A Better Global Asset Allocation Strategy?

As parts of the economy slowly recover, investors may be looking for a better and more strategic global asset allocation strategy.

Below is a model that can be researched and implemented by investors that will provide exposure to the strongest performing global exchange traded funds (ETFs), while overlaying the portfolio with a risk-based strategy.

What Is A Global Asset Allocation Strategy?

A global asset allocation strategy attempts to take advantage of relative strength and momentum within global markets. Typically asset classes are used via ETFs or mutual funds instead of individual securities, as the latter may have higher overall transaction costs.

Since most of these strategies focus on quantitative methodologies, they tend to have shorter holding periods when compared with a portfolio holding individual equities. As a result, positions are typically held less than a year and can rotate between various asset classes such as equities, fixed income, currency, etc.

The objective is to provide investors with the opportunity to invest in economies around the world — both major and emerging — while providing a risk-based approach in order to reduce exposure to volatile economies during uncertain times.

Active Management vs Buy and Hold?

The first question I usually hear from investors is: why we don’t just buy and hold instead of using a global asset allocation strategy? The truth is, informed portfolio managers have had much more success using a systematic-based approach instead of the “set it and forget it” attitude of the 1990s.

The last secular bear market that US investors faced occurred in 1968 and lasted until 1982. During that time, buy and hold investors saw a great deal of market volatility, but received little in return for their patience.

global asset allocation strategy

The National Association of Active Investment Managers (NAAIM) did a study on the time period from January 1984 to December 2008 to show the difference in performance that active investment management can have over a buy and hold strategy. The study found that if you missed the 10 best and 10 worst days in the market, the resulting return would have been 8.15%, as compared to the 7.06% S&P 500 Index return:

active money management

So how does an investor miss the worst days?

In his 2006 book, Stocks for the Long Run, Jeremy Siegal studied the Dow Jones Industrial Average (DJIA) from 1886 to 2006 and  found that the 200 day moving average provided a way for investors to reduce volatility in their portfolios and increase returns by avoiding stocks when they trade below the 200 day moving average.

More recently, Mebane Faber’s book The Ivy Portfolio studies the use of moving averages and found similar results using a 10 month moving average:

ivy portfolio

Additionally, this strategy was able to avoid most of the 2008 stock market decline:

2008 market decline

Timing + Relative Strength + Allocation

First, for those not familiar with the concept of relative strength, Investopedia defines it as follows:relative strength

By comparing relative strength among globals ETFs, we can figure out the 10 strongest performing ETFs (done on a monthly basis). The 10 ETFs are allocated equal weight within our global asset allocation strategy, then overlayed with the 10 month moving average.

The ETF universe that I used is prescreened for liquidity, trading volume, overlap, and bid/ask spreads and is as follows:

etf list

If the ETF is trading below the 10 month moving average, then it is replaced with iShares Barclays 20+ Yr Treasury Bond ETF (“TLT”) or similar ETF. The reason the country specific ETF is replaced with “TLT” is that as equity markets in overseas countries start to decline, assets tend to move to one of two places: stronger performing countries or safe haven assets.

Currently, US Treasury Bonds are considered by many to be the safest asset class in the world. In fact, this model allows 100% of the portfolio to be invested in TLT in cases of global shock, as in 2008.

This process is continued and rebalanced monthly.

Results For The Global Asset Allocation Strategy

To compare results of our strategy, I took the above criteria and backtested the results using ETFreplay.com (which is a fantastic site that allows investors to research and backtest different ETF strategies). During this time frame, the model outperformed the S&P 500 with less overall volatility:

Relative Strength + 10 Month Moving Average

results

Conclusion

Investors are able to reduce volatility and drawdowns by investing in a US Treasury Bonds ETF (“TLT”), as global economies trend downward below their respective 10 month moving average.

By combining relative strength with a 10 month moving average, investors can create a more tactical investment strategy which has outperformed the S&P 500 Index during the past 10 years.

Data:

For those interested, here are links to the buy/sells for the above strategies. I used ETFreplay to produce the backtested graphs.

Global Asset Allocation Strategy Data:

Global Asset Allocation Strategy

-Relative Strength Only Model Data

-Moving Average Only Model Data

-Buy and Hold Model Data

Note: I am including the data using the non relative strength/moving average model, but instead of cash, the model moves into “TLT”. The backtested performance is better, however I didn’t include it above, since the higher levels of trading may be a bit complex and costly for non-institutional investors.

-Moving Average Only Model Data with TLT

 

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Comments

  1. By DMThomas on

    Very interesting. In addition to the asset allocation strategy results, have you tested this with other ETFs? Specifically international bonds, sectors, currency etc.

    I am curious as to the results in international yields vs stock performance.

    • By John Rothe on

      I am in the process of doing a more in-depth white paper which examines the pros/cons of relative strength over various asset classes and time frames. I will post the research when its finished.

      Thanks
      John

  2. By Tim Mazanec on

    Hi John, Interesting but two items of note. You are using monthly charts to invest “tactically”. Also using price action to discover allocation and trend appears to make it vulnerable to future shocks. Please have a look at SectorID.com where I utilize market behavior to discover trend and asset allocation across asset classes. Regards, Tim

    • By John Rothe on

      Thanks Tim – I will look at the site in more detail. Looks interesting. Thanks for sharing – John

  3. By chrisusnvet on

    Has anyone tested the model on a longer term basis? How would one do that? Most ETFs haven’t been around longer than 15-20 years.

    Maybe a backtest using the top weighting of each index, each year, per country?

    Is is possible to get a copy of the best/worst days missed? I haven’t seen a study where it misses both the best and worst days.
    Thank you

    • By John Rothe on

      @Chris – using country based indices for longer term testing is one of the topics I am working on now. It does become more difficult to test these type of strategies with the limited ETF data,

  4. By chwilowki on

    Does your strategy take into account the change in currency prices?

    If the US dollar continues to drop will the model change?

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