The Top 4 World Country Strategy

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The Top 4 World Country Strategy 2017-03-15T23:30:29+00:00

Project Description

  • The World Country Top 4 strategy is a strongly momentum driven strategy creating high returns.
  • The strategy profits from a maximum global diversification.
  • With a 20 year CAGR of 20.7% the strategy has a much lower volatility and lower risk than an S&P 500 investment.

The World strategy adds excellent geographic diversity strength through rotating between a wide variety of individual countries ETFs by blending the best mix of risk adjusted growth. This strategy offers significantly more non-US global exposure than our other strategies, and adds performance diversification by rebalancing between the top 4 countries at the end of each month.

The strategy uses a dynamic ranking method of our proprietary Max Sharpe engine, and for this model it is tuned to capture momentum between individual countries ETFs. Here also we use a volatility attenuator of 2, which means that volatility has a slightly higher weight in the formula. Each month our model chooses which countries mix together to provide the best basket of momentum growth, with balancing each other for risk adjustment.

As of December 2016, the strategy includes allocation to our Bond Rotation strategy’s best bond ETF. This means that WT4 may hedge equity risk from a wider range of bonds, not just TLT. For example if the best performing asset from the BRS strategy is JNK, then WT4 will allocate a % to that bond ETF.

We extensively reviewed all of the ETFs by each country and group, and choose those they best captured each area. If you look at the ETF table you will see that there are quite a lot of interesting countries, in which a normal investor would probably never invest without the help of such a strategy.

The model picks up to four ETF each month. All are equity market ETFs. The model will ‘hedge’ the equity part by allocating a percentage to the top bond ETF chosen by the Bond Rotation strategy. BRS picks form these bond ETFs: JNK,CWB,PCY and TLT . The US is represented through the Nasdaq 100, which fits well with the momentum nature of this strategy.

1 AFK Market Vectors Africa Index
2 ASHR Deutsche X-Trackers CSI 300 China A Shares
3 ECH iShares MSCI Chile Fund
4 EGPT Market Vectors Egypt Index
5 EIDO iShares MSCI Indonesia Index
6 EIRL iShares MSCI Ireland Capped
7 EIS iShares MSCI Israel
8 ENZL iShares MSCI New Zealand Investable Market
9 EPHE iShares MSCI Phillipines
10 EPI WisdomTree India Earnings Index
11 EPOL iShares MSCI Poland Index
12 EPU iShares MSCI Peru Index
13 EWA iShares MSCI Australia Index Fund
14 EWC iShares MSCI Canada Index Fund
15 EWD iShares MSCI Sweden Index
16 EWG iShares MSCI Germany Index
17 EWH iShares MSCI Hong Kong Index Fund
18 EWI iShares MSCI Italy Index
19 EWJ iShares MSCI Japan Index Fund
20 EWK iShares MSCI Belgium Index
21 EWL iShares MSCI Switzerland
22 EWM iShares MSCI Malaysia Index Fund
23 EWN iShares MSCI Netherlands Index
24 EWO iShares MSCI Austria Index
25 EWP iShares MSCI Spain Index
26 EWQ iShares MSCI France
27 EWS iShares MSCI Singapore Index
28 EWT iShares MSCI Taiwan Index Fund
29 EWU iShares MSCI United Kingdom Index
30 EWW iShares MSCI Mexico Index Fund
31 EWY iShares MSCI South Korea Index Fund
32 EWZ iShares MSCI Brazil Index Fund
33 EZA iShares MSCI South Africa Index
34 FM iShares MSCI Frontier Markets ETF
35 FRN Guggenheim BNY Mellon Frontier Mkts
36 FXI iShares FTSE China 25 Index Fund
37 GAF SPDR S&P E.M. Middle East & Africa
38 GULF WisdomTree Middle East Dividend Index
39 GREK Global X FTSE Greece 20
40 GXG Global X Interbolsa FTSE Colombia 20
41 IDX Market Vectors Indonesia
42 MCHI iShares MSCI China Index
43 MES Market Vectors DJ Gulf States (GCC) Titans
44 NORW Global X FTSE Norway 30 ETF
45 QQQ PowerShares Nasdaq-100 Index
46 RSX Market Vectors DAXglobal Russia
47 THD iShares MSCI Thailand Index
48 TUR iShares MSCI Turkey
49 VNM Market Vectors Vietnam

Bond Rotation Strategy Hedge picks from:

50 CWB – SPDR Barclays Convertible Bond

51 JNK – SPDR Barcap High-Yield Junk Bond (4-7yr)

52 PCY – PowerShares Emerging Mkts Bond (7-9yr)

53 TLT – iShares Barclays Long-Term Trsry (15-18yr)

Risk and Performance Profile

Risk Score:?
3 Months12 MonthsSince Inception
Annual Performance vs. Benchmark

Summary World Country ETFs Top 4 strategy

• The World Country ETFs Top 4 strategy is a strongly momentum driven strategy creating high returns.
• The strategy profits from a maximum global diversification.

In my last articles I described various momentum strategies with variable allocations using our maximum Sharpe method. A good example how to build such a strategy is the Universal Investment Strategy (UIS) which always invests in a variable allocation of TLT and SPY. However, UIS is a strictly a U.S.-based equity and bond strategy. In the short term, this strategy cannot do much better than its own underlying ETFs, namely SPY and TLT.
Today, many market analysts are less optimistic about the US market. The US stock market may have culminated after 6 very strong years following the 2008 subprime crash. Treasuries, at least in the past 2 months, are underperforming as they begin to anticipate rising yields. It is possible that the UIS strategy underperforms for a few months. Keep in mind that the UIS strategy has been backtested for more than 20 years and I am quite sure that it will continue to work in the future. However, as with ETFs, every so often, one has to evaluate which strategies outperform and possibly switch some capital to the better performing ones.
We have several new strategies under development (e.g., Countries, Nasdaq 100, Dow 30, US Industries) and we are already investing in these strategies, as to validate them before publication.
To address an underperforming US market, I think the best of these strategies is the Country ETF rotation strategy, which always invests in the top 3 to 4 of 49 countries. One thing is for sure: there are always countries in this selection which are doing well, unless there is a major global crisis. During global crisis, all country equity markets may struggle, while money will rush to safe assets like treasuries. Individual country ETFs can easily lose 50% or more of its value if there is a bad government in place. However, after such a period, most of the time, the next government will be more market oriented and the ETF will recover. This political influence of changing governments creates good up and down movements of the country ETFs and these movements are quite independent of the world stock markets. So these country ETFs are well suited for ETF rotation momentum strategies.

If you look at the ETF table at the end of this article, then you will see that there are quite a lot of interesting countries, in which a normal investor would probably never invest without the help of such a strategy.

At the moment the strategy is for example invested in:
30% – EWA ETF (iShares MSCI Australia Index Fund)
20% – EWL ETF (iShares MSCI Switzerland)
20% – EWS ETF (iShares MSCI Singapore Index)
30% – EIS ETF (iShares MSCI Israel)

If you read financial papers, you may from time to time, read of these countries. But by the time you read the positive articles in the press, it is already too late to invest. The country strategy uses a look-back period of 68 trading days. This means that it only needs a little bit more than 3 month to detect if a country is changing from a loser to a winner.

Not all ETFs are single countries. Some represent regions, like for example Africa, the Gulf states or Frontier markets. These ETFs allow you to invest in regions where a single country ETF would be much too small and volatile.

Country ETFs can be quite volatile, so a Top 1 ETF strategy would be much too dangerous. With 50 ETFs you can invest in quite a lot of top ETFs. For Hedge funds, we would even invest in the top 10 ETFs. For the individual investor the Top 4 ETF strategy gives the best results. It will smooth out single ETF volatility while simplifying execution and reducing costs. It should be easy and cheap to rotate these 4 ETFs once a month if you have a good discount broker account. Most of the time you will only need to rotate 2 ETFs every month since the strategy may stay invested in the other two for longer periods.

Update: As of December 2016, the TMF hedge mentioned below has been replaced by our Bond Rotation strategy’s top bond ETF. For more details see this post.

Besides country ETFs you still need a “safe haven” asset in the case of a market correction. The best safe haven asset is the long term Treasury bond. Rising rates do not negatively affect the strategy in this case. Once the markets crash, Treasuries quickly become the asset to go to for many investors, and this will remain so even in a raising rate environment.

In our strategy we use the TMF 3x leveraged long-term Treasury (20yr) ETF. The 3x leverage of TMF makes sure that we can hedge the volatility of the other country ETFs with a relatively small amount of TMF ETFs. Normally the strategy will invest in 0-30% TMF Treasury ETFs and 70% or more country ETFs. TMF effectively reduces the volatility and risk of the strategy. The volatility is nearly reduced by a factor of 2 and the strategy is less volatile than a normal S&P 500 investment.
Another advantage of TMF is that you do not have to pay the 30% withholding tax on the dividends like with non-leveraged bond ETFs.

The strategy uses a dynamic ranking method using our modified Sharpe ratio. The country ETFs and the TMF treasury are mixed together to achieve the maximum modified Sharpe ratio for the lookback period. Here also we use a volatility attenuator of 2, which means that volatility has a slightly higher weight in the formula. If Treasuries don’t do well then the strategy will not invest in Treasuries.

Backtest description of the World Country ETFs Top 4 strategy

20 year backtest of the World Country ETFs Top 4 strategy

The first backtest was run for the maximum possible duration of 20 years. Only about a third of the ETFs go back to 1996. These include mostly major European countries as well as Japan and Mexico. So for the first 10 years the ETF selection is much smaller than today, but nevertheless the backtest shows that such a country rotation worked well during the last 20 years. I have used the VUSTX mutual fund which is very similar to TLT to construct a synthetic long term TMF ETF.
It is interesting to see, that the strategy always kept a high annual performance of about 20% with a volatility lower than the volatility of an S&P500 investment and considerably lower than an investment in European or Asian stock markets.

ishares msci single country ETF ETFS ishares country ETFS

20 year statisticsReturnCAGRVolatilityDrawdownSharpe
Top 4 country3380%20.8%16.5%-36%1.257
VUSTX (TLT)288%7.5%10.8%-18% (27%)0.692

10 year backtest of the World Country ETFs Top 4 strategy

The 10 year backtest uses TLT as the safe haven asset and uses more available country ETFs. The strategy did well during the 2008 crisis. The Sharpe (Return to Risk) ratio of 1.2 is nearly 3x higher than a SPY or TLT investment.

comparison ishares msci single country ETF ETFS ishares country ETFS

10 year statisticsReturnCAGRVolatilityDrawdownSharpe
Top 4 country556%20.7%16.4%-36%1.267

5 year backtest of the World Country ETFs Top 4 strategy

The 5 year backtest has an even higher Sharpe of 1.82 because since the 2008 crisis the long term Treasury (TMF) correlation to the stock market was mostly negative, which allowed to further reduce volatility.

msci single country ETF ETFS ishares country ETFS

5 year statisticsReturnCAGRVolatilityDrawdownSharpe
Top 4 country183%23.1%12.7%-10%1.821

Year to date backtest

The last backtest is the year to date performance. As you can see the strategy did quite well with a 12.3% performance and at this point it carries no Treasury exposure at all. In other words, presently, it will not be affected by further declining Treasuries due to rising rates.

gold ETF miners gold etfs msci single country ETF ETFS ishares country ETFS

YTD statisticsReturn until May 21CAGRVolatilityDrawdownSharpe
Top 4 country12.4%35.8%14.3%-5%2.511

Table of Country ETFS in the strategy

1AFK ETFMarket Vectors Africa Index
2ASHR ETFDeutsche X-Trackers CSI 300 China A Shares
3ECH ETFiShares MSCI Chile Fund
4EGPT ETFMarket Vectors Egypt Index
5EIDO ETFiShares MSCI Indonesia Index
6EIRL ETFiShares MSCI Ireland Capped
7EIS ETFiShares MSCI Israel
8ENZL ETFiShares MSCI New Zealand Investable Market
9EPHE ETFiShares MSCI Phillipines
10EPI ETFWisdomTree India Earnings Index
11EPOL ETFiShares MSCI Poland Index
12EPU ETFiShares MSCI Peru Index
13EWA ETFiShares MSCI Australia Index Fund
14EWC ETFiShares MSCI Canada Index Fund
15EWD ETFiShares MSCI Sweden Index
16EWG ETFiShares MSCI Germany Index
17EWH ETFiShares MSCI Hong Kong Index Fund
18EWI ETFiShares MSCI Italy Index
19EWJ ETFiShares MSCI Japan Index Fund
20EWK ETFiShares MSCI Belgium Index
21EWL ETFiShares MSCI Switzerland
22EWM ETFiShares MSCI Malaysia Index Fund
23EWN ETFiShares MSCI Netherlands Index
24EWO ETFiShares MSCI Austria Index
25EWP ETFiShares MSCI Spain Index
26EWQ ETFiShares MSCI France
27EWS ETFiShares MSCI Singapore Index
28EWT ETFiShares MSCI Taiwan Index Fund
29EWU ETFiShares MSCI United Kingdom Index
30EWW ETFiShares MSCI Mexico Index Fund
31EWY ETFiShares MSCI South Korea Index Fund
32EWZ ETFiShares MSCI Brazil Index Fund
33EZA ETFiShares MSCI South Africa Index
34FM ETFiShares MSCI Frontier Markets ETF
35FRN ETFGuggenheim BNY Mellon Frontier Mkts
36FXI ETFiShares FTSE China 25 Index Fund
37GAF ETFSPDR S&P E.M. Middle East & Africa
38GULF ETFWisdomTree Middle East Dividend Index
39GREK ETFGlobal X FTSE Greece 20
40GXG ETFGlobal X Interbolsa FTSE Colombia 20
41IDX ETFMarket Vectors Indonesia
42MCHI ETFiShares MSCI China Index
43MES ETFMarket Vectors DJ Gulf States (GCC) Titans
44NORW ETFGlobal X FTSE Norway 30 ETF
45QQQ ETFPowerShares Nasdaq-100 Index
46RSX ETFMarket Vectors DAXglobal Russia
47THD ETFiShares MSCI Thailand Index
48TUR ETFiShares MSCI Turkey
49VNM ETFMarket Vectors Vietnam
50TMF ETFDirexion 3x leveraged 20-yr Treasury