Asset Class Rotation

A semi-active approach to asset allocation may be the way to go. WorldBeta points out the advantages of a simple asset class rotation approach. The data for the last 30 years shows a substantial increase in return and a reduced drawdown with a modest increase in volatility. WorldBeta describes buying the top 3 of 5 asset classes on a relative strength basis. The top 3 asset classes are selected each month. The asset classes used were US Stocks, foreign stocks, US REITS, US Bonds, and commodities. The first plot above shows the results for this approach over the last 11 years. The return was a bit better than the SPY over the period, and the return was more steady. The second plot shows the results for the last 5 years. The asset rotation had a much better return than SPY.



Adding more asset classes may improve results. For example, the plot above shows the results for the last 3 1/2 years using 4 of 8 asset classes. The return was substantially better than SPY. The asset classes in this case were actual ETFs (AGG, EEM, EFA, IWM, IYR, SPY, and TIP) and one commodity index (DJAIG).

CXOAdvisory reviewed an Asset Class Momentum Trading Strategy and found even better results than WorldBeta. This approach is described in detail at Class Outperformance Investment Strategy. This approach uses 50+ asset classes and selects the 8 or 15 top relative strength asset classes each month. Selecting 8 classes allows for higher returns and volatility equivalent to the S&P 500 while selecting 15 classes reduces the return a bit but also reduces the volatility to less than the S&P 500.

This looks to be a highly effective investment method for long term accounts. I will have to see if I can locate enough data (Yahoo?) to back test 50 asset classes over a substantial time period.