Generating Equity Returns with Bond Risk

Back in 2017 I posted about how I use some of Mebane Faber's long term investing systems - post #109 in the thread "Long Term Investing Strategies"

These 2 strategies form about 95% of my offshore investing.

The first one I have been using since about 2010, and during lockdown I wrote the attached which explains the logic behind it, and a step by step process of how to get to the end result, which is to generate Equity Returns with Bond Risk - "Global tactical Investing"

The second one I put into a Fund (with a couple more tweaks) as per my bio.

I will use this thread to post updates to the first strategy, what it is invested in, and results for the year/month - Anyone who would like further details on it, please ask away. It is easy to implement and run, takes 30 mins-1 Hour a month (although I know that will be too long for some of you )

Current Holdings are:-
SPY (S&P 500)
IYR (US Real Estate)
DBC (Commodity basket)

the strategy lost 1.63% in September, and is up 19.7% Year To Date.

And just to clarify, I am a big believer in index investing and diversification. 90% of my Australian investments are LIC/ETF, very simple. I do like the above strategies as they diversify the portfolio primarily from a Risk Management point of view.

 

A couple of quick questions from an initial scan.

How do the returns look after tax compared to a buy and hold strategy given the high turnover going back and forth between the 5 assets and cash?

How is relative strength determined to pic the 3 strongest assets?

 

Hi
Geneally the wins are held for longer than a year and receive CGT benefits. I have not done a detailed analysis of after tax returns, but ideally you would hold in a low tax environment such as super. Mine is in the Family Trust.

For the relative strength I use the average of the 1/3/6/9/12 month returns. Again many ways to skin this cat and I suspect they all work similarly well.
Cheers for the questions
gav

 

10 Month SMA?
exit/entry on day after month end?

 

Correct - same rules as Mebane's rules in the paper he wrote (and book).

 

Tax and slippage are your costs for volatility reduction.

You need a lot of data to know whether trend persists long enough to nullify slippage and tax consequences long term. Using 10 month EOM on individual shares enables a big data set - it doesn't appear to add value there.

Would have to be something special about interaction of 10M EOM with the items you are trading that will persist.........or something about the relative strength regime that will persist because its highly doubtful the trend trigger has any persistent benefit.

Your a million miles away from proving persistence of system or even making me think it might be there with what you have provided so far. The Upside, at least flipping the approach wouldn't likely prove profitable either with any sort of persistence so following it shouldn't do anything more than introduce a random outcome from the underlying exposure distribution.

From your perspective, picking up some management fees on random outperformance is good, from the investors perspective paying it is bad.

From my perspective you have a complete lack of data to prove that it is anything other than randomness but it certainly introduces tax costs. Don't mean to be rude in my opinion, it is just as I see it. Hey at least my post will give you something to address if you wish.

Trend is a nice theory for volatility reduction but in practice is a whole different matter. Relying on trend means you are holding higher volatility assets than you really want and hoping you can exit without more slippage than you can handle. Decrease the slippage and you increase the whipsaws and as always with any system - mind the GAP. How does 1987 look?

If somebody is tempted to buy into this "your cake and eat it too" scenario of equity return with bond risks, you don't know enough to be safe out there.

If you want less volatility, dampen your portfolio by consistently holding less volatile assets.

Don't buy lotto tickets and hope for random luck.

Be safe out there people.

 

Thx Dunno, lots to unpack.
I presume you are talking about the "Global tactical investing" system that was the focus of the attachment.
Tax and slippage are your costs for volatility reduction.
Agreed - Tax is highly personal, as I said obviously a low tax environment is preferred. Slippage is dependent on where you trade. If somewhere like Interactive Brokers it is negligible.

You need a lot of data to know whether trend persists long enough to nullify slippage and tax consequences long term. Using 10 month EOM on individual shares enables a big data set - it doesn't appear to add value there.

The system only deals with indices, not individual stocks. But you are right, 10M MA does not work on individual stocks, because they have roughly double the volatility of indices, and are subject to too many whipsaws.
This guy has a great blog which looks at exactly this problem, and comes up with a few solutions.
Trend Following In Financial Markets: A Comprehensive Backtest
Also has some excellent posts on trendfollowing, but you need a chunk of time...

Would have to be something special about interaction of 10M EOM with the items you are trading that will persist.........or something about the relative strength regime that will persist because its highly doubtful the trend trigger has any persistent benefit.

Your a million miles away from proving persistence of system or even making me think it might be there with what you have provided so far. The Upside, at least flipping the approach wouldn't likely prove profitable either with any sort of persistence so following it shouldn't do anything more than introduce a random outcome from the underlying exposure distribution.

The piece was meant as an intro to the work, and to see what was possible - anyone who would start trading the system based on that would fail as they would not have the confidence in it when it hit a tough patch - which make no mistake it does. There are dozens and dozens of books/academic papers out there on trend and momentum for further research, some of which I mentioned in the paper.

From your perspective, picking up some management fees on random outperformance is good, from the investors perspective paying it is bad.

From my perspective you have a complete lack of data to prove that it is anything other than randomness but it certainly introduces tax costs. Don't mean to be rude in my opinion, it is just as I see it. Hey at least my post will give you something to address if you wish.

I dont see it as rude, and am very happy to discuss. This system is completely different from my Fund. It is something for investors to investigate, and implement on their own if they think it suits - i dont want anything from it, all the info is out in the public domain.

Trend is a nice theory for volatility reduction but in practice is a whole different matter. Relying on trend means you are holding higher volatility assets than you really want and hoping you can exit without more slippage than you can handle. Decrease the slippage and you increase the whipsaws and as always with any system - mind the GAP. How does 1987 look?

1987 the system returned 9.89%, about 1% better than the index. Trend is all about volatility reduction, NOT return enhancement. If you read Meb's book he runs a basic trend system across multiple markets - the result across all was a significant reduction in drawdowns, and same or slightly improved returns. (these are all indices,NOT individual stocks as discussed above)

If you are an index investor, you are a trend trader - the indexes are constantly dropping weak stocks and adding strong stocks.

If somebody is tempted to buy into this "your cake and eat it too" scenario of equity return with bond risks, you don't know enough to be safe out there.

If you want less volatility, dampen your portfolio by consistently holding less volatile assets.

Don't buy lotto tickets and hope for random luck.

Be safe out there people.

Trend/Momentum and Value are probably the most researched factors in the financial arena. There is plenty of material to research and make up your own mind.

For me, a basic portfolio of the VAS/VGS type should be the foundation. From there if you want to diversify your risk profile, a system as described in the paper is a perfectly good place to start your research. It is not for everybody, goes through tough times when it is whipsawed and is hard to stick to at times - but so is gritting your teeth and holding when your portfolio is down 30/40/50% - choose your hard.

Happy to discuss further, I appreciate the input!!

 

Thanks @Gav for responding with discussion and not offence.

Two blog posts that I think you will enjoy (read in order). They will both re-enforce your position and question it and save me trying to convey in detail some of my thoughts.

Trend Following In Financial Markets: A Comprehensive Backtest
Growth and Trend: A Simple, Powerful Technique for Timing the Stock Market

Grab a coffee they are in depth. His other posts are also excellent and probably much of it would be of interest to you if you haven't already come across it, especially the older stuff where he was more technical oriented whereas the newer stuff is more fundamental/economics based.

 

No worries @dunno - there has been no shortage of financial scams recently, a sceptical attitude is the way to go.

Seems we have the same reading interests - the first blog post you referenced is the same one I referenced in my reply to you. I have really enjoyed his stuff, and it helped clarify a lot of my thinking.

Another blog you may enjoy, he also clarified a lot of my thinking is this guy if you have not come across him already.
- profiting from randomness

Lets catch up for a coffee at some point!!

 

Hi @Gav

Ha first apologies for not reading your response carefully and noting the link you referenced. A shared reading list of that uniqueness is rare. Knowing you have a deeper understanding puts things in a different light.

The claim of increased return and lower risk is the holy grail, bandied around by people selling stuff and half the time they don’t even have an inclination of how much they don’t know or worse still they are being deliberately deceptive.

I had made assumptions and put you in that club. In my defense – you had made the claim without too many qualifiers, the document you presented was superficial, you are selling your fund management.

Momentum both cross sectionally and time series(trend) like it seems is the backbone of your approach has potential merit. My overwhelming concern for most people is that it requires switching higher risk regime to lower risk regime to achieve average regime outcome. It only takes one transactional or behavioural mistake. Ie needing to take an action that you can’t because the exit/entry is not wide enough or because you behaviourally freeze, and you are holding a risk position not suitable for your appetite. If on the other hand you just buy and hold your desired risk appetite exposure – lack of action doesn’t expose you beyond your appetite, it simply keeps you where you should be.

In saying that what you are proposing is not suitable for most people is not saying it is not suitable for everybody. If you know all the potential pitfalls – realise nothing in this area is a given. There is way to many degrees of freedom in the approach for any back test data to give you anything more than potential glimpses of relevant information. Know your behavioural weaknesses and how they might be exposed by trading….. blah blah blah than then there is probably enough in TSMom and CSMom to stay interested if you are that way inclined.

If you are going to be the sort of participant in the forum that is more inclined to expose the weaknesses/concerns/risks of the system that you advocate so that anybody that may eventually join you is fully informed of what they are getting into than I would be very interested to see your future posts.

But stuff that looks like a superficial marketing route and I will probably ark up – just my nature, seems I have a combative instinct.

I probably won’t join in the discussion too much. My active investing passion lies in following trends in individual business fundamental performance so that’s where I like to direct most of my allocated investment time.

 

Thx @dunno, looks like we are largely on the same page.
My marketing skills are without a doubt subpar, and blunt....in my defence I am a complete newbie to the marketing game.....

I have always wondered why more people dont take advantage of this approach to investing. Sometimes I think I am just too close to it, but your views have given me a different perspective.

Anyway, really appreciate your input.
Cheers
gav

 

October Update
No change to the portfolio at the end of October. The system had a blinder in October, one of the better months I can ever remember trading the system, and probably the best year I have ever had trading the system as well (So far...)
Portfolio was as follows for October, and remains the same going into November.
SPY (+7.02%)
IYR (+7.28%)
DBC (+5.8%)

Return for the month was 6.7%, and Year to Date 27.6% (USD base)

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

For me it is another form of diversification for my portfolio.

 

November system update
No change again to the portfolio at the end of November. November was a tougher month, particularly for commodities, and some of the October gains were given back. The portfolio for November(and going into December) was as follows:-
SPY (-0.8%)
IYR (-2.41%)
DBC (-8.76%)

Return for the month was -4.3%, and Year to Date 22.13%.

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

For me it is another form of diversification for my portfolio.

 

December system update
No change again to the portfolio at the end of December. December delivered a nice Santa rally for the system, with one of its best month's ever , up 6.85% - individual constituents below
SPY (+4.63%)
IYR (+9.47%)
DBC (+6.67%)

Return for the month was +6.85%, and Calendar Year 30.5%.

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

This has been the best year for the system since I started trading it around 2011. Given that reversion to the mean is a real thing, I would expect a smaller return in 2022, but nobody can see what the future brings.

Hopefully its another great year for everyone!!

 

January 2022 System update
No change to the portfolio at the end of January. January was mixed, equity markets were lower, which was offset by a nice rally in the commodity index - individual results below
SPY - -5.27%
IYR - -8.23%
DBC - +7.89%

Net result was -1.87% for the month.

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

 

February 2022 System update
No change to the portfolio at the end of February. February pretty much a copycat of January, with Equities/RealEstate lower, and commodities higher, resulting in a flat month pretty much.
SPY - -2.95%
IYR - -4.59%
DBC - +6.47%

Net result was flat for the month. SPY and IYR both closed below there 10M moving averages, so stops are now put in place for those 2, just below last months lows. Risk management mode kicking in.

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

 

March 2022 System update
No change to the portfolio at the end of March. March was a good month, with all 3 components of the portfolio moving higher.
SPY - +3.76%
IYR - +6.86%
DBC - +9.17%

Net result was +6.6% for the month. SPY and IYR closed back above 10M moving averages, out of danger territory for now.

The strength of DBC (commodities) has been a real asset to the portfolio over the last year, however this exceptionally strong movement over the last 3 months has me a little nervous - anyway, just got to follow the system....

As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

 

April 2022 System update
No change to the portfolio at end April, however after the drops IYR and SPY have stops in (or would be sold if you follow the original paper)
SPY - -8.78%
IYR - -4.13%
DBC - +5.64%

Net result was -1.6% for the month, and +3.1% YTD. SPY & IYR closing below their 10M MA 's, and put back on notice. Commodities continue to save the day.


As has been stated before, this thread is meant as an introduction to a different style of investing and managing your risk (trend following). It is not for everybody, and requires a lot of research, understanding how the system works (and does not ) in different market conditions before you would even consider trading it. It is not designed to be a return enhancer, but is more a risk reducer.

The system I run is slightly different to the one presented in the paper in the first post, where I have tweaked the system to my personality (just full disclosure). Do your own research, past returns are no indication of future returns etc.

 

I'm assuming after a bit of whipsaw most trend following systems are flat by now.

 

Pretty much , this one was stopped out of SPY & IYR earlier in the month, so at present 2/3 cash, 1/3 long commodities