This is probably the #1 question I receive on email, usually in two forms:
q #1 – “Meb, have you considered combining the two timing systems? Use the rotation system across the 5 asset classes from your book, but sell an asset and move to cash when it declines below its X moving average?”
or
q #2 – “Meb, have you considered combining the two timing systems? Use a rotation system but move to cash for the whole portfolio when it declines below its X moving average?”
The questions sound similar but are slightly different. I don’t think #1 will make any difference in performance (since I wrote this post I tested it and confirmed that it makes no difference). For the vast majority of the time the asset is already above the moving average until the end when it drops, and the moving average usually doesn’t pick that up.
Q#2 is much more interesting to me. However, you can only test this WITHIN an asset class. Below we take a look at US Stocks. (I see no reason this wouldn’t work in other asset groups like commodities, bonds, currencies, and foreign stocks.)
I used the Fido Sector funds from 1988-5/2009.
I took the top fund, updated monthly, based on the average rolling 3/6/12 month performance.
I then took the top 3 funds, equal weighted and updated monthly, based on the average rolling 3/6/12 month performance.
I then took the same portfolios, but moved them to cash when the S&P500 declined below its long term moving average (10 month simple).
Results are below. Note how the rotation system generates about 5-6% outperformance per year. The volatility is high (likely due to the upside volatility), and drawdowns are similar to buy and hold. Using the timing system to hedge the portfolios resulted in declines in volatility (around 20%) and most importantly, a reduction in drawdown from 53% to around 27%. Sharpe #s are misleading due to the high returns. . .
One could simply buy the ETFs or mutual funds when above the SMA then hedge or sell and move to cash when below. Depending on the fund/broker, there could be $$ transactions costs involved (especially if the account was small). One could also just move into a rotation fund when above, then sell when below. (Note: I haven’t looked at ANY of these funds below so no recs either way. Most of them FAIL for various reasons). If I am missing any, add them in the comments and I’ll edit.
PS Anyone wanna take the over under on how long till Barclay’s Blackrock offers momentum ETFs? I say by the end of 2009.
Broad rotation funds (benchmark, 60/40 or diversified benchmark)
FUNDX Tactical Upgrader, (TACTX).
DWA Balanced (DWAFX).
US Stock rotation funds (benchmark, S&P500)
FUNDX Upgrader Fund (FUNDX)
Rydex Sector Rotation Fund (RYSRX)
DWA Technical Leaders (PDP)
VL Industry Rotation (PYH)
VL Timeliness (PIV)
Claymore/Zack’s Sector Rotation (XRO)
Foreign Stock rotation funds (benchmark, MSCI EAFE)
Rydex International Rotation Fund (RYFHX)
Claymore/Zack’s Country Rotation (CRO)
In registration:
AQR International Momentum Fund
AQR Momentum Fund
AQR Small Cap Momentum Fund
IndexIQ Momentum Leaders All Cap Fund
XTF COUNTRY ROTATION ETF PORTFOLIO
XTF SECTOR ROTATION ETF PORTFOLIO
Log and non-log charts of the equity curves below.
Interesting. I wonder how the strategy would work if you used leveraged funds when the S&P was above the 200 day SMA.
Soooo, basically you're sayign be invested in all times except apocalyptic events? How often is the TOP performing class/fund trading below its 200d MVA?
(sorry if it came across as unclear).
what i meant was that the rotation picks up assets going up, then they mean
revert at the end but still above the SMA,
so it doesn't work as a stop loss
we show leveraged results for the portfolio in my paper and book.
I have the book on order – thanks.
I bought the book – I thin you did a good job – it exceeded my expectations – the correct use of statistics was very nice. Most finance guys/economist types don't seem to have the best grasp of math. Of course math guys don't seem to have a good grasp of anything but math. You can thank Random Rodger for mentioning you on his site.
thanks!
Another thought is that as you mention there are a number of sectoral approaches possible – domestic, international, commodities, etc. At this point, some would not permit entry, since the relevant indexes are below their 200 day average, but others, such as using ishares international regional etfs, with the MCSI ACWI are above the 200 day average. I wonder how a strategy of searching several indexes before deciding which to use would work…
If I read the results correctly, if you sell your fund(s) that you rotated into when the S&P 500 dips below its 200 day SMA, you INCREASE your returns and LESSEN the volatility! This would seem to be a must, in other words.
What indexes would you use for the other asset categories? Less correlation among foreign countries and emerging markets and between diverse commodities would seem to preclude this in some of the other asset classes. I would guess bonds might work well though.
I see some difficulty in using this with different asset groups. If you were to try this strategy for currencies, what benchmark would be used given that in aggregate a currency benchmark is essentially a zero sum benchmark?
Also, for bonds, would it make sense to limit the sector rotation to one country (ie US bonds only via Lehman US bond index), given the difficulty in benchmarking global bonds via accessible and liquid investment vehicles?
Another idea for a filter for momentum-type systems (which I sometimes personally use) – go to cash when the median return factor (ie in your case this would be the sum of 3mo/6mo and 12mo return) for all assets that you track becomes negative – as this would indicate that most assets tend to decline over multiple timeframes that you track.
etfscreen.com is an excellent site for this type of analysis. Performance data are sorted and tabled with the click of a mouse. RSI ranks offer another cut at performance. It's free.
Thanks, Mebane. Your stuff is fabulous.
Could someone PLEASE elaborate on this: “I took the top fund, updated monthly, based on the average rolling 3/6/12 month performance.” Does one calculate three numbers for each fund being considered and then select the “top” independently from the times used? For example, if I were considering 5 funds, I would select the top value from a list of 15?
Thanks.
RG–I believe what Mebane does is average the returns for each fund for three periods, i.e., 3/6/12 months. That would give you one number for each fund, or 5 numbers for the 5 funds that you're considering. Pick the top one (or top three funds, if you perfer.) Repeat monthly.
My impression is that some folks have modified his system to their own specs. Read back through the comments on previous, related posts.
I don't understand why you can't do it along all five asset classes. Among the five asset claases that you use, lets take the strongest one. If it is above its X moving average you invest in it. Otherwise you remain in cash. Have you backtested this?
sree–Mebane has a post on that subject dated February 5th. Do a search for Asset Class Rotation. That was the original idea as I understand it.
What is Top1 Hedged? Is it sell the holdings and go cash when S&P 500 below 200 SMA? or go short?
Thanks
For this test, it appears to be the former–sell the holdings and go to cash when the S&P breaches the 10 month sma. I see no mention of going short.
Can you explain what you mean by 'hedged' in the post on combined timing and rotation models. I can't tell is it means to sell out of all positions when below the 200 sma for an index, or something else.
I have a comment/question about your answer to question 2. Let's assume you use the rotation and classes of assets in ivey league portfolio and use the top 3 assets. Assume a $100,000 account. Let's say I put a 1/2 in VTI,VEU and VNQ. If I then appy the timing model if any of these 3 assets class. Do I go to cash on each asset that goes below its 200 day moving arage. So for example if VTI dropped below its 200 day moving average would I just go to cash that month and then wait for the next month and buy. If the other two assets are above their 200 moving day average do I hold. In sum, confused about whether I move each asset class(of 3 that I hold) when breaks 200 day average. If I move to cash do I redploy to asset class above 200 moving day average or wait one month and then by best performing asset of the two I don't own if it is above its 200 day moving average. Finally, do you recomend 2 or 3 asset classes when using rotation with timing model. Thanks. Evan
I bought your book and found it very interesting. However, I found the explanation of the Rotation System just a bit thinner that I would have liked. I would like to see an example of exactly how your calculate the 3/6/12 return average. Is there somewhere I can get that level of detail. Also, if you use the rotation system with the five etfs mentioned in your book that cover the broad asset classes, do you simply put all your money into the top 1, 2, or 3 performing etfs based on the calculation at the end of each month? Or am I missing something? Do you a place where you update the rotation system each month like you do for the timing system?
Enjoyed your book. In it you describe the “top 3″ (momentum) portfolio. What is the “Top 3 Hedged”? Thanks.
Have you considered testing the same system but applying into to sectors within US stocks? Perhaps using GICS or Russell Sectors. I expect that it would further outperform as you not be in poor performing sectors even while the overall market might be going up.
Have you considered testing the same system but applying into to sectors within US stocks? Perhaps using GICS or Russell Sectors. I expect that it would further outperform as you not be in poor performing sectors even while the overall market might be going up.