A couple of weeks ago, I came across an excellent post on the blog Systematic Relative Strength, which focuses a lot on the benefits of relative strength investing, momentum and tactical asset allocation.
You already know that the average Hedge Fund return last year was around -5%, according to the HFRI Fund Weighted composite index. For the author, the problem in 2011 was not the strategies, it was the how the market behaved. The focus of his article is on how traditional tactical asset allocation (TAA) strategies based on relative strength performed in 2011. The research put together by the author provide interesting results.
To perform the analysis, they take a diverse universe of ETFs and create 100 different equity curves for a number of different momentum factors. The universe has a number of different asset classes represented including Equities, Bonds, Commodities, Currencies, and Real Estate. The results provide a good idea about how a simple momentum-based, global TAA strategy would have performed.
The graph and table on the left summarizes the range of expected performance for different lookback periods: 1, 3, 6, 9 and 12-month returns. See how under almost the whole range of parameters the simple TAA strategies underperformed the S&P500. The only exception here was the 3-month period, where in some cases you could get returns above 5%. But the mean return was still negative at around -2%. Our oldest members have seen by themselves that the returns of our strategies have strongly outperformed the returns proposed in these simulations. The Retirement Portfolio returned +11.4%, the Platinum +6.99%, the Conservative +6.23% and the Aggressive +4.71%.
How can that be? There you have evidence that profitable and consistent TAA strategies are not just about choosing a look-back period, listing ETFs and buying the top X. Careful consideration to the ETF universe, asset allocation, volatily and correlation are paramount to design an efficient TAA relative strength strategy.
In his post, that you can read in full here, the author then splits the results over the first four month of the year, where TAA strategies have performed strongly, and the second part of the year, where the extreme chopiness and sharp and quick trend reversals in so many asset classes took a strong toll on performance, whatever the metrics. Clearly, you also have seen the big difference in the two period in our portfolio performance, whose most of the gains were recorded in the first four month of the year. Another take away: stick to your system, you never know which month is going to reward you greatly, and the meat of the performance can be concentrated over only a few months.
This is how the author concludes, and we could not agree more:
“Markets change, and TAA based on momentum is very adaptive. We will not be in a choppy, range bound environment forever. Trends will emerge. (If they don’t, it will be the first time in history.)
Investors were euphoric about momentum-based TAA strategies in the first part of the year. Looking at the data you can see why – they were working exceptionally well. After the last few months, people are certainly not as excited. In reality, now is the time to be really excited about relative strength strategies, not back in April. Now is the time you want to be adding money.”