This post contains my personal notes from the book Asset Rotation by Matthew Erickson.
The text in bold are my viewpoints and reflections.
1. It is important to avoid prolonged declines in the investment markets to avoid significant losses. Buy, hold and pray will not prevent prolonged declines. Therefore a rotational approach to investment is better than ” buy and hold”. But remember that multi-asset class portfolios with proper proportion of bonds have withstood the test of time when you use short-term bonds.
2. In the current era of low-interest rates, bonds are not safe because an increase in interest rates will lead to price declines in bonds. The greater the maturity of bonds, the greater the price decline. Who knows?
3. Better active managers for long duration are very rare. So you cannot depend on better active managers to get you better returns. That is why you should invest in index funds.
4. Investing in individual stocks is also risky and not recommended for most investors. Yes, that is true but you can invest in index funds.
5. A simple strategy of asset rotation can yield better returns over the long run. Yes it can, but can it after accounting for slippage, trading costs and taxes.
6. Consider this simple strategy: Take 2 asset classes: S&P 500 and long-term government bonds. Buy the asset class which was up the most the previous month. If S&P 500 was up the most the previous month, we will buy S&P 500 and hold it for the next month and vice versa. The returns for this strategy from 1929 to 2012 has been 8.89% annualised return for the asset rotation and 8.96% for S&P 500 buy and hold. The returns for the asset rotation strategy have lower drawdowns compared to the S&P 500 buy and hold. Yes, timing lowers drawdowns, we all know that. But what would have been the return after accounting for trading costs, slippage and taxes. A lot lower.
7. The other strategy the author talks about is sector rotation with the 9 major sectors of the S&P 500: consume discretionary, consumer staples, energy, financials, health care, industrials, materials, technology and utilities. The 10th asset class is long-term bonds. Each month we will hold the top five best performing sectors of the market. When less than 5 sectors of the market have a positive return, the portfolio will rotate incrementally into fixed income( provided fixed income has a positive rate of return). Therefore the portfolio can have any of the following allocations: 100% stocks, 80% stocks/20% bonds, 60% stocks/40% bonds, 20% stocks/80% bonds, 100% bonds. This strategy had an annualised return of 13.36% from 1989-2012 compared to 8.55% for the S&P 500. Yes, this is great, but again we do not know how much trading costs, slippage and taxes will eat into our returns.
8. The author says you can also have country based asset rotation and broad global asset class rotation like ( US, EAFE, Emerging, Small, Large, Value and Growth).
9. The author also advocates the use of RSI( relative strength index). When you use RSI, you have to remember that higher the value means the investment class is overbought and therefore has a lower ranking and we should avoid buying it. You can combine this with returns to choose your asset classes.
10. You can also use asset rotation for part of your portfolio and buy and hold for part of your portfolio.
The basic premise of this book is that momentum based asset rotation works. I have also written about in various places on this blog.
- ETF momentum strategy
- Simple momentum strategy using 4 highly liquid asset classes
- Simple ETF momentum strategy using stocks and gold
Yes, it seems to work but one has to understand that we do not really know the returns after trading costs,slippage and taxes. In a tax-deferred account with minimum slippage and minimum trading costs, it probably works.