Rotation strategies have often been touted as a way to increase returns, reduce drawdown, and avoid the nasty drawdowns associated with buy and hold portfolios and improving risk adjusted returns for holding single funds or stocks.
Bear markets and corrections have proven difficult for buy and hold strategies, resulting in drawdowns, and less than stellar performance in great markets. Bonds surged while the stock market crashed in 2008, but many bonds faltered for much of 2013 while the stock market soared. If you recall 2008, the S&P 500 lost around 55% of it's value, but Gold didn't miss a beat until it has lost 1/3 of it's value from 2011-2013. Recently the stock market has been volatile but the bonds markets have surged upward.
Why do we hold onto funds in our portfolios that are performing so poorly and are very volatile instead of just removing them from our portfolio or only investing in the best funds? One obvious answer is to just get rid of funds that are doing poorly and wait for them to do better again before getting back into that fund. That is the idea rotation investing attempts to accomplish quantitatively instead of just relying on emotions or guesses about when funds are doing poorly.
Rotation Based Strategies
The idea behind rotation strategies is simple, each month (or week or quarter...) you check a list of stocks, ETFs and/or mutual funds to see which is stronger and buy the top 1 or more funds and sell the old funds. This results in a portfolio constructed of only the strongest funds each month. These type of strategies have proven very effective in avoiding bear markets in the past while gaining exposure to uptrends. So instead of holding onto funds when they are dropping or very volatility like buy and hold lets test out rotating or swapping out these funds for stronger funds.
Many rotation strategies have suffered in 2015, however my adding mean reversion into strategies there has been a lot of success in the past few years.
Building a high return strategy using RotationInvest.com's Tools
Tool: RotationInvest.com's Advanced Rotation Tool
Funds: QLD, MIDU, and TMF
Settings: Choose top 2 funds, 40% 3 month momentum, 60% 10 day mean reversion.
The performance for this rotation strategy is:
2040% Total Return over the period
1.39 Sharpe Ratio
21.94% maximum monthly drawdown
No single year had a negative return
Monte Carlo Warning
The Monte Carlo simulation allows users to run a random sampling of possible performances and stress test a portfolio's results. This shows users possible outcomes given a return and volatility. What this simulation shows is for this particular strategy the higher volatility numbers mean a much larger range of possible outcomes, anywhere from ~$2M to more than $25M!
The Monte Carlo simulation reveals an average of $8,050,000 average account balance after only 10 years with $100K starting balance and $1K monthly deposit, however the 90th Percentile and 10th Percentile (really good vs. really bad outcomes) vary dramatically due to strategy volatility! This difference in best possible outcome vs. a bad outcome shows how a high return strategy like this can result in vastly different outcomes even when they perform well in the future.
Strategies presented anywhere on this site are ideas only, and only for education. This is not investment advice, or suggested financial information.
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Strategies presented anywhere on this site are ideas only, and only for education.
RotationInvest.com/PortfolioBuilderInvest.com do not provide investment advice, and are not investment advisors.