Gyroscopic Investing

I downloaded annual returns from portfoliovisualizer.com to create my own backtesting spreadsheet for the PP+SCV+Top-2-MOM strategy.  The numbers work out a bit differently from InsuranceGuy's but generally the same.  It seems like much of the outperformance was in the 1970s when gold was going crazy, which some people think is not likely to happen again or at least within a foreseeable return period.  The real CAGR from 1973-1979 for the PP+SCV+Top-2-MOM was 13.09%, whereas for the PP+SCV (5x20) it was 5.84%.  For the period of 1980-2015, the CAGRs were 6.29% versus 5.21%, so there still was a significant difference, but not as pronounced.  However, very surprisingly, the worst-year real return of the PP+SCV+Top-2-MOM for 1973-2015 was only -6.76%, which is better than the worst-year real return of the PP+SCV of -9.49%.  Thus, by adding a once-a-year momentum trade, you can gain significant CAGR and potentially reduce your downside risk.  Seems like a free lunch.  The chart below shows the rolling 5-year average real returns for the two portfolios.

InsuranceGuy wrote:

MachineGhost wrote: BTW, whats the difference between LC Blend and the S&P 500?

No difference, just differing terminology for the same thing.

Did you rebalance the PP/VP mix each year?  I'm surprised that using 5 more years (1968-1972) would cause such differing results from what I am seeing.

I wonder too if you could provide the Sortino Ratio for each case as the MaxDD may be larger but on average you have less frequent drawdowns.

An asset was bought (sold) anytime the rolling 12-month absolute momentum less cash return was positive (negative), so if you want that condition to only be checked only once a year (or quarterly, monthly, weekly), I'll have to generate a third set of statistics.  But I can tell you that could be much riskier because of waiting up to 12 months to actually sell the asset.  Signals also can come and go as quick as one day before and/or one day after the day you choose to buy (sell). 

Since you're using annual return data, you have to consider that the methodology is not robust because it is using a fixed 12-month period only back from a fixed January 1st.  That is potentially data mining the calendar.  The PP itself will actually have a 5% or so larger MaxDD depending on when you buy and rebalance every year, reaching the worst in about the middle of summer.  Another thing to consider is the size effect only exists in January since it is a rebound from December's tax-loss selling.

I don't have Sortino coded up in Excel, but Sortino doesn't measure the frequency of drawdowns, only the downside deviation below a minimum return threshold.  If you care about the depth and the duration of drawdowns, then the Ulcer Index is what you want and is what I personally use.  I don't like to publicize it as I don't want it becoming widely known.

Actually, I guess doing it that way with relative momentum doesn't make too much sense.  They should be all ranked at the same time, regardless of their absolute momentum.  Blimey, back to work!

Here are the real inflation-adjusted CAGRs and worst year returns for different percentages of the Base portfolio (5x20 golden butterfly) plus remainder in the Top 2 assets from the previous year, trading once per year and backtested using annual returns only.  Notice that at 30% Base plus 35% each in the Top 2, you have a worst year that is actually slightly better than the worst year for the Base portfolio, but your 1980-2015 backtested CAGR is 1.23% better, which is a significant improvement.  This may be a great strategy for a younger person who feels rightfully that the PP is underpowered for retirement investing.  To reduce number of trades each year, I'd probably start at say 20% or 30% Base and let the Base drift downward for the next few years as new money is invested, and only bring it back to the starting percentage after it gets severely out of whack.

The percentage of the time in the Top 2 for each asset was as follows:

Large Cap Blend              26.1%
Small Cap Value              28.4%
Long Term Treasuries      17.0%
Gold                              18.2%
Cash/Money Market        10.2%

LCB and SCV were in the Top 2 together 34% of the time.

Also, on average, you only need 1.05 switches per year.  In other words, typically one of the Top 2 will stay in the Top 2 the next year, so you only have to sell one of the Top 2 and buy a different asset to replace it, rather than having to sell both and replace both.  Of course, sometimes you have to sell both (and sometimes you don't have to sell either one, because they both remain in the Top 2), but on average you only need to sell one per year.

stuper1 wrote: Very interesting that each time either LCB or SCV was negative, the other was positive.  This is not what I would have expected.  I thought they were more correlated than that.  In fact, there were only five times when either one of them was negative (out of 30 total events, demonstrating the efficacy of momentum), and in four of those cases the other one had a positive return that was greater than the negative return of the negative one.  Of course, this is no guarantee of future results, but it is very interesting.

A rising tide lifts all boats, but small companies are the first to move after a bear market (flight to growth) and large companies are the last to implode after a bull market (flight to quality).  Small companies also don't have any or as much foreign currency sales exposure so they benefit from a stronger USD whereas large companies do not.  Similar to gold, you had a confluence of what seems like one time events occuring in the 1970's: high inflation, a Nifty 50 bear market, a depreciating currency and then a secular bottom in 1982....  so that was some major tailwinds.  Since stocks were undervalued en masse, a simple shotgun approach of investing in a dumb size/value index would have (and did) worked.

stuper1 wrote: Seems like a free lunch.  The chart below shows the rolling 5-year average real returns for the two portfolios.

Don't be fooled.  It's an artifact of using low sample data.  If you only sample once a year as with annual returns, you miss the sequence of downside risk in-between.  In all cases, momentum will increase risk to a portfolio, requiring some kind of downside risk management to keep it from getting out of control.

It goes without saying that if you don't overweight your equity to whatever factor, you won't wind up missing out on the others that you may not have been exposed to.  Market-cap weighting naturally concentrates into the large sizes.

MachineGhost wrote:

stuper1 wrote: Seems like a free lunch.  The chart below shows the rolling 5-year average real returns for the two portfolios.

Don't be fooled.  It's an artifact of using low sample data.  If you only sample once a year as with annual returns, you miss the sequence of downside risk in-between.  In all cases, momentum will increase risk to a portfolio, requiring some kind of downside risk management to keep it from getting out of control.

It goes without saying that if you don't overweight your equity to whatever factor, you won't wind up missing out on the others that you may not have been exposed to.  Market-cap weighting naturally concentrates into the large sizes.

Can you try to explain this in a bit more detail, but maybe simpler language for a simpleton like me?  I can understand that using annual data is only going to be an approximation of actual results.  But if I'm only trading once per year at the end of the year, is the approximation really going to be that far off from reality? 

On a separate point, isn't the downside risk management for this strategy the fact that you check at the end of each year, and if an asset is not in the Top 2, then you switch it?

stuper1 wrote: Can you try to explain this in a bit more detail, but maybe simpler language for a simpleton like me?  I can understand that using annual data is only going to be an approximation of actual results.  But if I'm only trading once per year at the end of the year, is the approximation really going to be that far off from reality? 

On a separate point, isn't the downside risk management for this strategy the fact that you check at the end of each year, and if an asset is not in the Top 2, then you switch it?

If you don't check your portfolio performance daily, weekly, monthly or quarterly then its a case of out of sight, out of mind.  How likely is that with an active strategy you don't trust 100%? 

Yes.

EDIT: I don't think starting at 1968 makes sense for gold.  It would need at least one year after depegging to generate any true momentum (or not).

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InsuranceGuy,

Very nice spreadsheet.  Thank you for sharing that.  Much more elegant than my own.  My returns are slightly lower than yours because, I think, I used "cash/money market" returns for cash rather than "short term treasuries".  Overall my results are consistent with yours, which hopefully provides some validation to both of us.

There is something I noticed in both of our results that is very intriguing to me.  With a PP+Top-2-MOM strategy, the maximum single year drawdown increases as you increase the percentage allocated to the Top 2.  This is what I would expect.  However, with a PP+SCV+Top-2-MOM strategy, the maximum single year drawdown actually decreases until you get past 50% allocated to the Top 2, and this is consistent for all decades you looked at, as well as for the entire period.  For some of the decades, you get all the way up to 100% allocated to the Top 2 and the MaxSYDD is still lower than the PP+SCV alone.  This makes me think that maybe there is some reliable "secret sauce" here that is not just an artifact of backtesting.  Do you agree?  If so, what do you think might explain this?

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InsuranceGuy wrote:

stuper1 wrote: InsuranceGuy,
There is something I noticed in both of our results that is very intriguing to me.  With a PP+Top-2-MOM strategy, the maximum single year drawdown increases as you increase the percentage allocated to the Top 2.  This is what I would expect.  However, with a PP+SCV+Top-2-MOM strategy, the maximum single year drawdown actually decreases until you get past 50% allocated to the Top 2, and this is consistent for all decades you looked at, as well as for the entire period.  For some of the decades, you get all the way up to 100% allocated to the Top 2 and the MaxSYDD is still lower than the PP+SCV alone.  This makes me think that maybe there is some reliable "secret sauce" here that is not just an artifact of backtesting.  Do you agree?  If so, what do you think might explain this?

My hypothesis is that the the PP+Top-2-MOM it increases as there the 2nd top asset is either adding little reward or reducing little risk so no matter how much you add you are hurting your risk to reward ratios.  The PP+Top-1-MOM on the other hand adds reward for little risk up to a point and then at some allocation the added return is not enough to compensate for the risk.  The PP+SCV+Top-2-MOM seems to show a similar pattern where you are able to add reward while maintaining adequate risk levels until you reach a point where additional rewards do not compensate for the additional risk.

Alternate Stock classes seem to be a good diversifying choice for moving up to the Top-2 from the Top-1.  It seems to not just be SCV, I see that SCB or REIT or Pacific or Emerging seem to have a similar effect.

Is it basically that with 5 asset classes to choose from, instead of 4, there is a greater chance that the Second-Best Asset will be a good one in the following year?

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I was able to finally use yearly periodicity on daily data for rebalancing so I've redone the stats.  This will show the proper MaxDD compared to using just annual returns.  Also I corrected a bug so 1yr TBills can never be bought (how can it as it will never exceed the return of itself?), so all uninvested capital is in 90day T-Bills.  TopX 100% would just be using dual momentum without any position size enhancing on top of the HBPP; TopX 0% would be the 25%x4 HBPP.

[img width=800]http://i.imgur.com/Ls7ln7L.png[/img]

So it looks like a 90% HBPP, 10% Top4 Dual Momentum VP is optimal.  That would be 22.5% into each asset, plus an extra 2.5% for those assets evidencing dual momentum.

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InsuranceGuy wrote: MG how are there such different CAGR for 10% momentum?  I see <0.1% change in CAGR for top4 how in the world are you getting a 1.06% increase?

I'm not sure what you mean?

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InsuranceGuy wrote: I mean if I go from TOP4 0% to 10% my CAGR based on 1973-2015 increases from 8.71% to 8.74%... I'm at a loss how you're seeing an increase from 7.58% to 8.64%.

Okay, I found and corrected some minor mistakes.  How's this:

[img width=800]http://i.imgur.com/MEjgoGt.png[/img]

I'm burned out on this.  I've come to loathe Excel.

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InsuranceGuy wrote: It still doesn't look right as adding momentum should probably increase your CAGR yet for TOP3 and TOP4 that is not happening.  If you have the daily data and wouldn't mind sharing I'd be happy to try my hand at it.

Okay, my latest try (I used monthly periodicity instead of yearly and new code):

[img width=800]http://i.imgur.com/Cy1kk50.png[/img]

I believe this is correct as there is no momentum to add in a Top 4 with four assets.  It would just be pure absolute momentum which lowers returns and risk.  (I hate that term "absolute momentum" so I'm going back to using "trend following").

Let's see what you come up with!!!

Note that for accuracy purposes, I sell at close on the last business day of the year and buy at open on the first business day of January.  In reality we'd probably wait 366 days but it gets it out of sync too much.

EDIT: The MaxDD for HBPP is not matching reality which is 20%.  I quit for now.  I just can't put up with another 30 second freeze (or permanent lockup!) in Excel while it recalculates.

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Except for the MaxDD your results more or less tracks my latest results.  Maybe I got a bug somehwere in that routine in Excel but I sure am not going to go look for it anytime soon.

So can we conclude that doing dual momentum is still worth the bother?

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