Description of US Sector Rotation Strategy

The U.S. Sector strategy allocates dynamically between four long U.S. sector sub-strategies and one short U.S. sector strategy. Each of the four long sub-strategies use different momentum and mean reversion criteria. The short U.S. sector sub-strategy is used as a hedge to limit losses in case of a large market correction.

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 addition of the negatively correlated short strategy significantly reduces volatility and drawdowns during difficult market periods.

What makes this strategy interesting is that it does not rely on either treasuries or bonds to hedge in times of market stress, it uses the short US sector strategy instead. The hedging mechanism is purely "short equity" and unrelated to whether interest rates rise, a common concern when holding bonds in a portfolio.

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:
  • The total return, or performance over 5 years of US Sector Rotation Strategy is 94.8%, which is greater, thus better compared to the benchmark SPY (68.2%) in the same period.
  • Compared with SPY (47.7%) in the period of the last 3 years, the total return of 43.5% is lower, thus worse.

CAGR:

'Compound annual growth rate (CAGR) is a business and investing specific term for the geometric progression ratio that provides a constant rate of return over the time period. CAGR is not an accounting term, but it is often used to describe some element of the business, for example revenue, units delivered, registered users, etc. CAGR dampens the effect of volatility of periodic returns that can render arithmetic means irrelevant. It is particularly useful to compare growth rates from various data sets of common domain such as revenue growth of companies in the same industry.'

Which means for our asset as example:
  • The compounded annual growth rate (CAGR) over 5 years of US Sector Rotation Strategy is 14.3%, which is higher, thus better compared to the benchmark SPY (11%) in the same period.
  • Compared with SPY (13.9%) in the period of the last 3 years, the annual performance (CAGR) of 12.8% is lower, thus worse.

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.'

Which means for our asset as example:
  • Compared with the benchmark SPY (13.2%) in the period of the last 5 years, the volatility of 8.1% of US Sector Rotation Strategy is smaller, thus better.
  • Looking at historical 30 days volatility in of 7.6% in the period of the last 3 years, we see it is relatively smaller, thus better in comparison to SPY (12.4%).

DownVol:

'The downside volatility is similar to the volatility, or standard deviation, but only takes losing/negative periods into account.'

Which means for our asset as example:
  • Compared with the benchmark SPY (14.6%) in the period of the last 5 years, the downside volatility of 8.7% of US Sector Rotation Strategy is smaller, thus better.
  • Compared with SPY (14%) in the period of the last 3 years, the downside deviation of 8.2% is lower, thus better.

Sharpe:

'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 Sharpe Ratio over 5 years of US Sector Rotation Strategy is 1.45, which is higher, thus better compared to the benchmark SPY (0.64) in the same period.
  • During the last 3 years, the ratio of return and volatility (Sharpe) is 1.36, which is larger, thus better than the value of 0.92 from the benchmark.

Sortino:

'The Sortino ratio measures the risk-adjusted return of an investment asset, portfolio, or strategy. It is a modification of the Sharpe ratio but penalizes only those returns falling below a user-specified target or required rate of return, while the Sharpe ratio penalizes both upside and downside volatility equally. Though both ratios measure an investment's risk-adjusted return, they do so in significantly different ways that will frequently lead to differing conclusions as to the true nature of the investment's return-generating efficiency. The Sortino ratio is used as a way to compare the risk-adjusted performance of programs with differing risk and return profiles. In general, risk-adjusted returns seek to normalize the risk across programs and then see which has the higher return unit per risk.'

Using this definition on our asset we see for example:
  • The downside risk / excess return profile over 5 years of US Sector Rotation Strategy is 1.35, which is greater, thus better compared to the benchmark SPY (0.58) in the same period.
  • Compared with SPY (0.81) in the period of the last 3 years, the downside risk / excess return profile of 1.26 is higher, thus better.

Ulcer:

'The Ulcer Index is a technical indicator that measures downside risk, in terms of both the depth and duration of price declines. The index increases in value as the price moves farther away from a recent high and falls as the price rises to new highs. The indicator is usually calculated over a 14-day period, with the Ulcer Index showing the percentage drawdown a trader can expect from the high over that period. The greater the value of the Ulcer Index, the longer it takes for a stock to get back to the former high.'

Applying this definition to our asset in some examples:
  • Looking at the Ulcer Ratio of 1.89 in the last 5 years of US Sector Rotation Strategy, we see it is relatively lower, thus worse in comparison to the benchmark SPY (3.95 )
  • Looking at Ulcer Index in of 2.1 in the period of the last 3 years, we see it is relatively smaller, thus worse in comparison to SPY (4 ).

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 drop from peak to valley of -8.6 days of US Sector Rotation Strategy is larger, thus better.
  • During the last 3 years, the maximum reduction from previous high is -8.6 days, which is higher, thus better than the value of -19.3 days from the benchmark.

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.'

Using this definition on our asset we see for example:
  • The maximum days below previous high over 5 years of US Sector Rotation Strategy is 135 days, which is lower, thus better compared to the benchmark SPY (187 days) in the same period.
  • Compared with SPY (131 days) in the period of the last 3 years, the maximum time in days below previous high water mark of 135 days is higher, thus worse.

AveDuration:

'The Drawdown Duration is the length of any peak to peak period, or the time between new equity highs. 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:
  • Compared with the benchmark SPY (39 days) in the period of the last 5 years, the average days below previous high of 26 days of US Sector Rotation Strategy is lower, thus better.
  • Compared with SPY (33 days) in the period of the last 3 years, the average days below previous high of 34 days is higher, thus worse.

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 (%)

  • "Year" returns in the table above are not equal to 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.