Tag Archives: nreum

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 (MUTF: VSMGX ), which allocate 60% stocks/40% bonds, or Conservative Growth (MUTF: VSCGX ), with a 60% bonds/40% stock allocation. The majority of returns were generated by the Growth (MUTF: VASGX ), Income (MUTF: VASIX ), and the S&P 500 Fund (MUTF: 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. Moderate 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 (MUTF: 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 (click to enlarge) 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 (click to enlarge) 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 improve 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 (MUTF: 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. Disclosures: None

3 Keys To Navigating A Low Return Environment (Video)

2015 has me wondering – is this a precursor to what the future could look like? That is, are the low returns across so many asset classes likely to be a sign of what’s to come? In a BNN interview from this morning, I laid out the case for why returns are likely to be lower, and how we can be proactive about it. Here’s the gist of my thinking: We know that the Global Financial Asset Portfolio is roughly a 45/55 stock/bond portfolio today. We also know that bonds likely won’t generate high returns in the future, given the low interest rate environment (current rates are a very reliable indicator of future returns). We also know that stocks are overvalued by many metrics, and are very likely more risky than they were in 2009/10/11. So, let’s be generous on the stock side and assume 10% returns and 3% from bonds (also generous given the aggregate yield of about 2.5%. That gets us to about 6.5%. But what’s scary about the 6.5% is that it will be driven mainly by the inherently more risky piece of the portfolio – the stocks. So, returns are likely to be lower and/or riskier than we’re used to. Given this high-probability outcome, I think the markets have forced us to get creative to some degree. No one in their right mind is going to hold a 30-year T-bond to maturity, given the near-0% probability of generating a high real return. Likewise, given the risks in stocks, I think you have to be somewhat selective about where you diversify. So, what can we do? I offered three keys: Control what you can control. The only way to guarantee higher returns is by reducing taxes and fees. My general rule of thumb is to try to always maintain a 366-day time frame and never pay more than 0.5% per year in fees. Diversify, but don’t diworsify. You can be diversified without owning everything in the whole world. This market environment is forcing us to be somewhat selective about where we diversify our assets. I focus on a cyclical approach . Learn to be dynamic without being tax- and fee-inefficient. A static 50/50 or 60/40 isn’t likely to generate the types of returns investors have become accustomed to. You can be strategic in your portfolio without being hyperactive. This could mean a more thoughtful approach to rebalancing, or it could mean veering more into strategic asset allocation. “Active” is only a four-letter word in this business if it’s tax- and fee-inefficient. After all, as I’ve discussed repeatedly , we all have to be active to some degree, but there are smart ways to do this and self-destructive ways to do this… You can watch the full interview here: Share this article with a colleague

Regional Banks And Canadian Dollar: 2 ETFs Trading With Outsized Volume

In the past trading session, U.S. stocks were broadly mixed as relatively positive bank earnings and a favorable Chinese GDP data outweighed imminent rate hike worries. Among the top ETFs, investors saw the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) shed 0.03%, the SPDR Dow Jones Industrial Average ETF DIA move higher by 0.01% and the PowerShares QQQ Trust ETF (NASDAQ: QQQ ) gain 0.11% on the day. Investors can take note of two more specialized exchange-traded products in particular, as both saw trading volume that was far ahead of normal. In fact, both these funds experienced volume levels that were more than double their average for the most recent trading session. This makes these ETFs ones to watch in the days ahead to see if this trend of extra-interest continues. iShares U.S. Regional Banks ETF (NYSEARCA: IAT ): Volume 6.61 times average This regional banking ETF was in focus today, as over 1.36 million shares moved hands, compared to an average of roughly 227,000 shares. We also saw some share price movement, as shares of IAT gained 1.3%. The movement can largely be credited to the Fed’s latest indication of a rate hike later this year. This can have a big impact on regional banking stocks like what we find in this ETF’s portfolio. Also, relatively upbeat expectations for banking earnings led to this heavy trading. Though for the month IAT was down 0.2%, the fund currently has a Zacks ETF Rank #2 (Buy). CurrencyShares Canadian Dollar Trust ETF (NYSEARCA: FXC ): Volume 3.66 times average This Canadian dollar ETF was under the microscope today, as nearly 195,500 shares moved hands today. This compares to an average trading day volume of 53,400 shares. FXC lost about 1.4% in the session. The big move today was largely the result of depreciation of the Canadian dollar after the Bank of Canada slashed its key interest rate to 0.5%. FXC was down about 4.7% in the past month, though the shares currently have a Zacks ETF Rank #3 (Hold). Original Post Share this article with a colleague