World Beta Blog

Mark Hulbert takes a look at trendfollowing in his recent article Making the Trend Your Friend. In the post he backtests the 200-day SMA back to the late 1800′s and finds that it beats buy and hold.  (Although he does not mention the reduction in volatility and drawdown which are the two main benefits of a moving average strategy – they are NOT absolute return enhancers even though they often beat buy and hold by a few percentage points – many people miss this…however for a more apples-to-apples comparison one can use momentum or relative strength to outperform by 3-4 percentage points with similar vol.)

He goes on to test the system over the past two decades and comments that the system didn’t work on an absolute basis (again no mention of vol or drawdown).  Oddly he ignores cash returns –  Tbills yielded 3.7% over this period which is not nothing.  He also ignores transaction costs which would have penalized the timing system depending on the account (some accounts have transaction and friction free trading, etc).

Anyways, below is the same system (on a monthly level using the 10 month SMA) since 1990 on the S&P 500 total return (not sure why he used the Dow which is priced based and very very few people invest in).  I included the return on cash when out of the market.  As you can see, the trendfollowing system beat buy and hold across every metric – compounded return, volatility, Sharpe Ratio, and maximum drawdown.  (If you are new to the site you can find more info on the topic in a couple white papers “A Quantitative Approach To Tactical Asset Allocation“, and “Relative Strength Strategies for Investing“.)

LeBaron also mentions currency trend systems no longer working which contradicts the work I have done internally (will get the paper out soon, promise!)

With the US Dollar being undervalued against most pairs on a PPP valuation basis I thought I would chime in quickly as a follow up to our last currency post.  This post is a snippet from a much longer post/white paper/book but below I take a look at a simple topic, the currency carry trade, and a different way to think about it.

The most popular currency valuation model is the purchasing power parity model (PPP model, wiki entry here).  It often takes makes many years for currencies to revert to their “fair value”, and there is a gazillion additions and refinements one can make to improve a model such as this.   A chart of the USD/AUD is below and you can see how slow the PPP line moves:

However, that doesn’t mean one cannot profit from simple models, and the carry trade has been an example of another simple model that has worked over time, and DBV is an ETF that is listed on the strategy.  (Disclosure:  We do not own any DBV but own other currency ETFs and may own any/all in the future.)

But as far as the simple currency strategies go (momentum, trend, yield curve, etc) carry is one of the best returning but worst diversifying to a normal portfolio as it has some nasty left skew and kurtosis.  However, like many asset classes or strategies, it depends on when you allocate – and in this case it depends on the valuation of the long basket vs. the short basket.  The methodology we are using is the G-10 based on OECD numbers.

If you look at the one year returns since 1975, the returns to a carry trade are largely dependent on the basket valuation.  ie you are essentially betting on a valuation spread and historically it has been better to be relatively long undervalued currencies and short overvalued ones.  But that has been the case with every asset in history – it is better to pay a lower value than higher (duh).  That seems like an obvious statement but how you determine “value” in a world of emotional humans is the $mm question.  It looks like the Yen and the Swiss Franc are particularly vulnerable right now.

Below are the returns to the carry trade for one year holding periods based on valuation spread (I also included a leveraged version as many funds run it 2x)  for various buckets of under/overvaluation (long 3/short 3 from G10):

Hat tip to Deutsche Bank for the inspiration for the concept.

David Merkel is doing some really nice posts lately and here is one focusing on combining valuation and momentum in building a stock model:  The Impossible Dream

(And if you can’t tell by the stream of posts I am finally back in town after my 13 city trip…)

Surfer Keith Malloy’s movie about his passion for bodysurfing: “It’s about taking a breath, and kicking your feet, in the big blue sea … come hell or high water.”

(Hat Tip: MS)

I’d like to hear from any of the currency trader followers on their favorite models for trading currencies based on valuation (not momentum, interest rates, carry or anything else).  The most typical is Purchasing Power Parity (ie think the Big Mac Index) using OECD data.  The biggest difficulty is that the valuation in currencies can take many years to correct.

Some more background from Deutsche Bank here on some very simple models (here and here).

I’ll follow up with a longer post in the next few days on an interesting take on the currency carry model.

Nice post by the good folks at Empirical Finance on testing the Magic Formula and having quite a bit of difficulty replicating it…

In a related note, I was reading a magazine on the plane recently and read a really odd statistic.  It referenced another research piece, which referenced another research group.  I emailed them, and sure enough they had coded it wrong.  The funny thing is, I’ve now seen it replicated about 10 places on the web elsewhere…goes to show you should always take a critical view and question what you read.

(Note:  We all make mistakes and I’m focusing less on the error as this group does fantastic work, and more on the way disinformation can spread like wildfire….)

with the way I receive and distribute information.  I am constantly thinking of ways to better streamline my life and to have better filters for the info I receive…lots of room for improvement and would love to hear from readers with ideas.

Now that I am back in town I have about 6 papers, ideas, and pieces I’d like to publish in some form or another and not real sure how to do it…

That Way I Receive Information

I want resources that make my life easier, not more difficult.  The web, for the most part does the opposite for me in that I get blasted with more (but less relevant) info than less (but more relevant) info.  Most financial websites, in an attempt to accumulate as many pageviews and thus revenue, do the exact opposite of what I want.  While I have friends at most of these sites, I would take Abnormal Returns 1000x over the site that does 350 posts/day and another site that has over 4000+ contributors.

One difficulty here is the scatterbrained way in which I get my info, which currently consists of:

-Subscribing to 20+ magazines that get read mostly on the exercise bike or airplane,

-ordering 70+ books from Amazon per year, reading/skimming them and returning/selling probably two thirds,

-visiting the blogs on the blogroll sporadically (maybe weekly unless linked elsewhere, and I hate RSS readers),

-using Instapaper for longer form posts and reads,

-going to Abnormal Returns everyday,

-reading Twitter and getting frustrated that I can’t seem to save links easily,

-reading new papers on SRRN (usually linked by CXO),

-reading Ned Davis everyday, etc etc.

I need a better process for this.  #1 is the inability to have a single resource for reading the manager commentary/research from the institutional crowd in one place.  I originally designed Hedge Fund Letters to do this but it became a distraction as it required MORE effort not less to update, etc.  I’ve been playing around with Scoopit and some other ideas for curation and aggregation but no simple answers yet.  Fire over any ideas you have…

The Way that I Distribute Information

This is equally as big of a challenge for me.  So far I have experimented with :

-publishing academic articles, but the drawback is looong cycle time, and limited review audience,

-posting to SSRN, although I feel like the audience is limited,

-publishing books, but the publishing model is dead as my friend James has pointed out so many times (although PushPop is interesting),

-writing for third party websites, but the relationship is one-sided, and most sites I don’t want to be associated with (ie noise machines),

-writing the blog, but the format is not suitable to longer form pieces which is my biggest interest (although I am going to attempt a 20 page piece here next week to see what it looks like).

Would love to hear any suggestions for improving/streamlining either process.  And an update, I just bought a MacBook Pro and an Ipad 2 and loving both so far…

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Great new sites from Entrepreneur’s 100 Brilliant New Businesses:

CalcMoolator

For your Groupon drunks – Bevvy

We had the opportunity to ring the bell for the NYSE this morning for our listed ETF – here’s a rare chance to see me in a suit!  I will also be chatting with the folks at Bloomberg around 3:30 as well.