ETF Rotation Strategies
These strategies use the weighted relative price increases of different ETF’s over both short and longer time frames to decide which ETFs exhibit the strongest price momentum.
There is considerable empirical evidence that shares and funds that exhibit the strongest relative price momentum over several months tend to outperform their peers over subsequent periods (see http://www.ft.com/intl/cms/s/0/58852d80-d910-11e3-837f-00144feabdc0.html#axzz3gXQph017)
There are eight funds we time within MarketTiming’s Global and Local ETF Rotation strategies. Six are used for equity bull markets (three Global regional share funds and three Local industry sector share funds) while two are used in equity bear markets (gold and cash funds). The ASX codes for each ETF (other than CASH) are shown in parentheses.
International Regional Share Funds
Australian Industry Sector Share Funds
Safe Refuge Funds
In bull markets we recommend the local share ETF and the global share ETF which are winning on relative price momentum. In bear markets when share ETFs lose momentum we shift to gold or cash instead.
How it Works
The beauty of the first six funds is that in a bull market at least two of them should be rallying and hence ideal candidates for holding based on their relative rate of price momentum. The gold fund is used for profiting in bear markets (since gold normally rallies in a share crash) and the cash fund is used if none of the other funds exhibits positive price momentum.
Think of a Rotation strategy as a diverse asset class race where you always back the Global ETF doing best and the Local ETF doing best or in a share market crisis (like 2008) using a gold or cash fund for protection. Its construction makes an ETF Rotation strategy the closest thing to an all-weather portfolio.
We use a multiple-period momentum model to time each ETF on a weekly basis (at closing prices each Friday). We then list the best performing Global and Local ETFs in our Weekly Update bulletin as Buys and signal any changes to them as Sells. When commencing a Rotation strategy, equal amounts of capital should be used to buy each ETF. At the end of each financial year the Rotation Strategy’s portfolio can be rebalanced so that its two ETFs are equalised in value.
Back-testing shows a Rotation strategy works with a delay of up to 5 days in executing a signal change to sell an ETF and buy another in its place. That means you don’t need a margin loan account for bridging finance between one ETF being sold and its replacement being bought. Nevertheless, the sooner you act after an ETF rotation alert appears in MarketTiming’s Weekly Update bulletin the better should be the result.
How they have Performed
Because market timing the full set of ETFs only became possible after the 6th February 2012 we are not able to back-test our model’s performance before that date.
But between the 30th June 2012 and the 31st December 2015, the Global part of the ETF Rotation Strategy (comprising a US share fund, a non-US developed markets share fund, an Asian share fund, a gold fund and a cash fund) would have delivered an average annual return 18.0%.
The Local part of the ETF Rotation strategy (comprising an Australian finance sector fund, an Australian resources sector fund, an Australian real estate sector fund, a gold fund and a cash fund) would have generated an average annual return of 12.2%.
These returns were after brokerage of 0.12% per trade and before ETF income distributions.
Over this period the average number of signal changes a year was 4.0 for the Global Rotation strategy and 1.7 for the Local Rotation strategy. The maximum drawdown per trade was 5.0% for the Global strategy and 6.3% for the Local strategy.
To avoid others copying our model we don’t divulge our ETF rotation methodology which is based on a combination of research, back-testing and live trading since September 2015. Of course past performance can’t predict future results. But our ETF Rotation model is based on international best practice in momentum investing.
Attractions and Risks
The ETF Rotation strategies have both attractions and risks. Their main appeal is that momentum investing beats other investment styles such as buy and hold, growth or value (see www.aqrindex.com/resources/docs/PDF/News/News_Case_for_Momentum.pdf and http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2435323)
Also back-testing shows they have less downside risk than buying and holding a portfolio of comparable ETFs. Finally, each strategy does not require a lot of time since it involves on average only around 3 ETF switches a year (i.e. 6 ETF trades); about one ETF switch every four months.
The main risk of a Rotation startegy is that like all trading strategies it can involve losses and opportunity costs, but these are relatively small. For instance the maximum drawdown (i.e. loss) on any trade over the period back-tested was 5.0% for the Global strategy and 6.7% for the Local strategy.
Finally, the Rotation strategies are different to MarketTiming’s Share strategies which are timed on a daily rather than a weekly basis and have tighter stop loss limits; two features that reduce their risk. Note, however, that the Rotation strategy, based on back-tests, is still less risky than buying and holding an indexed share fund indefinitely.
MarketTiming discloses the performance results of its Rotation Strategies as well as its Share Strategies each half year.
How to Trade
You can use your own online broking platform to trade the Rotation Strategies’ ETFs which appear in MarketTiming’s Weekly Update bulletin received by all clients. Alternatively you can use an auto-trade service that automatically applies MarketTiming signals for any of our ETF trading Strategies. Question 4b under the FAQs section of the MarketTiming website menu explains how to open a personal broking account that automatically applies MarketTiming signals to ETFs for minimal cost.
MarketTiming provides only general advice. As such, we do not take into account your objectives, financial situation or needs and risk tolerance. Before acting on our advice, you should consider the appropriateness of that advice in the light of your own circumstances.