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Investment Strategies

Recommended Strategy

At the end of the second to last trading day of the month, each investment fund in a portfolio or basket of funds are ranked based on a momentum-based score. By the close of the following trading day, the highest ranking fund is purchased with the proceeds from selling last month’s fund (if these two funds differ.) Only one fund is invested at one time.

The portfolio of funds is mostly composed of equity indexes and bond indexes. In the Standard Portfolio, the equity indexes are separated by geographic markets (e.g. Europe, Asia, and Latin America) except for those in the United States where there is further segmentation into large capitalization (S&P 500), and small/medium capitalization. US Bonds can be separated by maturity dates such as short term US Treasuries, medium term government and credit bonds, and long term Treasuries. (Alternatively, one can construct a portfolio out of any available ticker at Yahoo! Finance. Avoid company stocks; their volatilities do not match well with the system's horizon.)

The momentum score is calculated using an algorithm from the Asset Class Rotation Investment System (ACRIS). It processes 1 year of price data for each fund and calculates a score.

Summary of recommended Trading Rules
When to buy and sell
At or near the close of the last trading day of the month.
What to buy
The highest scoring fund from the Standard Portfolio, scored after the close of the second to last trading day of the month.
What to sell
The fund held in the previous month.
Exceptions to buy/sell
No need to rotate funds if the fund held in the previous month continues to be the highest scoring fund for the next month.
If trading on the last trading day of the month would incur a redemption fee, delay the transaction until the fee no longer applies.
How much to buy/sell
100% of the value of the account using this system.

Standard Portfolio

Fund Ticker Asset Class (equiv. ETF)
VFINX S&P 500 Index (SPY)
VEXMX S&P Completion Index, US small / midcap (VXF)
VPACX Developed Asia Pacific Index (VPL)
VEURX Developed Europe Index (VGK)
FEAAX Emerging Asia Pacific Index (GMF)
FLATX Latin America Index (ILF)
VEIEX Emerging Market Index (VWO or EEM)
VBMFX Lehman Bros. Aggregate Bond Index (BND)
VSBIX Barclays 1-3 Yr Treasury Bond Index (SHY)
EDV Zero-coupon U.S. Treasury Securities Index (EDV)
DBC DB Commodities Index (DBC)

For scoring purposes, the ETF equivalent (in parenthesis) should be used if you prefer trading ETFs rather than mutual funds.

The Basic Portfolio is a simpler portfolio; in particular it aggregates the geographic regions into developed countries and emerging markets. Returns are likely less, but so is the volatility.

Basic Portfolio

Fund Ticker Asset Class (equiv. ETF)
VFINX S&P 500 Index (SPY)
VEXMX S&P Completion Index, US small / midcap (VXF)
VWIGX International Growth, MSCI EAFE Index (EFA)
VEIEX MSCI Emerging Market Index (VWO or EEM)
VBMFX Lehman Bros. Aggregate Bond Index (BND)
SHY Barclays 1-3 Yr Treasury Bond Index

Custom Portfolios

The general approach to construct a portfolio or basket of funds to generate a momentum ranking is to match an available fund with one of the above asset classes, either in the Standard Portfolio or Basic Portfolio. These portfolios of asset classes were chosen based on backtesting and on a particular philosophy to focus equities primarily on geographic regions rather than other alternatives such as industry sectors. Some guidelines when constructing your own portfolio:

  • Index funds are preferred over similar funds for the same asset class. They would have the lowest expense ratio.
  • If available, ETFs are preferred over mutual funds because of intra-day liquidity.
  • Funds are strongly preferred over stocks, especially if you plan to invest in only the top 1 to 3 securities in a portfolio. See the risks section.
  • Duplicate funds (e.g. multiple large-cap stock funds) are okay.
    • Many funds are institutional funds, so there is no public ticker to determine historical daily performance. If possible, choose the fund that has a public ticker symbol. Institutional index funds can use publicly available index funds as a near-perfect proxy.
    • Depending on transaction fees (including “over-trading” penalties common in 401k accounts), it may be unnecessary to rotate to a fund in the same asset class as the prior fund in order to get similar returns.
  • Try to avoid funds with redemption fees that apply for holdings longer than a month. A redemption fee for approximately a month (e.g. 30 days) is manageable with the trading system. ETFs do not have redemption fees.
  • Avoid company stock funds. Individual stocks are too volatile for this trading system. The company stock fund is particularly risky because one is now tying investment risk with earnings risk (job security).
  • Similar to stock funds, avoid funds that focus on too small of a niche, such as timber or a small country. Because the strategy is based on one to three month holding periods, a general level of stability is desired.
  • Avoid target-date retirement funds. These funds apply strategic asset class management based on a risk trajectory as one nears retirement age.
  • If cash is desired in the portfolio, use stable-value funds if cash is not a direct option.

After matching available fund(s) to asset classes in your portfolio, the next step is to determine which fund to use to calculate an ACRIS score.

  • If the fund has a publicly available ticker, then there is no need for a proxy fund for scoring.
  • If the fund is based on an index, simply search for a publicly available fund that follows the same index.
  • If the institutional fund does not follow an index, one could try determining the actual management company (and fund manager) for the fund. Then find a similar public fund run by the same management company (and ideally the same fund manager).
  • If all else fails, simply use an index fund proxy for the asset class represented by the fund.

401K Example

An example offering of institutional funds from a 401K plan, with descriptions and suggested ticker for scoring:

Available 401K Fund Description Ticker
Company US Large Cap Equity Fund “…investing in large cap stocks, as represented by the Russell 1000 Index” IWB
Company US Small/Mid-Cap Equity Fund “…investing in small/mid-cap stocks, as represented by Russell 2500 index” VEXMX
Company International Equity Fund “…investing in companies based outside the U.S.and to outperform MSCI international equity benchmark (MSCI All Country World Index ex-U.S. Index)” VWIGX
Company US Large Cap Equity Index Fund “Seeks to track the performance of the Russell 1000 Index” IWB
Company US Small/Mid-Cap Equity Index Fund “Seeks to track the performance of the Russell 2500 Index” VEXMX
Company International Equity Index Fund “Seeks to track the performance of the MSCI All Country World Index ex-U.S. Index.” VWIGX
Company Short Term Bond Fund “Seeks to … outperform the 1-3 year Barclays Capital Government/Credit Index over a market cycle” CSJ
Company Core Bond Fund “…investing primarily in high-quality bonds, as represented in the Barlcays Capital Aggregate Bond Index” VBMFX
Company Prime Money Market Fund “Seeks to provide current income while maintaining liquidity and a stable share price of $1″ Cash
Company Emerging Markets Equity Fund “…investing in emerging markets and to outperform MSCI Emerging Market Index” VEIEX
Company Global Real Estate Fund “…investing in real estate stocks globally, and to outperform FTSE EPRA/NAREIT Developed Index” IFGL
Company Commodity-Linked Fund “…outperform the custom benchmark 50% DJ-UBS Commodity Index and 50% S&P GSCI Commodity Index” GSG
The Company Stock Fund “…Company’s stock performance by investing primarily in Company common stock” COMPANY
Company Real Return Bond Fund “…outperform the Barclays Capital U.S. TIPS Index” TIP
Company Long Term Bond Fund “…outperform the Barclays Capital Long Term Government/Credit Index” LWC
Company High Yield Bond Fund “…outperform the BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index” PRHYX
Company Core Bond Index Fund “Seeks to track the performance of the Barclays Capital Aggregate Bond Index” VBMFX
Company Conservative Fund ~70% various bond funds and 30% various equity funds from above N/A
Company Birth Date Fund: YYYY Mix of bond and equity funds depending on YYYY birth year. Targeted retirement asset allocation. N/A

The greyed-out funds are institutional funds with no public ticker. Generally use index fund proxies that match the asset class in their description. Here, the 401K plan has a matching index fund for each of these institutional funds, so we skip these funds in our portfolio.

The funds marked yellow are acceptable funds, though in my experience, real estate and junk bonds tend to have shorter term trends that do not fit ACRIS as well as other asset classes.

The funds marked red are funds that are not recommended by 401kBooster.com. Company stock is too volatile and risky, as explained above. Target Retirement Date funds are already a portfolio of asset classes that slowly changes its asset allocation as it reaches the target date. These funds are not suited for ACRIS.

None of these funds are publicly available (institutional), so proxy index fund tickers are matched to the index described for each fund.

TSP Example

The Federal Government’s Thrift Savings Plan is listed below:

Available 401K Fund Description Ticker
G Fund “Interest income without risk of loss of principal” Cash, 2%
F Fund “To match the performance of the Barclays Capital U.S. Aggregate Bond Index” VBMFX
C Fund “To match the performance of the Standard & Poor’s 500 (S&P 500) Index” VFINX
S Fund “To match the performance of the Dow Jones U.S. Completion TSM Index” VEXMX
I Fund “To match the performance of the Morgan Stanley Capital International EAFE (Europe, Australasia, Far East) Index” VTMGX
L Funds (various Target Dates) “To provide professionally diversified portfolios based on various time horizons, using the G, F, C, S, and I Funds” N/A

Custom Strategy Variations

Although ACRIS was developed for intermediate term rotation trading, the scoring algorithms can be used for alternate strategies. 401kBooster.com cannot backtest many of the following variants, but because one can score funds in the past from historical data, one can manually backtest these strategies on his own.

  • Increasing scoring and potential trading frequency to every week or semi-monthly. More volatile funds may find this useful. This feature is available in Backtest Settings.
  • Buy the top N funds (assuming they score > cash) rather than the top 1. Compared to only buying the top 1, this variant likely reduces returns but also reduces volatility. May improve risk-adjusted returns. This feature is available in Backtest Settings
  • Single fund buy/sell signal. Can be backtested by 401kBooster.com with "use-cash" setting. Experiment with cash score between -5 and 0 and with various scoring methods.
  • For N funds in a portfolio, split the equity in N portions (each portion represented by a single fund). After generating a score at the end of each month, invest in only those funds (with matching portions) that meet some threshold score (e.g. > 0.0). All remaining portions go in a cash equivalent fund. Each portion need not be the same. Proportion of portions may be rebalanced once a month or at a schedule comfortable to you. This strategy is similar to other TAA strategies such as the “Ivy Portfolio” by Melane Faber.
  • Short the worst scoring fund, if it is below a threshold score. Shorting requires margin, and is only available in taxable accounts. Alternatively, use short or “bear” funds, though these funds are rarely available for tax-sheltered accounts.
  • Use leverage to improve returns (and magnify volatility and drawdowns). Generally use margin (only available in taxable accounts) to provide leverage up to 2X. Be sure to understand margin interest rates, margin call risk, and the concept of fractional Kelly. For example, if you expect 20% annual return and 40% max drawdown without leverage, then after leveraging 1.5X at 8% annual margin interest rate, you might expect 27.6% annual return and almost 60% max drawdown over the long term. Alternatively, use leveraged funds that magnify daily returns. Note that leveraged daily returns do not mimic using margin as leverage.
  • Use the ACRIS recommended strategy with the 100 stocks in the Nasdaq 100 index. Hold the top 5 stocks each month. Rotate at the end of each month. Perhaps add a market filter: 401kBooster score of QQQ or ^NDX must be above zero. High risk but high reward.