The previous article in this series discussed the ebb and flow of stock markets as they move through long periods of strong and weak returns, often lasting 15 years or more at a time. As such, there are periods when investors can set their sails and ride the prevailing winds to a sunny investment horizon. Alternatively, there are long periods where markets go sideways or down, and where any growth in investment portfolios must necessarily come at the expense of someone else.
Unfortunately, our analysis suggests that we are in the early, or perhaps middle stages of a multi-year period of low market returns, where investors will need to ‘row’ their way to positive investment performance. During such ‘rowing’ periods it is important to consider active strategies that have the potential to provide substantial risk-adjusted returns in any type of market.
Heave Ho
One such rowing strategy was recently outlined in a paper entitled Optimal Momentum by Gary Antonacci. This paper has practical relevance because it closely mirrors the general principles we apply in our proprietary investment models for clients. In the study, Antonacci constructs an investment universe that broadly captures the set of global opportunities available to investors. We simplified the strategy presented in the paper slightly, and altered the investable universe in our study to accommodate the options available to Canadian investors by investing in Exchange Traded Funds (ETFs).
One such rowing strategy was recently outlined in a paper entitled Optimal Momentum by Gary Antonacci. This paper has practical relevance because it closely mirrors the general principles we apply in our proprietary investment models for clients. In the study, Antonacci constructs an investment universe that broadly captures the set of global opportunities available to investors. We simplified the strategy presented in the paper slightly, and altered the investable universe in our study to accommodate the options available to Canadian investors by investing in Exchange Traded Funds (ETFs).
At any given time, our model was able to invest in any two of the asset classes below (in bold) via a corresponding ETF (in italics).
· US Real Estate - iShares Cohen & Steer Realty REIT
· Gold Bullion - SPDR Gold Shares
· Japanese Stocks - iShares MSCI Japan Index Fund
· European Stocks - iShares S&P Europe 350 Index Fund
· Cash - Barclays Low Duration Treasury
· Asian Stocks (ex-Japan) - iShares Pacific ex-Japan
· US Treasury Bonds - iShares Barclay 7-10 Yr. Treasury - 7-8 Yr.
· US Stocks - Vanguard MSCI Total U.S. Stock Market
ETFs trade on the major stock exchanges just like regular stocks, but they behave largely like very low-cost index mutual funds. That’s because each Exchange Traded Fund, or ETF, is constructed to deliver the same performance as a very broad index of underlying securities. For example, investors can purchase a single ETF to experience the exact returns of the entire S&P/TSX Index, the S&P 500, theNasdaq, gold, European stocks, or a wide variety of other asset classes or indices.
In his paper, Antonacci presents a strategy that ranks the investment opportunities above based on how each investment has performed over the prior six months. The concept is based on the well-documented phenomenon in markets called ‘Momentum’, whereby securities that have done well over the recent past have a high probability of continuing their positive performance over the subsequent 1 to 3 month period.
Accordingly, in our study we ranked the above basket of investments at the end of each month according to their relative price performance over the previous six months. At the end of each month, we altered the holdings of the portfolio so that the portfolio always held the two most highly ranked investments. In other words, the portfolio adapted at the end of each month to hold the most prospective investments over the following month based on our ranking criteria.
Table 1.
| |
SYMBOL
|
EXCHANGE TRADED FUND (ETF)/ INVESTMENT MODEL
|
ICF
|
US Real Estate - iShares Cohen & Steer Realty REIT
|
GLD
|
Gold Bullion - SPDR Gold Shares
|
EWJ
|
Japanese Stocks - iShares MSCI Japan Index Fund
|
IEV
|
European Stocks - iShares S&P Europe 350 Index Fund
|
SHY
|
Cash - Barclays Low Duration Treasury
|
EPP
|
Asian Stocks (ex-Japan) - iShares Pacific ex-Japan
|
IEF
|
US Treasury Bonds - iShares Barclay 7-10 Yr. Treasury - 7-8 Yr.
|
VTI
|
US Stocks - Vanguard MSCI Total U.S. Stock Market
|
To illustrate the effect of this ranking and rotation into the most prospective markets each month, in the diagram below, we tracked our model’s holdings for each month of the year 2008 in Figure 1. to demonstrate how the ETF holdings of our model change over time. The numbers represent the monthly total returns for each investment, and coloured squares identify the months where our model actually held the investment.
You can see that our model rotated into gold (GLD) and U.S. bonds (IEF) for the first 7 months of 2008, and then moved out of gold and into cash (SHY) for the remainder of the year.
Figure 1: Highlighted Monthly Model Holdings in 2008
January
|
February
|
March
|
April
|
May
|
June
|
July
|
August
|
September
|
October
|
November
|
December
| |
VTI
|
-6.17%
|
-2.50%
|
-0.90%
|
4.89%
|
2.02%
|
-8.12%
|
-0.62%
|
1.46%
|
-9.24%
|
-17.48%
|
-8.01%
|
1.78%
|
IEV
|
-8.80%
|
-0.47%
|
1.18%
|
4.43%
|
0.41%
|
-9.34%
|
-2.57%
|
-3.97%
|
-12.36%
|
-21.25%
|
-6.72%
|
7.70%
|
EWJ
|
-4.29%
|
-1.49%
|
-1.28%
|
7.36%
|
1.96%
|
-7.47%
|
-3.77%
|
-4.92%
|
-6.57%
|
-15.57%
|
-3.78%
|
11.56%
|
EPP
|
-7.88%
|
-2.57%
|
-2.09%
|
7.76%
|
2.86%
|
-9.16%
|
-4.66%
|
-4.95%
|
-12.67%
|
-26.52%
|
-6.90%
|
9.45%
|
SHY
|
1.65%
|
1.03%
|
0.25%
|
-0.84%
|
-0.35%
|
0.24%
|
0.43%
|
0.47%
|
0.78%
|
1.10%
|
1.10%
|
0.56%
|
IEF
|
3.36%
|
1.24%
|
1.34%
|
-2.41%
|
-1.78%
|
1.14%
|
0.72%
|
1.53%
|
-0.14%
|
-0.87%
|
7.75%
|
5.15%
|
GLD
|
10.84%
|
5.23%
|
-6.00%
|
-4.16%
|
0.92%
|
4.52%
|
-1.44%
|
-9.29%
|
4.11%
|
-16.14%
|
12.57%
|
7.73%
|
Source: Antonacci (2011), Butler|Philbrick & Associates (2011)
It Pays to Row
In terms of performance, our modified Antonacci Model achieved a 407% total return between 2003 and July 2011. In the same period, the S&P 500 index of the largest U.S. stocks returned 68% including dividends. This works out to an average annual return of 21.8% for our simple strategy versus 6.6% annualized for U.S. stocks. Further, while U.S. stocks were dropping over 50% in 2008 our Antonacci study portfolio delivered a positive return of 16.1% (see Figure 2 below). Figure 2. demonstrates the relative performance of our model in each calendar year relative to all of the available investments. Notice that from 2003 to 2011 our modified Antonacci Model never dropped out of the top half in terms of annual calendar-year performance, and never experienced a losing year.
Figure 2:
Source: Antonacci (2011), Butler|Philbrick & Associates (2011)
Source: Antonacci (2011), Butler|Philbrick & Associates (2011)
SYMBOL
|
EXCHANGE TRADED FUND (ETF)/ INVESTMENT MODEL
|
ICF
|
US Real Estate - iShares Cohen & Steer Realty REIT
|
EWC
|
Canadian Stocks - iShares MSCI Canada Index Fund
|
GLD
|
Gold Bullion - SPDR Gold Shares
|
EWJ
|
Japanese Stocks - iShares MSCI Japan Index Fund
|
IEV
|
European Stocks - iShares S&P Europe 350 Index Fund
|
SHY
|
Cash - Barclays Low Duration Treasury
|
SPY
|
US Large-cap Stocks - SPDR S&P 500 Index
|
ANT
|
Modified Antonnacci Model
|
EPP
|
Asian Stocks (ex-Japan) - iShares Pacific ex-Japan
|
IEF
|
US Treasury Bonds - iShares Barclay 7-10 Yr. Treasury - 7-8 Yr.
|
VTI
|
US Stocks - Vanguard MSCI Total U.S. Stock Market
|
Even more impressive, the modified Antonacci model’s worst full calendar year return was positive 10%, versus minus 35% or more for the major stock markets. In fact, the Antonacci model never dropped more than 10% from any peak to trough on its ride to the top, while markets dropped 50% or more!
The Long and Short
The take away from this study is that, if left alone, and especially during low-return periods, financial markets do not deliver returns in a consistent fashion. As such, it is of paramount importance that any investment strategy be able to adapt over time as markets change - moving to bonds, cash or perhaps gold when markets are falling, or into the most prospective markets when markets are rising – rather than sticking with a constant allocation to one market or another over time, per the traditional approach.
The take away from this study is that, if left alone, and especially during low-return periods, financial markets do not deliver returns in a consistent fashion. As such, it is of paramount importance that any investment strategy be able to adapt over time as markets change - moving to bonds, cash or perhaps gold when markets are falling, or into the most prospective markets when markets are rising – rather than sticking with a constant allocation to one market or another over time, per the traditional approach.
After studying the performance of Antonacci’s momentum based strategy over the past decade and considering the returns that buy and hold investing delivered during the same period, it should be clear that a systematic adaptive investment strategy has the potential to add tremendous value in all types of market environments, and especially during highly uncertain and volatile times like today.
For more information about how adaptive, systematic strategies may work well for you, or to read our Estimating Future Returns piece, please visit us on the Web at
http://www.macquarieprivatewealth.ca/specialist/butlerphilbrick/case-studies .
