"An investment in knowledge pays the best interest."
Most investors have one or many diversified portfolios, whether with a 50/50 ,60/40, etc ... allocation between equity and bonds. One of the main benefits of a diversify portfolio is that it helps level out volatility and risk, essentially avoiding putting all your eggs in the same basket. However, over the long run these portfolio will produce inferior return compared to an index fund.
The pictures above illustrate both pros and and cons of a diversified portfolio. This 60/40 portfolio clearly underperform the SPY. However, we can see that the drawdown is signficantly less during bear markets. Here's another view of the portfolio, using ETFs : SPY ( 60 %), TLT ( 20 %), and IEF( 20 %)
What if there was a way to be allocated in the right sector most of the time ? is it possible ? of course there is. We could use relative strength (RS) to attempt to be allocating in the right assets. Our systematic rules are simple :
- Each month, calculate the monthly Relative strength of each assets ( SPY, TLT, IEF)
- Allocate 100 % in the strongest asset
- Repeat at month's end.
We are essentially buy the asset with the greatest momentum.
We can see that the performance was underwhelming from 2003 to 2008. However, it gotten better after 2009. The strategy has less drawdown and better return then our traditional 60/40 portfolio.
We could also use the ratio of the two assets ( SPY/TLT or SPY/IEF ratio) against a moving average, and buy assets once the ratio crosses above or below its moving average. We'll go over that strategy in a later post.
Happy trading !