by Erez Katz

Summary

While the US market continues to exhibit historically low volatility, underneath the surface there is an interesting rotational trend between asset classes and market sectors. It’s rather fascinating to see a sizeable flow of funds away from small caps to ultra-large cap stocks and between industry sectors, such as from technology into healthcare. Tactical rotational asset management is an ETF-based active investment strategy designed to exploit this fund-flow phenomenon.

What is Tactical Asset Allocation?

Tactical asset allocation (TAA) is an investment strategy that dynamically adjusts a portfolio’s asset allocation. The goal of a TAA strategy is to improve the risk-adjusted returns of comparable passive management investing. Judging from backtesting the last decade, selecting well-diversified large cap ETFs and applying a few simple technical momentum indicators to determine which ETFs to overweight and underweight is sufficient enough to produce strong risk-adjusted returns.
Lucena’s Sector Rotation Strategy

WaveRider is a proprietary Lucena Research sector rotation strategy with three variants:

  • Long only MVO based on historical momentum
  • 2x leveraged long/short MVO based on ML forecaster
  • 2x leveraged long/short MVO based on historical momentum

WaveRider assumes that there is a clear seasonality in the flow of funds between the major US industry sectors, fixed income instruments and cash (cash equivalent instruments, to be more specific). WaveRider holds 11 highly liquid ETFs representing all major US sectors, fixed income instruments and cash.

WaveRider’s Edge

In backtesting, WaveRider has outperformed the S&P 500 in total return, risk-adjusted return and low volatility.

Image 1: WaveRider backtest simulation 2X leverage. The backtest demonstrates a substantial lower volatility (even when it is 2X leveraged) when compared to the S&P’s.
Past performance is no guarantee of future returns.

The fund only rebalances its positions when the machine recommends a substantially different allocation than it presently holds. WaveRider also follows strict min/max allocations per constituent in order to keep its diversification and volatility in check.

WaveRider Live Forward Trades Simulation

Since the 2016 election, WaveRider has outperformed the S&P, even in the face of strong overall market performance.

Image 2: WaveRider live paper trading simulation. November 2016 to present.
Past performance is no guarantee of future returns.

Conclusion

WaveRider is just another example of how disciplined quantitative analysis can drive a dynamic tactical asset allocation strategy that delivers returns with low volatility and turnover.