Tag: ETF

Building Winning Portfolios with SPDR Sector ETFs

A few years ago, we had a look at using momentum to rotate through SPDR Sector ETFs. We concluded that just buying & holding the S&P 500 ETF was a winning idea. However, after looking at industry rotation in Indian stocks, we checked if using the same technique on SPDR Sector ETFs made sense.

Sadly, no. If you held the top 5 ETFs in the Leading quadrant for a month, you solidly under-performed SPY.

What if you did a 5-year rolling window to pick a portfolio of 4 ETFs that had the highest Sharpe Ratio and held them for a year?

There’s enough juice even after assuming a 25bps transaction cost.

However, the out-performance is uneven. You could go years before you will see this strategy pay off.

There’s a caveat here for Indian investors. Gains for holding periods of less than two years is treated as regular income. So, depending on your tax slab, you could lose in taxes what you gained employing this strategy. A two-year holding period where half the portfolio is rebalanced every alternate year to meet the capital gains treatment had uninspiring returns.

We explored a bunch of other scenarios that did not clear the bar. You can read about it and have a look at the code on github.

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MSCI Country Index Momentum

There are currently around 40 to 45 single-country ETFs actively trading on US exchanges. Is it possible to construct a momentum portfolio that beats a generic all-world momentum offering using them?

We ran a few scenarios. First, we looked at 50-, 100- and 200-day momentum and then we overlaid the same length of trend over them. Compared to both the market-cap and momentum all-world indices, 200-day Momentum + Trend out-performed.

You could also average out the look-backs to get a parameter-free portfolio without regrets.

With the portfolio being equal weighted, it avoids the geographic and industry concentration problem that plagues most momentum ETFs. Besides, there are no ETFs that track the MSCI ACWI Momentum Index right now. Until such a time, DIY!

Code and charts on github.

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Index and Funds

Index funds and ETFs proved most naysayers wrong and finally took off post-COVID. Now, we are dealing with a problem of plenty.

The number of indices and index funds have skyrocketed with the vast majority of AUM concentrated in large-cap market-weighted indices.

As everything in investing, it is always better to wait for things to settle down before committing capital. Index post-launch returns tend to disappoint.

And these numbers are worse for index funds.

While investors win by having low-cost access to a wide range of strategies and sectors, they can still lose by rushing in to “hot” launches. Patience pays.

Charts and code on github.

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Sector Momentum

Previously, we had looked at using the momentum of S&P 500 Sector SPDRs for potential rotation strategies. How would the Indian story unfold?

We take 16 sector indices, use a 6-month look-back window and go long the sector with the highest returns, holding it for a month.

You end up with higher returns but lower Sharpe – makes sense given the super-concentrated nature of the portfolio.

The 4 points of out-performance (after costs, pre-tax) over the NIFTY 100 index is not much to write home about. Besides, this strategy trailed the benchmark pre-2020. If this were pitched back then, nobody would’ve deployed it and nobody would’ve been around for the post-2020 out-performance. On a positive note, the availability of index funds and ETFs should make this strategy fairly easy to implement.

The main caveat is that the index construction rules themselves are subject to change. Mid last year, SEBI capped the maximum concentration of a single stock for a sector index at 35% and required them to have at least 10 stocks.

Code and charts are on github.

Here are some other things we tried, so that you don’t have to:

Equal-weight all Sector Indices

Inverse-volatility weight all Sector Indices

Equal-weight Sectors in an Up Trend

Inverse-volatility weight Sectors in an Up Trend

The excess returns of these alternatives do not justify the costs.

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Index Fund/ETF Tracking Difference

Previously, we had pointed out the wide gulf between ETF closing prices and NAVs. While that continues to exist, the underlying funds themselves don’t track their indices correctly. This tracking difference is the absolute difference between the returns of the fund and the underlying index.

In an ideal world, an index fund or ETF returns should only trail its benchmark by its expense ratio. However, that is not always the case. Some indices are tough to replicate in the actual market due to liquidity issues. Sometimes reference bonds get called away. Proxies don’t exactly replicate the underlying, and so on and so forth.

Thankfully, AMFI (tasked by SEBI) publishes these metrics on their website for all to see.

The differences are hard to notice in short-term data…

… but they add up.

Investors should be aware that not all index funds/ETFs and indices are the same and proceed with caution.

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