The U.S. Sector strategy allocates dynamically between four long U.S. sector sub-strategies. Each of the four long sub-strategies use different momentum and mean reversion criteria
Due to the low correlation of these strategies, the combination creates a strategy with a considerably higher Sharpe Ratio than a simple sector rotation.
The strategy uses SPDR sector ETFs, but you can replace these with the corresponding sector ETFs or futures from other issuers.
US sectors have historically been good for trend following systems because each sector usually over or under performs for long periods at a time due to longer lasting economic cycles and not just short-term market fluctuations.
The economy itself is not a linear stable system, but swings between periods of expansion (growth) and contraction (recession). This results in a series of market cycles which are visualized in the following picture.
Source: http://www.nowandfutures.com (Global Business Cycles)
Each market cycle favors different industry sectors. The goal of a good working strategy is to choose the best performing sectors while avoiding or even shorting the worst performing sectors.
You can read the original strategy whitepaper for more details.
U.S. industry sectors ETFs, their corresponding inverse or short sector ETFs and optional futures:
|U.S. Sector||ETF||Inverse (leverage)||Globex Futures|
|Consumer Staples||XLP||SZK (-2x)||IXR|
|Real Estate||XLRE||SRS (-2x)||-|
|Health Care||XLV||RXD (-2x)||IXV|
|Consumer Discretionary||XLY||SCC (-2x)||IXY|
'The total return on a portfolio of investments takes into account not only the capital appreciation on the portfolio, but also the income received on the portfolio. The income typically consists of interest, dividends, and securities lending fees. This contrasts with the price return, which takes into account only the capital gain on an investment.'Which means for our asset as example:
'The compound annual growth rate (CAGR) is a useful measure of growth over multiple time periods. It can be thought of as the growth rate that gets you from the initial investment value to the ending investment value if you assume that the investment has been compounding over the time period.'Using this definition on our asset we see for example:
'Volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security. In the securities markets, volatility is often associated with big swings in either direction. For example, when the stock market rises and falls more than one percent over a sustained period of time, it is called a 'volatile' market.'Using this definition on our asset we see for example:
'The downside volatility is similar to the volatility, or standard deviation, but only takes losing/negative periods into account.'Applying this definition to our asset in some examples:
'The Sharpe ratio is the measure of risk-adjusted return of a financial portfolio. Sharpe ratio is a measure of excess portfolio return over the risk-free rate relative to its standard deviation. Normally, the 90-day Treasury bill rate is taken as the proxy for risk-free rate. A portfolio with a higher Sharpe ratio is considered superior relative to its peers. The measure was named after William F Sharpe, a Nobel laureate and professor of finance, emeritus at Stanford University.'Which means for our asset as example:
'The Sortino ratio, a variation of the Sharpe ratio only factors in the downside, or negative volatility, rather than the total volatility used in calculating the Sharpe ratio. The theory behind the Sortino variation is that upside volatility is a plus for the investment, and it, therefore, should not be included in the risk calculation. Therefore, the Sortino ratio takes upside volatility out of the equation and uses only the downside standard deviation in its calculation instead of the total standard deviation that is used in calculating the Sharpe ratio.'Applying this definition to our asset in some examples:
'Ulcer Index is a method for measuring investment risk that addresses the real concerns of investors, unlike the widely used standard deviation of return. UI is a measure of the depth and duration of drawdowns in prices from earlier highs. Using Ulcer Index instead of standard deviation can lead to very different conclusions about investment risk and risk-adjusted return, especially when evaluating strategies that seek to avoid major declines in portfolio value (market timing, dynamic asset allocation, hedge funds, etc.). The Ulcer Index was originally developed in 1987. Since then, it has been widely recognized and adopted by the investment community. According to Nelson Freeburg, editor of Formula Research, Ulcer Index is “perhaps the most fully realized statistical portrait of risk there is.'Using this definition on our asset we see for example:
'Maximum drawdown is defined as the peak-to-trough decline of an investment during a specific period. It is usually quoted as a percentage of the peak value. The maximum drawdown can be calculated based on absolute returns, in order to identify strategies that suffer less during market downturns, such as low-volatility strategies. However, the maximum drawdown can also be calculated based on returns relative to a benchmark index, for identifying strategies that show steady outperformance over time.'Applying this definition to our asset in some examples:
'The Drawdown Duration is the length of any peak to peak period, or the time between new equity highs. The Max Drawdown Duration is the worst (the maximum/longest) amount of time an investment has seen between peaks (equity highs) in days.'Using this definition on our asset we see for example:
'The Average Drawdown Duration is an extension of the Maximum Drawdown. However, this metric does not explain the drawdown in dollars or percentages, rather in days, weeks, or months. The Avg Drawdown Duration is the average amount of time an investment has seen between peaks (equity highs), or in other terms the average of time under water of all drawdowns. So in contrast to the Maximum duration it does not measure only one drawdown event but calculates the average of all.'Which means for our asset as example: