Long-term Component Timing Model

My primary concern here is to test a component (subsector) timing model going back more years than ETF data is available. Total return data isn't available for sub-sectors for all asset classes in a way that could be approximated with ETFs available now. However, there are total return series available that replicate them well enough to be comparable with prior results developed in this space (here). For domestic equities, I was able to use the S&P indices (used in Rydex ETFs). For commodities, I was able to use the DJ-AIG indices (just using futures is not comparable to total return indices. I used total return series for a number of foreign equity indices. Finally, I added a AAA corporate bond index to the 10 year treasury since none of the other bonds really are that impressive for the long-term (30 year has strong returns, but too much volatility). Reits are kept the same.

The general strategy is as simple as the TAA strategy. If the subindex is above 10month SMA, invest, otherwise stay in commercial paper. For equities, I also entered the entire asset class in CP when the broad index is below the SMA. They have much stronger correlation to the index than the other asset classes. Asset classes are equally weighted. I'll only report since 1991 (when I have data for commodities). The returns are consistent over time, they tend to slightly decrease, but with consistently lower volatility.

For reference, the AA strategy has a return of 9.65% (7.8% stdev) and the TAA is 10.8% (6% stdev). Extending the strategy with the component timing model gives 10.4% (4.7% stdev). Adding in a currency strategy similar to this* will reduce returns to 9.9% (4.2%).

*including interest rates from holding foreign currencies, but not counting the movements of currencies when in domestic currency since other asset classes do not control for value of the dollar which makes it not comparable to past strategies, all this does it lower the return and keeps volatility relatively constant, just wanted to be conservative

For the unlevered strategies, the alpha of each strategy is highly significant (<.01%) at 3% (.64 Beta) for the original, 3.6% (.46 Beta) timing w/o currencies, and 3.2% (.42 Beta) with currencies. The alpha of the timing (w/o curr) vs. the TAA strategy is significant at 1.7%. Using 2:1 leverage (except for the currencies), the TAA strategy has an alpha 4.86% (1.2 Beta), 6.3% (.92 Beta) timing w/o currencies, and 5.4% (.8 Beta) with currencies. Note that the levered returns are 16.1% (12% stdev) for the TAA, 15.6% (9.4% stdev) for the timing w/o currencies, and 14.3% (8.1% stdev) with currencies. Using even more leverage (1.5x), would give an even larger return for the timing model with roughly the volatility of the 2:1 TAA strategy.

Note that I did not use a momentum strategy, just the timing model. This means that there would be relatively small transaction costs, but you could not use futures contracts to implement it (except commodities and foreign indices). Nevertheless, it shows that there is significant evidence that this strategy has worked over a significant period of time with a variety of asset classes. I expected the returns to be different since I am using more equally weighted portfolios than cap-weighted as the indices are (within each it is cap, between each it is equal), but I was pleasantly surprised at how well it performed over the past 18 years or so (and 30 years) which gives further evidence that the momentum strategy for the component TAA strategy or a strategy like this with much less in trading costs.