%), and 3 month price volatility (weighted 30%). The top 4 are purchased  at the beginning of each month. When a holding drops out of the top 5 ETFs it will be sold and replaced with the next highest ranked ETF.

The 14 ETFs are listed below:

Symbol Name
RWX SPDR DJ International Real Estate
PCY PowerShares Emerging Mkts Bond
WIP SPDR Int’l Govt Infl-Protect Bond
EFA iShares MSCI EAFE
HYG iShares iBoxx High-Yield Corp Bond
EEM iShares MSCI Emerging Markets
LQD iShares iBoxx Invest Grade Bond
VNQ Vanguard MSCI U.S. REIT
TIP iShares Barclays TIPS
VTI Vanguard MSCI Total U.S. Stock Market
DBC PowerShares DB Commodity Index
GLD SPDR Gold Shares
TLT iShares Barclays Long-Term Trsry
SHY iShares Barclays 1-3 Year Treasry Bnd Fd

 

Bring Your Portfolio Into The 21st Century
Free Access – INO.com Special Report

In addition, ETFs must be ranked above the cash-like ETF (SHY) in order to be included in the portfolio, similar to the absolute momentum strategy I profiled here. This modification could help reduce drawdowns during periods of high volatility and/or negative market conditions (see 2008-2009), but it could also reduce total returns by allocating to cash in lieu of an asset class.

The cash filter is in effect this month.  SHY is the highest rated ETF in the 6/3/3 system.  Therefore,SHY will continue to be the sole holding in the portfolio.

The top 5 ranked ETFs based on the 6/3/3 system as of 7/31/15 are below:

6mo/3mo/3mo
SHY Barclays Low Duration Treasury (2-yr)
VTI Vanguard Total U.S. Stock Market
HYG iShares iBoxx High-Yield Corp Bond
PCY PowerShares Emerging Mkts Bond (7-9yr)
TIP iShares Barclays TIPS

 

In 2014 I introduced a pure momentum system, which ranks the same basket of 14 ETFs based solely on 6 month price momentum. There is no cash filter in the pure momentum system, volatility ranking, or requirement to limit turnover – the top 4 ETFs based on price momentum are purchased each month. The portfolio and rankings are posted on the same spreadsheet as the 6/3/3 strategy.

The top 4 six month momentum ETFs are below:

6 month Momentum
EFA iShares MSCI EAFE
VTI Vanguard Total U.S. Stock Market
SHY Barclays Low Duration Treasury (2-yr)
HYG iShares iBoxx High-Yield Corp Bond

 

(EEM), a holding for just one month, will be sold for a loss of 6.31%.  (RWX), a holding since April, will be sold for a loss of 3.89%.  They will be replace by (VTI) and (SHY).

The updated holdings for each portfolio are below.

6/3/3 strategy:

Position Shares Avg Purchase Price Purchase Date Cost Basis Current Value Gain/Loss Excluding Dividends
SHY 149 84.86 5/29/2015 & 6/30/15 $12,644.14 $12,644.14 $0.00

 

Pure Momentum strategy:

Position Shares Purchase Price Purchase Date Cost Basis Current Value Gain/Loss Excluding Dividends
VTI 22 108.84 7/31/2015 $2,394.48 $2,394.48 $0.00
SHY 29 84.86 7/31/2015 $2,460.94 $2,460.94 $0.00
HYG 27 88.8 6/30/2015 $2,397.60 $2,375.19 -$22.41
EFA 39 66.51 4/30/2015 $2,593.89 $2,526.42 -$67.47

Ivy Portfolio August Update

The Ivy Portfolio spreadsheet track the 10 month moving average signals for two portfolios listed in Mebane Faber’s book The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. Faber discusses 5, 10, and 20 security portfolios that have trading signals based on long-term moving averages.

The Ivy Portfolio spreadsheet tracks both the 5 and 10 ETF Portfolios listed in Faber’s book. When a security is trading below its 10 month simple moving average, the position is listed as “Cash”. When the security is trading above its 10 month simple moving average the positions is listed as “Invested”.

The spreadsheet’s signals update once daily (typically in the late evening) using dividend/split adjusted closing price from Yahoo Finance. The 10 month simple moving average is based on the most recent 10 months including the current month’s most recent daily closing price.  Even though the signals update daily, it is not an endorsement to check signals daily or trade based on daily updates. It simply gives the spreadsheet more versatility for users to check at his or her leisure.

The page also displays the percentage each ETF within the Ivy 10 and Ivy 5 Portfolio is above or below the current 10 month simple moving average, using both adjusted and unadjusted data. If an ETF has paid a dividend or split within the past 10 months, then when comparing the adjusted/unadjusted data you will see differences in the percent an ETF is above/below the 10 month SMA. This could also potentially impact whether an ETF is above or below its 10 month SMA. Regardless of whether you prefer the adjusted or unadjusted data, it is important to remain consistent in your approach. My preference is to use adjusted data when evaluating signals.

Bring Your Portfolio Into The 21st Century
Free Access – INO.com Special Report

The current signals based on July 31st’s adjusted closing prices are below.    This month  (BND) (RWX) (VWO) (DBC) (GSG) (VNQ) and (TIP) are below their 10 month moving average.

The spreadsheet also provides quarterly, half year, and yearly return data courtesy of Finviz. The return data is useful for those interested in overlaying a momentum strategy with the 10 month SMA strategy:

Ivy

I also provide a “Commission-Free” Ivy Portfolio spreadsheet as an added bonus. This document tracks the 10 month moving averages for four different portfolios designed for TD Ameritrade, Fidelity, Charles Schwab, and Vanguard commission-free ETF offers.

Not all ETFs in each portfolio are commission free, as each broker limits the selection of commission-free ETFs and viable ETFs may not exist in each asset class. Other restrictions and limitations may apply depending on each broker.

Below are the 10 month moving average signals (using adjusted price data) for the commission-free portfolios:

Free Free2

Mid-Week Reads

Below is a short list of investment articles I’m reading this week:

Stop Thinking About Markets as if They Were Human – Bloomberg View

From Meb Faber: A Summary of Global Asset Allocation

Momentum vs Moving Averages – Newfound Research

From The Reformed Broker:

The World Gets Serious About Climate Change
My Views on Gold: Setting the Record Straight
The Next Big Short…

Pick a Valid Strategy, Stick With It – The Aleph Blog

Swedroe: It’s OK To Ignore Your Portfolio – ETF.com

The Problem With Bond Indexing & A History of Gold Returns– A Wealth of Common Sense

From Alpha Architect:

Eureka! A Valuation-Based Asset Allocation Strategy that Might Work
Market timing with Value and Momentum

Back to Fundamentals – Dual Momentum

Buyback Extravaganza – The Investor’s Field Guide

The Worst Mutual Fund in the World – Fund Reference

Research Affiliates has updated their Asset Allocation tool, definitely worth a look!

More on this topic (What's this?)
Optimizing Your Asset Allocation
2014-Q4 Performance Review
Read more on Asset Allocation at Wikinvest

Sunday Investment Articles

Below are some of my favorite investment related articles from the past several days:

Three Years Down in a Row System – Meb Faber

7 Reasons Google Exploded – The Reformed Broker

From A Wealth of Common Sense:

Luck vs. Skill in Active Management
Why Momentum Investing Works
15 Problems With Real World Portfolios
World Class Comedy or Investing: Are They Teachable?

Alpha Architect:

Our Free Tools Are Updated: Do-It-Yourself Investors Unite
A Live Lesson in Value-Investing: The Energy Meltdown

Decoding The Myths Of Managed Futures 2015 – Seeking Alpha

ETF.com:

Swedroe: Fund Construction Matters
Swedroe: The Truth About The Carry Trade

A Random Ass Kicking of Wall Street – Following the Trend

Lessons from a Crystal Ball – Newfound Research

How To End Index Gaming – The Aleph Blog

All Strategies “Blow Up” – GestaltU

Adding a VIX Signal to Momentum – Econompicdata

Value and Momentum are Correlated – Dual Momentum

The Observation Model is the Best Defense – Blue Sky Asset Management

The Whole Story: Factors + Asset Classes – Research Affiliates

Diverse Momentum – Can We Do Better?

A Diverse Momentum System Using Vanguard Allocation Funds generated a plethora of feedback.  Can we improve or simplify the system? And does it hold up well if variables are changed?

The systems tested in the original article rarely held the Moderate Growth  (VSMGX), which allocate 60% stocks/40% bonds, or Conservative Growth (VSCGX), with a 60% bonds/40% stock allocation.  The majority of returns were generated by the Growth (VASGX), Income (VASIX), and S&P 500 Fund (VFINX).  VASGX’s objective is to hold 80% equities and 20% bonds and VASIX’s objective is to hold 80% bonds and 20% equities.

For example, you can see below the returns of the dual momentum 12 month system without VSCGX or VSMGX.  The system rotated between VFINX, VASIX, VASGX, and cash:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $60,384 9.66% 10.46% 33.21% -6.73% -17.29% 0.71 1.09
Equal Weight Portfolio $10,000 $40,025 7.37% 10.71% 23.23% -27.31% -38.97% 0.5 0.71
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

These returns are largely in line with the original test which included all 5 funds and cash:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $59,952 9.62% 10.45% 33.21% -6.73% -17.29% 0.71 1.09
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

Thus, we are left with a system which largely generated returns based on an 80/20, 20/80, 100% equity, or, with the dual momentum systems, cash (which does not generate a return, but improved risk-adjusted performance by avoiding crashes). I found similar results with the 5 month relative strength and dual momentum systems – dropping the 2 moderate funds had minimal impact on results.

However, another option is to employ a volatility adjusted momentum system to the strategy.  This gets us  closer to the Hoffstein paper referenced in the first article, which compares on a monthly basis, the Sharpe Ratio over a  look-­back period and invested in the option with the greatest risk-adjusted return.

Portfolio Visualizer allows users to make a “volatility adjustment” to momentum tests, whereby the “performance number can be volatility adjusted, in which case the model adjusts the asset return performance by calculating the average daily return over the timing period divided by the standard deviation of daily total returns over the volatility window period.”

When adding a volatility adjustment to our momentum strategy we would expect a more diverse source of returns in our 5 fund model.  Since we are no longer ranking the funds based purely on momentum and instead on their risk-adjusted returns, the moderate funds should have a greater representation in our back-tests. Moderates funds will tend to generate lower pure momentum because they are less concentrated in either stocks or bonds, but their risk-adjusted returns may score higher at times because they have greater balance and potentially lower volatility than the funds more concentrated in stocks or bonds.

In addition to adjusting for volatility, we can also add a 100% bond fund, the Vanguard Intermediate-Term Treasury Fund (VFITX) to our tests, to offset our (potential) exposure to 100% stocks via VFINX. In addition, this gives us the full spectrum of stock/bond allocation, from 0-100%.

A relative momentum system with a 5 month look-back period for returns and volatility adjustment (essentially a  sharpe ratio calculation, excluding the risk-free rate, which is a mute point since we are ranking funds relative to each other) in our 6 fund portfolio of VFINX, VASIX, VASGX, VSMGX, VSCGX and VFITX generates the following:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $49,837 8.59% 6.82% 24.77% -1.70% -11.01% 0.89 1.49
Equal Weight Portfolio $10,000 $37,503 7.01% 8.08% 19.13% -19.10% -29.10% 0.59 0.86
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

A 12  volatility adjusted momentum system on the same portfolio generates the lowest standard deviation and drawdown of any system tested yet:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $49,085 8.50% 6.48% 23.09% 0.36% -4.88% 0.92 1.64
Equal Weight Portfolio $10,000 $37,503 7.01% 8.08% 19.13% -19.10% -29.10% 0.59 0.86
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

 

12 month adj

In both the 5 and 12 month volatility adjusted system we also see much greater representation of all funds, unlike the momentum-only system.

We could test variations of this strategy almost indefinitely. However, two final tests  are relevant for today’s article.  What if we exclude the conservative growth and moderate growth funds in our volatility-adjusted system? Can we simplify things without impacting results? A 5 month volatility adjusted system and a portfolio of VFINX, VFITX, VASIX, and VASGX generates comparable returns to the 6 fund portfolio:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $50,103 8.62% 7.00% 22.79% -1.49% -11.01% 0.87 1.46
Equal Weight Portfolio $10,000 $38,487 7.16% 7.86% 19.66% -17.15% -27.12% 0.62 0.91
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

And the 12 month system and 4 fund portfolio also generates comparable returns to the 6 fund portfolio:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio
Timing Portfolio $10,000 $51,111 8.73% 6.67% 27.77% 0.36% -6.12% 0.93 1.67
Equal Weight Portfolio $10,000 $38,487 7.16% 7.86% 19.66% -17.15% -27.12% 0.62 0.91
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64

4 fund

In both cases the 4 fund system had only slightly higher volatility but comparable risk-adjusted returns.

Hopefully these tests, while not intended to be exhaustive, provide some insight into the potential for a Diverse Momentum strategy. My initial thoughts are that a momentum system of asset allocation funds has merit. Diversification within the assets themselves appears to improved risk-adjusted returns, but the bulk of the returns is in the extremes and not in the moderate allocation funds.  In addition, using risk-adjusted returns to select assets generates superior returns compared to purely momentum systems like the ones in our first article.

Areas of further exploration could include additional asset allocation funds, such as The Permanent Portfolio (PRPFX), or other alternative allocation models, changes to the look-back period, modifications to the 100% stock and bond funds, and/or additional trend filters.

A special thanks to Portfolio Visualizer for the wonderful resource

 

A Diverse Momentum System Using Vanguard Allocation Funds

One of the criticisms of momentum systems is they are prone to crashes when momentum reverts. The system highlighted in this article can be implemented using any number of “life style” or target-risk funds or ETFs.  The system chooses from a small number of funds that reflect a range of asset allocation models.  The purpose is to employ a diverse, momentum-based asset allocation system.  Rather than allocate based on momentum to singular asset classes which increases the potential for momentum crashes, we allocate to asset allocation models themselves.

The tests were conducted using Portfolio Visualizer.  If you have not checked out their site I highly recommend this free tool.  Also, for additional research on this topic please see this award-winning paper by Corey Hoffstein of Newfound Research which served as the original inspiration for these tests.

I ran 5 tests using Vanguard Target-risk funds and the Vanguard S&P 500 Index Fund (VFINX).  The Target-risk funds used were LifeStrategy Conservative Growth (VSCGX) , LifeStrategy Growth (VASGX) , LifeStrategy Income (VASIX) , LifeStrategy Moderate Growth (VSMGX) .  According to Vanguard these funds are “a series of broadly diversified, low-cost funds with an all-index, fixed allocation approach that may provide a complete portfolio in a single fund. The four funds, each with a different allocation, target various risk-based objectives.”  The funds allocate different percentages to bonds (international and domestic) and stocks (international and domestic).

The tests consisted of two simple momentum systems I frequently use on Scotts Investments.  The first is a simple relative strength system where the best performing asset based on trailing returns is purchased.

The seconds is a “dual momentum” system that holds the best performing fund based on trailing returns.  A second filter is used, absolute momentum, to switch the best performing asset to cash if its total returns were below the risk-free rate of cash over the lookback period.  This is similar to my Dual Momentum Portfolio, which is inspired by a paper written by Gary Antonacci and available on Optimal Momentum.  Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk, also highlights his specific system  in greater detail.

The test results for the relative momentum system is below. All tests were from 1996 – present.  The first model used a single performance window of 5 months. The best performing fund was held, and trades were performed at the start of each month.  For comparison purposes an “equal-weight” version each portfolio is also provided but since these are asset allocation funds the comparison is a bit redundant (equal weight is essentially a balanced fund itself):

Timing Model Assets
Ticker Name
VSMGX Vanguard Lifestrategy Moderate Growth Fund
VASIX Vanguard Lifestrategy Income Fund
VSCGX Vanguard Lifestrategy Fund Conservative Growth Fund
VASGX Vanguard Lifestrategy Growth Fund
Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $51,597 8.78% 8.53% 24.22% -10.53% -18.49% 0.75 1.14 0.84
Equal Weight Portfolio $10,000 $35,621 6.73% 8.56% 19.57% -22.73% -32.75% 0.53 0.75 0.96
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

What if we add VFINX to the pool of potential assets? We would expect higher volatility with potentially higher returns since a 100% stock allocation is held at various times ( you will also see the equal weight portfolio has slightly higher returns/volatility because it is tilted towards stocks with its allocation to VFINX):

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $70,161 10.51% 10.21% 33.21% -10.53% -18.49% 0.8 1.24 0.82
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve

Returns and standard deviation increase, which may have been expected.  However, max drawdown and the worst year remained the same, so adding a 100% stock allocation did not impact our biggest loss.

Next, we test a dual momentum approach with a 12 month look back period.  The top 1 fund is purchased based on 12 month returns, but only if the returns are also greater than the return on the risk free rate of cash.  Testing the 4 life style funds (excluding VFINX) yielded the following results:

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $49,142 8.51% 8.78% 22.26% -7.61% -16.17% 0.71 1.08 0.73
Equal Weight Portfolio $10,000 $35,621 6.73% 8.56% 19.57% -22.73% -32.75% 0.53 0.75 0.96
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

What if we include VFINX?

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $59,952 9.62% 10.45% 33.21% -6.73% -17.29% 0.71 1.09 0.73
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve 2

 

Finally, what is we use a 5 month look back period, like the relative strength tests, instead of 12 months?

Portfolio Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Stock Market Correlation
Timing Portfolio $10,000 $62,456 9.85% 9.72% 33.21% -4.74% -15.38% 0.77 1.22 0.7
Equal Weight Portfolio $10,000 $38,242 7.12% 9.85% 21.35% -25.59% -36.63% 0.51 0.73 0.98
S&P 500 Total Return $10,000 $48,177 8.40% 15.47% 33.36% -37.00% -50.95% 0.45 0.64 0.99

Eq Curve 3

 

The sharpe ratio in all 5 tests ranged from .71 – .80 and in each instance outperformed an equal weight portfolio and the S&P 500.   Investors looking for a simple, momentum based system that avoids “all-in” investments in single asset classes should consider a system using asset allocation funds.

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