Quick 5 ETF Rotational Strategy Returns the Upside of Stocks with Half the Risk

11% CAGR, 0.87 Sharpe, at half of the drawdown that the market returns.

Out strategy in red versus VTI total stock market in purple.

The last few posts have been a lot to chew through. So here is a simple ETF rotational strategy that you can do to capture the upside of equities while eliminating half the risk.

The inspiration for this strategy comes from the paper Looking for Synergy with Momentum in Main Asset Classes which you can read for yourself here.

The strategy is simple: we break up exposure to 5 asset classes into a single stock representation via an ETF.

• Stocks - VTI

• Bonds - AGG

• Real Estate - VNQ

• Commodities - DBC

• Gold - GLD

On the last trading day of each month, calculate the returns between today and the past 1, 3, 6, 9, and 12 months ago for each ETF and average the returns together. See the formula below:

\(M_{\mathrm{mix}} = \frac{R_{1}+R_{3}+R_{6}+R_{9}+R_{12}}{5}, \qquad R_k=\frac{P_t}{P_{t-k}}-1\)

Then, rank the 5 assets based on their returns, highest to lowest, and select the top 3. Invest a third of your portfolio in each. Hold until the next rebalancing period. Simple!

In an easy step-by-step:

1. If it is the last trading day of the month, continue. 
    - Otherwise, wait until tomorrow.
2. For each of VTI, AGG, VNQ, DBC, and GLD, 
    - calculate their average returns for the last 1, 3, 6, 9 and 12 months.
3. Rank the 5 assets, highest returns to lowest returns.
4. Select the top 3.
5. Rebalance your portfolio so that 33% is allocated to each of the top 3.
6. Done.

Your portfolio allocation should look something like this over time. Notice the low turnover, which is key for minimizing trading fees.

With this rotation, you get the same upside as investing in the entire market (VTI) while cutting your drawdown risk in half. Here is the tearsheet:

Metrics that outperform just buy and hold VTI are in green. The second column assumes a 10bps fee on all turnover.

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The Code

This basket was found by searching against 125,000+ combinations of rotational strategies based on the original paper cited above. I implemented the search myself, and it’s available in the paid subscriber Google Drive, along with the backtests and implementation of the strategy itself.

Check out the code itself here if you are a paid subscriber:

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Hope you enjoy the quick one this week, and happy trading!

Stuart