Going systematic is a sound alternative for investors to navigate the market noise and avoid the large drawdowns of buy and hold. Simple strategies have so far generated high risk-adjusted returns.
After accepting the reality that the available market information is not enough to generate robust forecasts for the future, going systematic is a sound alternative.
Going systematic requires realizing that the various furus who operate in the markets and who pretend to have unique forecasting abilities are in reality guessing the market’s next move.
Going systematic is not hard; the simpler methods only require checking the price of the S&P 500 once at the end of the month and simple indicators, data that are widely available online nowadays for free.
Since 1988, the simple 12-month moving average strategy (buy when the monthly closing price crosses above the 12-month moving average and sell when it crosses below) has generated a 9.8% annualized return with a 21.8% maximum drawdown in the S&P 500 index total return. The Sharpe ratio is 0.79.
This is a simple trend-following strategy based on price series momentum. However, execution requires a level of discipline.
How many furus have outperformed this simple strategy? I have a personal estimate: none. Instead, they are selling complicated narratives that involve selection bias about the state of the economy using a few economic variables. This is no way to generate reasonable risk-adjusted returns.
Superior risk-adjusted returns are possible with more advanced timing strategies. For example, the Dynamic Momentum strategy we use for our monthly systematic signals has a Sharpe ratio of about 1.1 in backtests.
Systematic strategies are not a panacea. They may also fail if there is a significant regime change. However, they provide a sound alternative to attempts to predict market moves using fundamental analysis.
The next level of systematic investing complexity involves portfolio allocation and timing. The goal is to achieve even better risk-adjusted returns and potentially create conditions for leveraged alpha. Funds use these strategies, which are beyond the capabilities of the average investor. Furthermore, it is highly debatable that, over the long term, these portfolio allocation methods outperform the simple ones. However, some of those strategies have a low beta with the market, and they offer investors a high level of comfort. The backtest performance of our ETFNRW cross-sectional asset momentum strategy, which we use in our systematic weekly signals ensemble, is shown below.
The annualized return since 2008 is about 10%, with a less than 11% maximum drawdown and a Sharpe ratio of 0.92. Higher frequency (weekly) allows for better fine-tuning, but more work is required.
There are many shades of systematic investing. Still, the simplest versions are adequate for escaping the furu trap and do not require much work.
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Specific disclaimer: This report includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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