Momentum vs. Reversion to Mean and how it impacts being diversified/hedged

[jmont42]

First Query: When I take all of your positions from multiple strategies and when I put them in a watchlist and scroll through the charts, it seems like the majority are momentum trades…QQQ, GLD, EIS, EPOL, etc. but then in your U.S. Sector strategy, it’s XLP and XLV and they are clearly defensive/reversion trades. From a portfolio management perspective, I never want to be all momentum or all reversion. Even your hedge strategy lately has been relying heavily on GLD which has been working great but it’s a momentum position and I don’t usually think of momentum positions as hedges. Am I wrong to be concerned about relying too heavily on momentum?

Second Query: For the last few months, the top 3 strategy has been over 50% allocated to GLD which has worked out great but as someone who is subscribed here primarily to manage risk…I’m surprised to see one of your best performing strategies and one that could be used as a portfolio, so exposed to one asset? Can you comment on that?

Thank you!

[Frank1 Grossmann]

Only our sector strategy has a mean reversion sub-strategy. In general, it is quite difficult to build well-performing mean reversion strategies. I think you can really say that it’s all about momentum. If something goes well, it goes well for quite some time.
Nearly all of our strategies are hedged with the same hedging strategy and if this one is in gold then every strategy will be on gold in the top three strategies. It just doesn’t make sense to hedge with treasuries if they are not doing well. Even if this would diversify a portfolio. Some of our strategies, however, invest also in lower volatility ETFs or stocks if markets go down which also make the strategy more defensive.
Regards Frank

[jmont42]

Thanks Frank for taking the time to respond. I understand what you said about the benefits of momentum and it gives me more confidence to trust the strategies. However, you didn’t really respond to my concern about the top 3 strategy being almost 50% in one position. It has worked out great and it’s hard to argue with success, but I’ve always been taught that diversification was key and it’s not good to be over allocated to any one asset. Any thoughts? Thank you.

[kuber7979]

@LI Team ,
1.how to configure and test Long short strategy in QT please guide
2.how mean reversion configuration works in QT ? any documentation ?
3.how to configure new ccy in ccy list in symbol list manager window. (for overseas stock symbols other than those 4 prebuilt ccy’s).

[jmont42]

Hi, I think you might be better off posting a new question because I’m not sure Frank or anyone at the LI team will see this post. I got a notice because I’m the one who originally started this thread but it’s been inactive since July. Good luck with your search.

[Vangelis]

This question has been posted in another thread:
https://logical-invest.com/forums/topic/could-someone-provide-me-insights-on-portfolio-allocation-strategies

[luchetto]

I think Frank answered the other question. Most of the strategies built on LI have the same hedge component built into them. The Top 3 picks the best strategy which in turn all have the same hedge component built into it. If the hedge strategy on its own selects gold you will have that gold allocation over all top 3 strategies and that is why the total gold allocation becomes as large.
Whether gold is a true hedge or just another asset class is another discussion.
You might want to look into the CAOS ETF which is a true hedge but has a positive carry, so no losses while you wait for the crash to happen. You just need quite a large allocation to compensate for losses on the equity market. CAOS to me could be an alternative to GSY, same or higher cash return with a long vol kicker.

[jmont42]

Thank you for your reply. I’m a fan of logical invest and the top 3 strategy but I’m not a fan of being 50% in any one asset. This year it has worked out but over time, I’ve noticed when the market crashes and there are margin calls…gold gets sold just like everything else. I still use the strategy, I just limit my allocations based on my own risk tolerance. I looked at the CAOS etf and it looks good as a partial substitute hedge. I really appreciate you taking the time to respond and giving me an alternative that fits my risk profile…logical invest is a great service and a great community of investors!

[luchetto]

You’re welcome. If it wasn’t for the short history of CAOS it would make for a very good alternative hedge product in LI’s strategies.
Have you checked on AlphaArchitect’s website how the underlying strategy works? CAOS really only works well if we have a sudden crash and explosion of volatility. This is how the crash puts will protect you. If instead markets grind lower like in 2022 and vol rises but does not spike than the strategy will constantly lose with the put spreads but not have the offset from the crash put. It is important to understand what the limitations of such products are.

[Author]

Posts