Relative Momentum Portfolio Rotation To Minimize Bear Market Risk

One approach to a simple rules-based, mechanical system to manage opportunity and potentially minimize maximum drawdown in Bear markets is to use relative momentum between each strategic asset and a risk-free asset (T-Bills) as an alternative — all-in or all-out of each strategic asset based on its return versus the return of T-Bills.Bear market.

The shorter the evaluation period, the smaller the maximum drawdown exposure — but the greater the trade frequency which is not tax efficient in a regular taxable account, and the more frequent the whipsaw (sort of a head-fake by the market requiring reversal of the position with positive loss or opportunity cost).

The longer the evaluation period, the larger the maximum drawdown exposure — but the lower the trade frequency, which is more tax efficient in regular taxable account, and the less frequent and potentially less costly the whipsaw.

Ways to attempt the avoid the worst of each evaluation period length while attempting to capture some of the best of the each evaluation period may be to use an average of shorter and longer periods, or to step into and out of strategic positions in phases by using more than one evaluation period length.

Relative Performance Rotation With the Swensen Portfolio:

Let’s look at an example, using the Swensen Reference Portolio as a base case with 2018-08-23 data.

Swensen is the CIO of the Yale Endowment, who proposed his “Reference Portfolio” as something from which to depart for a personally suitable portfolio in his book, “Unconventional Successs: a Fundamental Approach to Personal Investment”. He did not recommend momentum rotation in that book.

The Swensen portfolio is 70% OWN, 30% LOAN and 0% RESERVE.

This table shows the Swensen portolio as the default allocation, and to the right of that are four alternative allocations based on whether the strategic risk asset has outperformed risk-free cash over a 3, 6, or 12 months rating period, or the average of those periods. Where the risk asset did not outperform, cash is held in lieu of the asset.