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Global Equities Momentum

A slice of Dual Momentum

Gary Antonacci created the Global Equities Momentum (GEM) model that applied dual momentum to stock and bond indices. It toggles between stocks and bonds using 12-month trailing returns. And when it toggles to “stocks,” it chooses between US equities and International (ex-US) equities based on whichever posted higher returns in the previous 12-months. The model uses the S&P 500 index as a stand-in for US equities and the WORLD ex USA index for international stocks.

Investors can use the ETFs SPY/VOO for the S&P 500, SCHF for World ex-US DMs and AGG for bonds while replicating this strategy.

The best part about this strategy is its simplicity. It takes just 3 inputs and anybody can set it up on Google Sheets. Execution is as simple as it gets because at any given point in time, it is long just one ETF. Also, given that it uses a 12-month look-back, it is less prone to whiplashes, resulting in a lower trading frequency.

Specifications & Expressions

When you automate systematic strategies, you need to nail down its exact specifications. In this case, they are mainly: inputs, look-back periods and traded instruments.

The original version of the Strategy uses the S&P 500 and World ex-US both for inputs and as proxies for the traded instruments. However, there is no reason why they both should be the same. Also, what is so magical about a 12-month look-back period anyway? Why can’t it be 6 -months, a month or an average of the last 6-months?

The Strategy only describes a broad idea with one set of Specifications and Expressions out of a multitude. It can (and should) be adapted to fit one’s risk profile and investment horizon.

The Momentum Expression

The easiest tweak to the original strategy is to swap out the traded equity instruments with their momentum counterparts.

At the final step, when it comes to executing the trade, you can use MTUM, the US Momentum ETF instead of SPY/VOO and IMTM, the DM ex-US Momentum ETF instead of SCHF.

Long-only momentum ETFs are highly correlated to their market-cap counterparts but have the potential to juice returns in bull-markets. Since we are trend-following anyway, why not go a step further up the risk-curve and embrace momentum as well?

This is the basic idea behind our Global Equities Momentum I strategy.

The Look-Back Specification

Picking a look-back for trend-following strategies is fraught with data-mining bias. One could potentially test 100s of periods and pick one that gave the best results historically. The data-mined look-back could even work in forward tests but inexplicably, and suddenly, fail in real portfolios.

The safest thing to do would be to not change the look-back periods outlined in the original research. However, the world would’ve changed since its first publication. How do you strike a balance between the two?

This is what we’ve tried to do in our Global Equities Momentum II strategy.

Long look-backs are slow at reacting to rapidly changing markets. Some might say that this is a bug while some might argue that this is a feature. Shorter look-backs, on the the other hand, can react faster but are prone to head-fakes and whiplashes.

The second version of our GEM strategy tries walk the fine line by taking the average of 6- through 12-month returns. It tries to hew close to the original research while acknowledging that the world has gotten faster since it was first published.

No Free Lunch

While the strategy adapts to the broad, slow-moving macro theme of US equity under-performance vis-à-vis rest-of-the-world (were it to occur,) it is not immune to getting whiplashed due to short and steep market dislocations like the COVID crash of March 2020. The strategy got into bonds just when the equity markets were recovering and stayed there until well-after. It is simply not possible to avoid all landmines when it comes to investing.

While we ran our back-tests, we tried a fair amount of permutations and combinations. Some where discarded in spite of having better risk-adjusted returns because they lacked internal consistency. While some slipped into data-mining territory in spite of our best efforts to avoid it. Readers interested in the process and the code can read through our GEM Collection.

Related: ETFs for Asset Allocation

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Embracing Volatility

Market volatility is a feature, not a bug.

In the short run, market is a voting machine; in the long run, it’s a weighing machine. – Benjamin Graham

Price is a measure of Sentiment

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Early last year, when it became clear that the China Virus had spread all over the world and was getting millions sick, overwhelming healthcare systems everywhere, the markets tanked. In USD terms, Indian stocks were down more than 40% and the S&P was down more than 30%.

Then, a miracle cure was discovered and the markets quickly recovered.

Just kidding!

Governments and Central Banks everywhere did whatever they could to lift sentiment. And markets quickly followed.

Sentiment remains one of the least understood but the most important factor in investing. All prices are eventually tied to how optimistic or pessimistic investors are feeling about the future.

While Graham’s weighing machine might arrive in time for tenured investments, like bonds, that have a fixed maturity date, perpetual securities like stocks are always at the mercy of the voting machine, i.e., sentiment.

The Market sets the Price

For stocks, Price = multiple x earnings

For prices to go up, you don’t need earnings to go up. It is enough if multiples do.

The market doesn’t care why you are transacting. Only that you are. It doesn’t matter what your investment horizon is or the type of investor you are, all transactions take place in the market at a price set by it.

As an investor, you can be right about the company (direction of earnings) but wrong about the sentiment (direction of multiple) and can end up with a stock that goes nowhere in price for years and exit with no rewards for your effort.

No such thing as Buy-and-Hold Forever

It is the end of a “long-term” for a subset of investors everyday.

Investors usually save with a specific goal in mind. These goals tend to be time bound: retirement, kid’s education, etc. While their horizons can be “long” at the outset, it gradually shortens as the D-day arrives. Equities (and other high-risk securities) are constantly being sold and rotated into bonds (and other low-risk securities) set by a glide-path.

As much as professionals like to fantasize about long-term investing, the investors in their funds have bounded horizons. This is especially true for open-end funds.

Sentiment + Finite Holding Periods = Volatility

Finite holding periods create the need to transact. This makes it impossible to ignore sentiment. The two combine to create volatility.

It is easy to blame investor greed and fear for bad portfolio outcomes. We have all seen this sketch make the rounds:

Buy High, Sell Low: How To Free Yourself From The Madness

However, even if an investor overcomes the call of greed and fear, it is impossible to ignore time. This makes sentiment the prime determinant of investment outcomes.

If you think investors having longer time-horizons can ignore volatility. Think again. As the chart above illustrates, volatility is an equal opportunity hater.

Embrace and Extinguish

Volatility clusters. You have reasonably long periods of calm, then suddenly a lot of things “go wrong.” Markets gyrate and you feel that all hell has broken lose.

This leads investors to assume that periods of calm are normal and volatility is abnormal. But in markets, the reverse is true. Sudden shocks, volatility and jolts to sentiment are the norm. Calm periods are the anomaly.

Sentiments wax-and-wane. Multiples expand and contract. Markets melt-up and melt-down for no good reason.

The only time-tested way of reducing volatility is asset allocation. Invest in a basket of different assets (make sure that at least a few of them a not financialized) and accept the market for what it is.

Embrace volatility and extinguish it.

Looking for a sensible way to invest? Here’s how to get started.

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Momo "Rapid-Fire" Momentum

High octane strategies for your portfolio

The biggest advantage that retail investors have is that they don’t have to worry about managing a huge portfolio with different types of investors with differing time-horizons and expectations. And of course, there’s the straightjacket of mandates that bind professional investors.

The problem with bucketing yourself as a “value investor,” “contrarian,” “growth,” or “momentum guy” is that you lose the biggest advantage that you have: flexibility and the ability to adapt to the market. Mandates, or lack thereof

Broadly, at a meta-level, investment strategies can either be Ferraris or busses but not both. They are built with different uses in mind. A Ferrari is not going to be able to seat 40 people or tug a 40 ton rig. And you don’t build a bus to go 0 to 60 mph in 3 seconds.

As a retail investor, your life becomes a lot simpler if you decide upfront if you want to drive a Ferrari or take the bus. But once you get on one, be at peace with your decision. Most investors would be better off taking the bus: DCA/SIP into a mutual fund, don’t chase performance, focus on asset allocation and increase your income and savings over time.

However, just because taking the bus is “right” according to conventional wisdom, doesn’t mean that everybody should be forced to get on one. Just like how you have Ferraris, buses and everything else in-between on the road, there are a wide range of investment strategies outside of the mainstream “at-scale” investment vehicles like mutual funds, PMS, managed accounts, etc.

Momo: The Ferrari Of Investment Strategies

Momentum is a well known Fama-French factor. The problem with momentum portfolios have always been the massive left-tail: when markets are volatile, the drawdowns have been heart-breaking. It doesn’t matter if the portfolio is long-only or long/short, there is no escaping the momentum whiplash.

Then there is the question of rebalancing frequency. To scale a momentum fund, managers need to trade-off transaction and impact costs with being responsive to the market. And that means leaving a fair bit of alpha on the table.

This is the constraint of driving a bus. It can be a fast bus. But it is still a bus.

However, what is true for professional investors and funds is not necessarily true for you, the retail investor.

Do It Often, Do It Better

Most of the early factors were researched at a time when compute power and data were hard to come by. Researchers took the short-cut of using monthly returns to run their analysis because it made the problem more tractable. That set a precedent that is being followed to this day: the monthly rebalance schedule.

The problem with a monthly or a quarterly rebalance schedule is that the market has got a lot faster since the days the papers were written. We live in a world where data is abundant and compute power is a fraction of what it used to be. And trading costs have crashed to a small fraction of what it was 30 years ago.

The world changed.

There is no reason why the market shouldn’t be sampled more frequently.

Some Left-Tails Can Be Docked

A higher frequency approach lends itself to better risk management. It allows for a more responsive position sizing system based on market volatility and the ability to employ “stop-loss” exits on individual positions.

While drawdowns are not entirely avoidable given the nature of the markets, it is quite possible to protect the portfolio against the extremely deep ones. And the deep ones seem to occur at least once every three years, or so.

Avoiding the worst of the drawdowns allows for faster compounding of the portfolio.

Momos are risk-managed, frequently sampled momentum strategies.

Our Experience With Momos

We have been running Momo portfolios for both Indian and US markets for a while and we do it for all three flavors of momentum: Relative, Velocity and Acceleration. We’ll get into the differences between these in later posts but irrespective of the flavor, the “container” within which they run are identical.

The flavors wax and wane depending on the market – there is really no way to quantifiably claim that one is better than the other. In terms of personal preference, I would rank Relative Momentum first, Velocity and then Acceleration. To keep things concise, we show Relative “Momo” Momentum performance below.

US Equities

Indian Equities

Does It Scale?

When we discuss these strategies with professional fund managers, the most common question that comes up is “does it scale?”

And the answer is: No.

It doesn’t scale to professional break-even levels. For eg: for an Indian PMS to break-even, it at least needs Rs. 100 cr in AUM. There is no way the Indian Momos scale up to that level.

But it really doesn’t matter to you, the retail investor. Remember: professional investors are driving a bus, you need not.

Trade-Offs

The market abhors a free lunch. So the next questions is: “What are the trade-offs?”

  1. Risk management is not free. There are always trading costs/taxes that affect the final outcome. But the known-knowns are factored into the performance metrics shown above.

  2. Execution lags. There is always a delay between when the trades are triggered and when the execution takes place. This can be narrowed down by automation to a de minimis.

  3. Compliance. There could be employer, broker or regulator imposed limits on how frequently positions can be churned in certain accounts. Momos would be a poor fit in these circumstances given that any deviation from the model triggered trades can lead to substantial deviation in performance.

Next Steps

If you decide that taking the bus is not for you, then we can help. Have a look at the Momo strategies linked below and let us know if you are interested. We are here to help.

US Momos

Relative Momentum

Velocity

Acceleration

Indian Momos

Relative Momentum

Velocity

Acceleration

Check out our completely automated strategies: stockviz.biz/themes

Investing in the US? We got you covered on us.stockviz.biz/themes

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The Permanent Portfolio

Pain is eternal

This post is part of our series on diversification and asset allocation. Previously:

  1. Diversification and its Malcontents

  2. Sequence Risk and Asset Allocation

  3. Static vs. Tactical Allocation

  4. Tactical Allocation

The Permanent Portfolio – an equal weighted allocation to stocks, bonds, gold, and cash – was devised by free-market investment analyst, Harry Browne, in the 1980s. The basic idea is that no matter what the macro environment, the portfolio will not totally crash and burn.

The American Experience

Turns out, the theory largely worked for US investors.

If you look at the rolling 3-year annualized returns of the Permanent Portfolio, never has it given negative returns. In sharp contrast to equities and gold, US bonds have been spectacularly stable. So naturally, an equal weighted allocation to all for assets delivered decent returns with low drawdowns.

Did it work for Indian Investors?

Indian investors need to be careful with their bond allocations.

The Permanent Portfolio allocates 50% towards fixed income. This is a problem for Indian investors because unlike US bonds, Indian bonds do not have a “flight to safety” bid – they tank along with stocks during market panics.

A density plot of annualized 3-year rolling returns highlights the left-tail problem with the Indian Permanent Portfolio:

Take-away

Beware of people preaching simple solutions to complex problems. If the answer was easy someone more intelligent would have thought of it a long time ago – complex problems invariably require complex and difficult solutions. – Steve Herbert

This is another instance of a “copy-paste” solution disappointing Indian investors.

The common thread connecting the misfiring of the 60/40 and the Permanent portfolios is the vastly different paths taken by Indian bonds. Is there a better way to crack this nut? Stay tuned.

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Decoding the 60/40 Portfolio

Get onboard with the embedded assumptions before diving head-first.

The 60/40 allocation – 60% in equities, 40% in bonds – is the bedrock on which most portfolios in the US are built. Jack Bogle was its biggest proponent and it serves as a benchmark in most portfolio discussions.

This post is part of our series on diversification and asset allocation. Previously:

  1. Diversification and its Malcontents

  2. Sequence Risk and Asset Allocation

  3. Static vs. Tactical Allocation

  4. Tactical Allocation

Historical Performance

From a cumulative performance point of view, it is easy to see why it is attractive.

Even with an annual rebalance, the 60/40 delivered. How did it achieve this remarkable feat? Should investors expect similar magic with the same allocation to Indian equities/bonds?

The biggest difference: Volatility

Ever since Volcker got done slaying inflation in the 80’s, US bond yields have been on a secular decline with declining volatility and increasingly occupying the place of a “flight-to-safety” asset.

Indian bonds, however, are in no way comparable to US bonds when it comes to volatility.

Volatility of US Bond returns (3-year, rolling) with those of Indian Gilts:

On a cumulative basis, Indian bond investors have taken a lot of pain for a 50bps out-performance.

Indian bonds haven’t exactly acted as a safe-haven in times of stress for Indian investors. Adding equities into the mix brings out the extreme volatility of Indian stocks:

However, the silver-lining is that Indian asset volatility have been moderating since 2015.

The 60/40

Over a long enough timeline, it looks like the 60/40 should work in India as well.

But, what if, most of the long-term returns that can be seen since 2000 was front-loaded? Rolling-returns over different windows should give us an idea:

The 5-year window shows returns stabilizing around an average of 5% (in USD.)

Embedded forecasts

All investing is forecasting. As much as one would want to follow a 60/40 allocation for its popularity, it behooves to ask: what are the embedded forecasts about Indian equities and bonds in such a strategy?

  1. Bond volatility will continue to go down.

    • The market will continue to deepen.

    • Inflation will be range-bound.

  2. Equities will be loosely efficient.

    • The gap between growth assumptions and equity valuations will be within a gradually tightening band.

  3. Ease of doing business:

    • Contract enforcement

    • Flexible labor laws

    • Infrastructure

    • Bankruptcy protection and resolution

    • Policy stability

Basically, India will move towards an environment with a predictable tax regime, a rules-based fiscal policy, and regulations that are fair and strictly enforced.

Take-away

There are millions of permutations and combinations of securities for investors to allocate. The question that every investor should ask themselves is how much time, effort and money they are willing to spend chasing returns that beats low-cost, set-it-and-forget-it strategies like the 60/40.

If you are in investor who craves simplicity & low-cost and your beliefs about the future is mostly in line with the assumptions presented above, then this is the strategy for you.

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