Description of US Sector Rotation Strategy

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.

Methodology & Assets

U.S. industry sectors ETFs, their corresponding inverse or short sector ETFs and optional futures:

U.S. Sector ETF Inverse (leverage) Globex Futures
Materials XLB SMN (-2x) IXB
Energy XLE ERY (-3x) IXEe
Financial XLF SKF (-2x) IXM
Industrials XLI SIJ (-2x) IXI
Technology XLK REW (-2x) IXT
Consumer Staples XLP SZK (-2x) IXR
Real Estate XLRE SRS (-2x) -
Utilities XLU SDP (-2x) IXU
Health Care XLV RXD (-2x) IXV
Consumer Discretionary XLY SCC (-2x) IXY

Statistics of US Sector Rotation Strategy (YTD)

What do these metrics mean? [Read More] [Hide]

TotalReturn:

'Total return is the amount of value an investor earns from a security over a specific period, typically one year, when all distributions are reinvested. Total return is expressed as a percentage of the amount invested. For example, a total return of 20% means the security increased by 20% of its original value due to a price increase, distribution of dividends (if a stock), coupons (if a bond) or capital gains (if a fund). Total return is a strong measure of an investment’s overall performance.'

Which means for our asset as example:
  • Looking at the total return, or increase in value of 76.6% in the last 5 years of US Sector Rotation Strategy, we see it is relatively larger, thus better in comparison to the benchmark SPY (67.2%)
  • During the last 3 years, the total return, or performance is 38.6%, which is smaller, thus worse than the value of 50.7% from the benchmark.

CAGR:

'The compound annual growth rate isn't a true return rate, but rather a representational figure. It is essentially a number that describes the rate at which an investment would have grown if it had grown the same rate every year and the profits were reinvested at the end of each year. In reality, this sort of performance is unlikely. However, CAGR can be used to smooth returns so that they may be more easily understood when compared to alternative investments.'

Which means for our asset as example:
  • Compared with the benchmark SPY (10.8%) in the period of the last 5 years, the annual return (CAGR) of 12.1% of US Sector Rotation Strategy is higher, thus better.
  • During the last 3 years, the annual performance (CAGR) is 11.5%, which is lower, thus worse than the value of 14.7% from the benchmark.

Volatility:

'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.'

Applying this definition to our asset in some examples:
  • Compared with the benchmark SPY (13.5%) in the period of the last 5 years, the historical 30 days volatility of 8.3% of US Sector Rotation Strategy is lower, thus better.
  • Compared with SPY (12.8%) in the period of the last 3 years, the 30 days standard deviation of 7.9% is lower, thus better.

DownVol:

'Downside risk is the financial risk associated with losses. That is, it is the risk of the actual return being below the expected return, or the uncertainty about the magnitude of that difference. Risk measures typically quantify the downside risk, whereas the standard deviation (an example of a deviation risk measure) measures both the upside and downside risk. Specifically, downside risk in our definition is the semi-deviation, that is the standard deviation of all negative returns.'

Applying this definition to our asset in some examples:
  • Compared with the benchmark SPY (14.8%) in the period of the last 5 years, the downside risk of 8.9% of US Sector Rotation Strategy is smaller, thus better.
  • Compared with SPY (14.7%) in the period of the last 3 years, the downside deviation of 8.7% is lower, thus better.

Sharpe:

'The Sharpe ratio was developed by Nobel laureate William F. Sharpe, and is used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Subtracting the risk-free rate from the mean return allows an investor to better isolate the profits associated with risk-taking activities. One intuition of this calculation is that a portfolio engaging in 'zero risk' investments, such as the purchase of U.S. Treasury bills (for which the expected return is the risk-free rate), has a Sharpe ratio of exactly zero. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.'

Which means for our asset as example:
  • The risk / return profile (Sharpe) over 5 years of US Sector Rotation Strategy is 1.15, which is greater, thus better compared to the benchmark SPY (0.62) in the same period.
  • During the last 3 years, the risk / return profile (Sharpe) is 1.14, which is higher, thus better than the value of 0.95 from the benchmark.

Sortino:

'The Sortino ratio improves upon the Sharpe ratio by isolating downside volatility from total volatility by dividing excess return by the downside deviation. The Sortino ratio is a variation of the Sharpe ratio that differentiates harmful volatility from total overall volatility by using the asset's standard deviation of negative asset returns, called downside deviation. The Sortino ratio takes the asset's return and subtracts the risk-free rate, and then divides that amount by the asset's downside deviation. The ratio was named after Frank A. Sortino.'

Which means for our asset as example:
  • The ratio of annual return and downside deviation over 5 years of US Sector Rotation Strategy is 1.07, which is higher, thus better compared to the benchmark SPY (0.56) in the same period.
  • During the last 3 years, the ratio of annual return and downside deviation is 1.03, which is greater, thus better than the value of 0.83 from the benchmark.

Ulcer:

'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:
  • Looking at the Downside risk index of 1.96 in the last 5 years of US Sector Rotation Strategy, we see it is relatively lower, thus better in comparison to the benchmark SPY (3.99 )
  • Compared with SPY (4.09 ) in the period of the last 3 years, the Ulcer Index of 1.91 is lower, thus better.

MaxDD:

'A maximum drawdown is the maximum loss from a peak to a trough of a portfolio, before a new peak is attained. Maximum Drawdown is an indicator of downside risk over a specified time period. It can be used both as a stand-alone measure or as an input into other metrics such as 'Return over Maximum Drawdown' and the Calmar Ratio. Maximum Drawdown is expressed in percentage terms.'

Applying this definition to our asset in some examples:
  • Compared with the benchmark SPY (-19.3 days) in the period of the last 5 years, the maximum DrawDown of -8.6 days of US Sector Rotation Strategy is higher, thus better.
  • Compared with SPY (-19.3 days) in the period of the last 3 years, the maximum drop from peak to valley of -8.6 days is larger, thus better.

MaxDuration:

'The Maximum 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. It is the length of time the account was in the Max Drawdown. A Max Drawdown measures a retrenchment from when an equity curve reaches a new high. It’s the maximum an account lost during that retrenchment. This method is applied because a valley can’t be measured until a new high occurs. Once the new high is reached, the percentage change from the old high to the bottom of the largest trough is recorded.'

Which means for our asset as example:
  • Looking at the maximum days below previous high of 135 days in the last 5 years of US Sector Rotation Strategy, we see it is relatively lower, thus better in comparison to the benchmark SPY (187 days)
  • Looking at maximum time in days below previous high water mark in of 94 days in the period of the last 3 years, we see it is relatively lower, thus better in comparison to SPY (139 days).

AveDuration:

'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.'

Using this definition on our asset we see for example:
  • Looking at the average days below previous high of 29 days in the last 5 years of US Sector Rotation Strategy, we see it is relatively lower, thus better in comparison to the benchmark SPY (42 days)
  • Looking at average days under water in of 27 days in the period of the last 3 years, we see it is relatively lower, thus better in comparison to SPY (36 days).

Performance of US Sector Rotation Strategy (YTD)

Historical returns have been extended using synthetic data.

Allocations of US Sector Rotation Strategy
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Allocations

Returns of US Sector Rotation Strategy (%)

  • Note that yearly returns do not equal the sum of monthly returns due to compounding.
  • Performance results of US Sector Rotation Strategy are hypothetical, do not account for slippage, fees or taxes, and are based on backtesting, which has many inherent limitations, some of which are described in our Terms of Use.