Research Review | 4.23.13 | Asset Allocation Strategy

Fooled by Data-Mining: The Real-Life Performance of Market Timing with Moving Averages
Valeriy Zakamulin (University of Agder) | April 2013
In this paper we advocate that the reported performance of the simple moving average market timing strategy proposed by M. Faber (“A Quantitative Approach to Tactical Asset Allocation” (2007) published in the Journal of Wealth Management) is contaminated by data-mining. In order to deal with the data-mining bias, we perform an out-of-sample simulation of the simple moving average timing model over the period 1930 to 2012. We then examine the real-life performance of the market timing strategy and assess the extent of the data-mining bias. Finally we revisit the myths about the superior performance of the market timing strategy and provide an unbiased estimate of its future performance.

Absolute Momentum: A Simple Rule-Based Strategy and Universal Trend-Following Overlay
Gary Antonacci (Portfolio Management Consultants) | April 2013
There is a considerable body of research on relative strength price momentum but relatively little on absolute, time series momentum. In this paper, we explore the practical side of absolute momentum. We first explore its sole parameter – the formation, or look back, period. We then examine the reward, risk, and correlation characteristics of absolute momentum applied to stocks, bonds, and real assets. We finally apply absolute momentum to a 60-40 stock/bond portfolio and a simple risk parity portfolio. We show that absolute momentum can effectively identify regime change and add significant value as an easy to implement, rule-based approach with many potential uses as both a stand- alone program and trend following overlay.
Risk vs Trend Driven Global Tactical Asset Allocation
Benoît Guilleminot (Riskelia), et al. | April 2013
The 2008 financial crisis has severely challenged passive forms of investment. In this paper, we compare two systematic investment processes that a global asset allocator may employ to preserve its capital in the face of a turbulent financial environment. The “risk-driven” allocation, derived from the popular “risk-parity” approach, has garnered a strong interest from both scholars and practitioners in the recent years. It aims at enforcing a constant risk target and maintaining a balanced risk profile over time. This paper introduces a novel “trend-driven” approach, which enhances the risk-driven strategy by cutting the exposure to downward drifting assets. We then compare the risk-adjusted performances of risk and trend driven approaches on different investment universes (composed of equity, commodity, currency and bond futures contracts) over the 1993-2012 period. We find that a trend-driven approach yields increased Sharpe ratios and lower drawdowns in average relative to a risk-driven strategy. However, the outperformance of the trend-driven process is not stable over time: periods with exploitable trends alternate with long-lasting trendless periods. Overall, the key advantage of the trending strategy over the risk-driven one is its higher smoothness. This is due to a better resilience to 2008-like financial meltdowns, which are well-predicted by trending signals and undermine the diversification objective pursued by the risk-parity approach. These results demonstrate the value of coupling risk and trajectorial signals in tactical asset allocation.
Gold – Fundamental Drivers and Asset Allocation
Dirk Baur (University of Technology) | February 2013
In this paper we perform a theoretical and econometric analysis of the fundamental drivers of gold. We demonstrate that gold is significantly influenced by inflation changes, interest rates, currency changes and central bank reserve policies. A key finding is that the influence of the drivers varies through time, e.g. inflation is a major driver in the 1970s and in the late 2000s but not in the 1980s and 1990s. We also examine the role of gold in asset allocation and show that gold can significantly enhance the risk-reward ratio in a portfolio comprised of stocks, bonds and cash. We argue that there are several factors that have the potential to support a historically high price of gold.
Risk-Based Allocation of Principal Portfolios
Christoph Kind (Frankfurt-Trust Investment Mgt) | April 2013
Risk-based asset allocation strategies are mainly used to diversify nominal asset weights. In this paper, we discuss the diversification of risk factors. The analysis is based on the idea of Partovi and Caputo (2004), who use principal component analysis to transform a portfolio into a set of uncorrelated principal portfolios. Risk-based asset allocation strategies can be applied to these uncorrelated sources of risk. A similar route has been taken by Meucci (2009) with his idea of a maximum entropy portfolio. We discuss the relation of this approach with the concept of principal risk parity. Both strategies are backtested against nominal diversification strategies in a multi-asset portfolio. We find no evidence that risk diversification does outperform nominal diversification and discuss possible reasons for this.
Achieving Your Target Return
Frank Benham (Meketa Investment Group) | October 2012
Many institutional investors have target annual returns in the range of 7% to 8% or higher. This could take the form of an actuarial assumed rate of return for a pension fund or a spending rate plus an inflation assumption for a foundation. Achieving this target return, however, is anything but guaranteed. In fact, events have conspired to make the challenge of meeting this goal particularly daunting over the next decade. While this challenge may be formidable, it is not insurmountable. This paper reviews various approaches that investors can take that may improve the likelihood of achieving their objectives.

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