Market Leadership Strategy Update

Our free Market Leadership Strategy tries to achieve positive risk-adjusted investment results (and positive alpha), using a long-only approach that is easy for investors to follow.  The model generates “equity style” recommendations that can usually be implemented with ETFs, mutual funds, variable annuities, or 401(k) plan choices. 

One feature that makes the model easy to follow is that it has only two holdings at any given time.  In addition, you only need to check for changes once per week, and the average holding period is about four months.

The selection universe is based on the Morningstar nine-square style box with additional entries, for mega-cap, micro-cap, aggressive growth, international, global, and money market.  This line-up places a few limitations on the resulting two-position portfolio.  Having one money market option allows the model to reduce risk during unfavorable conditions while still keeping the other half in a relatively good area of the market.  Likewise, the potential to be in one international and one global selection allows the model to have up to 75% foreign market exposure.  You can find more information in the Leadership Strategy section of our website.

Sectors, commodities, emerging markets, and single-country options are not included because having a 50% exposure to those areas might be too risky.  The resulting universe is still not perfect, of course; one could easily make the claim that 50% in micro-caps and 50% in small caps is also a very risky allocation.  While we could add additional asset classes like bonds and currencies, our goal was for this model to be an equity strategy.

The Market Leadership strategy uses Style Rotation, and is based on the observation that the investment styles and capitalization groups exhibiting the strongest relative performance will vary over the course of a full market cycle.  The ranking system is designed to capture that outperformance through a combination of price momentum, volatility, and alpha. The approach is to buy the top two ranked categories and hold them as long as they remain ranked in the top five of the 16 categories.

The rankings are updated on the homepage of our website every Monday.  There are also links to more information about the strategy, ETFs to consider, and the results of the hypothetical backtest.  We introduced this strategy about 15 months ago, and recently updated the backtest to reflect the most recent 10-year period.  A summary table and graphical representation of the results are shown below.

Disclosure:  Hypothetical backtesting has many inherent limitations.  Full disclosure can be found here.

Market Leadership Strategy

 Hypothetical Performance Results 1999 – 2008

Parameter	Market Leadership Strategy	S&P 500 Total Return
Annualized Return	13.3%	-1.4%
Cumulative Return	247.3%	-13.2%
Standard Deviation	15.9%	21.3%
Maximum Drawdown	-42.4%	-50.8%
Sharpe Ratio	0.62	-0.23
Correlation (r)	0.81	1.00
Beta	0.60	1.00
Alpha (traditional)	14.1%	0%
Non-correlated Alpha	14.3%	0%
# Trades	62	n/a
Avg Holding Time (mths)	3.9	n/a

 

Equity Curve 12/31/1998 – 12/31/2008