TAA Model for October, 2011
This is a monthly feature at the MarketSci Blog.
Our Tactical Asset Allocation (TAA) model selects up to four assets from a diversified basket of asset classes on the final trading day of each month. Below is the new allocation for today’s close. Click to read more about the TAA model.
I eat my own cooking, so I’ve devoted a healthy share of my own net worth to the TAA model (read why). On the last day of each month I share my new allocation (see above) and real-time performance (see below).
The model underperformed its benchmark in September, returning (as of yesterday’s close) -5.0% vs -1.5%.
Commodities and real estate performed poorly, but in recent history both of these asset classes have tended to move in line with equities, so it isn’t surprising that they would lose out for the month.
What hurt was gold breaking down (badly) as a defensive hedge against equities. If this continues it will make TAA (and asset allocation in general) that much more difficult because gold is one of the few remaining major asset classes that have been moving against equities in this market.
For the upcoming month of October, the model is taking a very defensive posture, investing in only Treasuries and gold. Predicting next month’s performance is pretty straightforward. If stocks continue to slide, we’ll do well. If stocks rally, performance should be middling. This will be the first time in 12 months of trading that our allocation will significantly deviate from the benchmark.
Note: I am a small bit concerned about the bearish seasonality for gold in October (read more) but I’m choosing to ignore it because of the small number of occurrences that the observation is based on.
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There hasn’t been a huge difference in performance between the model and the benchmark so far (see below). As I’ve discussed before, I think the real strength of TAA becomes apparent when equities and risk assets go through a protracted downturn. Until then, I’m happy to keep pace with the benchmark, given how diversified our holdings are.
Note that this month I’ve begun including the Permanent Portfolio mutual fund PRPFX as an alternative benchmark. Click to read more about PRPFX.
PRPFX has performed well over the last decade (and poorly prior to that) as a result of its large allocation to defensive assets like gold and Treasuries and relatively small allocation to risk assets like equities.
My $0.02 is that PRPFX is a very good portfolio built for a very specific type of market (namely one with a high degree of uncertainty like we’re in now) but that given enough time, TAA wins the day.
Risk comes in and out of favor and PRPFX doesn’t have the ability to adjust to that (which is why performance was so poor in the 1990′s). But for now, in this specific market, PRPFX is a tough benchmark to beat.
Happy Trading,
ms
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Filed under: Tactical Asset Allocation | 6 Comments
michael, what i write I do so with all due respect. let me start by writing what I assume many of your readers are thinking. following two of the biggest months EVER in the long bond, your model steps up its allocation to 61%. GULP. personally, I see the markets as getting more and more efficient/random and virtually all quantitative models suffering as a result. I’m sure you and others have seen this in their trading. this is not surprising given the amount of attention taa and other ‘easy” strategies have garnered. bottom line is it’s gonna be a bitch making money in the markets going forward. just my $.02.
Hello Steve – your thoughts are always appreciated – responses:
1. Readers have been beating the “beware Treasuries” drum from the model’s very first month and yet it’s managed to be our second best performing asset behind gold. Could next month finally be the one that gets us? Sure, but I see no reason to prematurely neuter the model on that fear.
2. 61% is arbitrary absent volatility. If that had read 25% SPY would that make you less nervous? By my calculations, in this market, 61% IEF is roughly as volatile as 25% SPY, and either scares me equally.
3. Yes, though it’s difficult to show empirically, I personally believe that systematic quantitative edges are becoming harder to exploit. I do not however believe that that extends to those core concepts that have ALWAYS worked for investors (over long enough periods of time): diversification + trend-following (i.e. TAA). More fleeting edges (ex. the ones YK is chasing) however are being traded out of the markets.
michael
I share the same concerns about treasuries, but:
1. Your point is well-taken; and
2. Going along with the point you made, the classic statement about being fundamentally “right” while the market continues to be “wrong” probably comes in to play here. E.g., I might feel that there is no way the yield on treasuries can possibly go any lower, and I’ve felt that way for several months now, but they continue to go lower. Who knows when it will stop?
Anyway, it’s good to see you posting more than just the monthly updates again.
Michael
I too have been stuck this month with exposure to fixed income and gold, having been filtered out of the ridiculous rally in stocks. As a consequence, I’ve been looking at possible ways to maintain exposure to all asset classes as the tracking error of missing the upside of equities seems far worse to me than catching more of the downside.
One thought I had is to add a value component to complement a trend/momentum methodology so as to have some exposure to an under-valued (downward trending) asset. The combination of the two uncorrelated strategies would seem to be a good fit.
And this clearly would have been helpful in adding equity exposure this past month as they were apparently very under-valued.
I was wondering if you’ve considered adding a value component, and if you’ve researched any methods to determine over-valued/under-valued assets using technical data. It seems that Jeremy Grantham at GMO has had success forecasting asset class returns using fundamental data.
Steve
Hello Steve – I have a different take on months like this. Perhaps it’s that the horrific bear markets of the last decade+ are fresher in my memory, but I’m more than willing to miss out on a few good months than be caught in a protracted bear market.
Concepts like trend-following have gone through long periods of being less effective than B&H. IMHO…I think you have to look at these types of models as “generational” and not get caught up in any one month, quarter, or even year.
Having said all of that, I am considering rotating into corporate bonds in place of Treasuries when I don’t have equity-like exposure in any given month. At least that would provide a small bit more balance in months like this.
michael