I love simple. Especially when it comes to investing. So, the standard issue “60/40’ approach holds a certain appeal. To be clear, the 60/40 version I am speaking of rebalances each year so that at the start of the year, the portfolio holds:
*60% Standard & Poor’s 500 Index
*40% Bloomberg Barclays Treasury Long Index
There are other versions. For example, some prefer to use a broader bond index that covers more than just long-term treasuries. The theory behind 60/40 is simply that:
*The stock market goes up in the long run, and;
*Bonds historically tend to perform well when stocks have a down year
Some questions are being raised regarding the viability of 60/40 going forward. And with interest rates extremely low and following close to a 40-year bull market in both stocks and bonds, the questions are reasonable. Still, many investors are OK with the returns generated utilizing a 60/40 approach. Of course, it would be a pretty boring article if I just typed “The End” right here, don’t you think? So, let’s examine a simple approach to improving on the standard issue 60/40 approach.
Applying Momentum
There is a fairly large body of research that highlights pretty clearly that a security that is outperforming some other security or securities, will often tend to continue to do so for some period of time. So, here is the method we will test:
*We use total monthly return data for the S&P 500 Index and the Bloomberg Barclays treasury Long Index starting in January 1973.
*At the end of each November we determine which security has outperformed during the previous 12 months
*If the S&P 500 Index has outperformed Long Term Treasuries over the latest November to November period, then on December 31st we rebalance to:
*S&P 500 75%
*Bloomberg Barclays Long Treasury Index 25%
*If the S&P 500 Index has underperformed Long Term Treasuries over the latest November to November period, then on December 31st we rebalance to:
*S&P 500 25%
*Bloomberg Barclays Long Treasury Index 75%
(NOTE: The monthly total return data is not typically available until several days into the new month. So, if we waited until the end of December to do our calculation we would have to wait until the December monthly total return data is available in early January before doing our rebalance. In order to be able to rebalance exactly at the start of each new year, we use 12-month total return at the end of November to decide what action to take on December 31st)
In a nutshell:
Instead of always starting each new year 60/40 favoring stocks, we start each new year with 75% in whichever index outperformed in the previous Nov to Nov period and 25% in the other index.
Is this a good thing to do? Let’s take a look.
The Results
Figure 1 displays the growth of $1,000 invested using our Momentum Strategy (blue) versus the standard 60/40 approach.
Figure 1 – Growth of $1,000 using Jay’s 75/25 Strategy (blue) versus Standard 60/40; 1974 through Sep 2019
Figure 2 displays a variety of statistical measures.
| Measure | 75/25 | 60/40 |
| Average 12-mo % | +11.7% | +11.3% |
| Median 12-mo. % | +10.6% | +11.3% |
| Std. Deviation % | 10.26% | 11.18% |
| Ave./Std Dev. | 1.14 | 1.01 |
| Worst 12 months % | (-9.9%) | (-22.2%) |
| Maximum Drawdown % | (-12.8%) | (-26.5%) |
| Average 5-yr% | +74.4% | +72.1% |
| Worst 5-yr% | +20.1% | (-1.5%) |
| $1,000 becomes | $121,963 | $97,114 |
| Cumulative % +(-) | +12,096% | +9,611% |
Figure 2 – Jay’s 75/25 versus Standard 60/40
*While the annual 12-month% is only slightly higher (and the median 12-month % is actually lower) using the Momentum Strategy, the net result is 26% more profit (+12,096% for the 75/25 Strategy versus +9,611% for the 60/40 approach).
*The 75/25 Strategy had a:
*lower 12-month standard deviation (10.26% versus 11.18%)
*smaller worst 12-month % loss (-9.9% versus -22.2%)
*significantly smaller maximum drawdown (-12.8% versus -26.5%)
*worst 5-year return of +20.1% versus -1.5% for 60/40
Other statistics appear in Figure 3.
| Measure | 75/25 | 60/40 |
| % of 12-mo. Periods UP | 89.6% | 83.6% |
| % of 12-mo. Periods DOWN | 10.4% | 16.4% |
| % of 12-mo. Periods>other approach | 57.2% | 42.8% |
| % of 5-yr Periods UP | 100% | 98.2% |
| % of 5-yr Periods DOWN | 0% | 0.2% |
| % of 5-yr Periods>other approach | 60.2% | 39.8% |
Figure 3 – Jay’s 75/25 versus Standard 60/40
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
Momentum. Trend-following in other words. Look… if you think you know the trend, why in the heck would you re-balance to a long allocation? If you had any conviction you would at least get out of the asset class that you think is going to decrease in value. The problem here is that you are stuck in the relative return paradigm. If you pick an asset class and learn everything you can about what presages changes in total return trends, then you can make equity-like returns while avoiding the lions share of drawdown. http://www.trendhaven.net.
Michael, Excellent points. The main point here is simply acknowledging that some (many?) investors migrate to 60/40 or something similar. This is just one simple way to (potentially) improve performance. Take Care, Jay