Backtest Strategy Enhancement. The Use Of 'First Date' Of New Period.

May 27, 2011

In response to feedback we have improved the suite of Relative Strength backtesting applications.  The "Use Next to Last Day Pick(s)" option, which some users found confusing, has been replaced by an option to "Invest on first day of next period". 

This change has two benefits:

A) Consistency throughout the site - because the "first day" option still uses the Screener’s end of period picks, the ETFs chosen will always match those shown on the Screener Ranks and RS Reader pages

B) Because the "first day" option invests in exactly the same ETFs, the performance is generally much closer to that of the standard backtest

To be clear, does not use opening prices in any of its backtesting apps.  This is because opening prices can often be skewed quite significantly.   Closing prices cannot be manipulated nearly as much because the final 30 mins is a very volume-intensive time and anyone trying to set a price could easily get 'run-over' trying to do it.  By contrast, opening prices are somewhat guesswork.  The underlying securities of an ETF haven't opened either - so it is impossible in some cases to precisely know how all the various gaps will play out in terms of the overall index.  Moreover, market makers can sometimes manipulate the opening price to fill existing market orders and then let the price go back to its natural point.   This is especially true on options expiration.  Sometimes the opening price might print a small number of shares and then move quickly in the other direction to a more natural price.   Consequently we think it's best, as a rule of thumb, to avoid trading the open.

In addition, it should be clear that if you trade on the first close of a month, then the comparison index return should also be set from the first close of the month.   You should not compare an entry on the first close to an index return that uses a prior day -- it is an unfair comparison.   You want to go for consistency and match the time periods.

Let’s go through one example using the 'Sample' Portfolio.   This portfolio was added to member’s lists to show an example of a few different ideas -- everyone got the same portfolio since we launched this idea in the Spring of 2010.

First note not only the raw return -- but the difference between the return and the index.   +12.0% vs +6.2% for a spread of +5.8%:


Then view using the first close to track performance for both the strategy return as well as the benchmark:


And then finally,  take note of the fact that the dates are offset by 1 day.   We go deep into the issues of dates throughout our site as there are many problems with dates in most financial databases.  If you 'miss' dates, your output will be garbage.  We make sure there are no missing dates for any ETF through the use of SQL database queries.


If we leave the "Invest on first day of next period" option unchecked, then the back test will invest in the chosen ETFs on the close of the last day of the period.  If we use the checkbox, two things happen: 

 1) the 'update' period will now be the first closing price of the new period 

2)  the comparison index will be tracked from the matching date.

 Since the picks are the same regardless of method, this tightens up the performance greatly.  The only difference is the performance on the first day of the period and the performance of the extra closing day on the update date.   These will affect the overall result -- but they treat both the chosen ETF and the comparison index the same.

Note the slight difference in year-to-date returns between the standard (unchecked) backtest and the first day option backtest. It will be better sometimes and worse sometimes and over time, some of the differences will offset each other.  To the extent the first day of the month goes up, you will be long the pick from the previous month and will benefit from this.   To the extent it goes down, so too will the comparison index.  We think this consistency will clarify some of the issues we've been having in email.


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Forward Test Review From Nov 2010 to Now

May 19, 2011 in Relative Strength | Video

Exactly 6 months ago we released the Relative Strength Reader application.    We review the example done then in the video below:



(original video is on the Tools Tab if didn't see the original).


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Month of May For Gold (GLD ETF) vs Last 15 Years

May 18, 2011 in Gold

The Gold ETF (GLD) had something of a spike up into the end of April. Since that time GLD has corrected and is now -4.4% for the month of May (so far).

Since the ETF only has a price history from 2004, we wanted to show a few extra years to get a feel for GLD moves. We use the London PM Fix price prior to November 2004 and then use GLD thereafter.


Click on image below to enlarge



Compare this drawdown to Gold Stocks (GDX) --- which is consistently one of the most volatile ETFs among all the major ETFs.   GDX is currently -10% this month.    The GLD etf has only lost -10% in 1 month in the last ~15 years and that was October of 2008 -- which was an outlier month in many ways --- including the economy, gov't policy,  credit spreads etc....



Understanding relative drawdowns is important way to view risk.



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Meredith Whitneys 'Fundamental Analysis'

May 17, 2011

This chart speaks for itself:


Bond ETF Snapshot

May 17, 2011 in Bonds

With the bond market assuming the role of leading segment this month, lets take a look at the structure of the market.    

The top 25 fixed-income ETFs have roughly $125 billion in assets.   If we weight this by the durations of each product,  this group has an overall duration of 4.8 years, which is in-line with the Barclays Aggregate Bond Index.   This highlights our recent focus on 5-year bond yields

While some think that the bond market means 10 or 30-year treasuries, you will see that only 1 ETF in the top 25 has a duration of 10 years or longer (TLT). From a bond market investment standpoint, investors on average own 5 year bonds, not 10-30 year bonds.  Below is the breakdown by product:


For a comparison, we use the Pimco Total Return mutual fund --- which also keeps a lid on its portfolio duration.    While many in the media like to speculate about how Pimco is short US Treasuries and so forth --- they seem to fail to understand the exposure of the OVERALL fund.   Pimco Total Return fund is LONG bonds.   While it may hold some things that trade inversely to certain bond segments, the overall fund trades WITH the bond market.   Here is a look at YTD performance of the above 25 ETFs, weighting by their assets and the performance of that overall portfolio vs the Pimco Total Return Fund:


For fun, here is how it ranks vs these 25.    Not surprisingly, it is trading about in the range you would expect given its structure (duration of Pimco is under the aggregate index but it does own some stronger performing Int'l bonds).  Pimco Total Return currently ranks 15th out of 26 (25 bond ETFs plus PTTRX).




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Protecting Capital: An ETF Manager Results Example

May 12, 2011

Many people still equate ETFs with ‘passive’. While it is true that most ETFs track indexes, dynamically choosing and assigning allocations to indices is as active as anything you can do.

Recently, we listened in on a panel with an ETF investment manager that currently has $2 billion under management. This fund manager stated that it decides its exposures based on 3-factors:


1. 50% Momentum Models

2. 25% Valuation & Monetary Policy Considerations

3. 25% Sentiment Models


Here are the published returns:

Note that despite a successful hedge-fund profile of returns, the fund did lose money in over one-third of all months. This is similar to many of the (successful) backtests we run, there is a cap on the % of up months any return-oriented fund can accomplish. It should encourage you to reduce the volatility of your portfolio to know that you will likely lose money at least one-third of the time. This should help temper your risk appetite somewhat as the nature of compounding dictates you obviously do not ever want to drawdown a large percentage.

Below we lined up all the 1-month returns from low to high. We like this visual because it should be obvious that most of the time, you should expect some low return – plus or minus. Limit your drawdowns and then during some point of the year, you would like to catch some type of trend and be overweight that group -- be it in natural resource stocks, domestic REITS or intermediate treasury bonds.


The point is really that whether you are a conservative investor or an aggressive investor --- you can pursue strategies at different weightings with the core-satellite structure. If you are conservative, then your satellite strategies can be smaller and your core more defensive. If you are aggressive, then you can run your satellites at a higher weighting. But in the end, the goal is essentially the same --- protect and grow capital.


Addendum: In a recent conversation with a venture capital investor --- he called anyone who doesn't actively advise the company on strategy and help make introductions on behalf of the company to customers a 'passive' investor. Its all a matter of perspective I guess.


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Schwab ETF Traction

May 11, 2011


CFA Institute on Relative Importance of Stock-Picking: Focus On What Really Matters

May 09, 2011

"There is now a greater understanding on the part of institutional investors that asset allocation is the issue rather than stock picking.” The CIO of a pension fund in northern Europe concurred: “Strategic asset allocation has always been a more important driver of returns than the selection of asset managers that pursue outperformance vis-à-vis a market benchmark.”



CFA Institute Publications Link believes that exchange traded funds will increasingly be viewed as the core building-blocks of modern portfolios -- not individual stocks. There is much larger value to be added in the decision to own the Australian market (EWA) and REITs and Commodities than spending too much time on the decision of which large-cap United States stocks to own.

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Yield To Maturity Charts Don't Tell The Full Story

May 05, 2011 in Bonds

Something to consider with bond funds.

You will often see charts in blogs and articles of 10 or 30-year bond yields plotted over time -- but from an investment perspective and when considering portfolio performance, realize that the 'meat' of the bond market is only remotely related to the 30-year.   The AGGREGATE bond market is a collection of bonds with an average maturity in the 4-5 year range.    There actually is not a single bond in the iShares Aggregate (AGG) with a stated duration anything approaching even 20 years.   None.

The 5-year yield is a good place to focus.   As of yesterday, this was 1.95%.  We scanned the history and found that on June 7, 2010 -- the yield was the same at 1.95%.   So we have unchanged TREASURY yields since then.  



But treasury bonds are just one piece of the landscape (an important piece but there are of course many others).   Below is a comparison of a few bond funds total return series since June 7, 2010.    Viewing the total return chart is not the same thing as viewing a yield to maturity time series.     We would say that the total return is much more applicable in terms of understanding movement --- as this does not strip out the distributions you earn along the way and will reflect changes in credit spreads automatically.   Total return charts are not just for bond funds obviously -- they are better for any investment that produces a cash flow.   The total return series (which is what indexes are) is a cleaner reflection of how investments perform --- and performance is what matters.



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Highest Volatility In ETF/ETN Universe

May 03, 2011 in Volatility


FWIW, of all exchange traded products > $500 million in assets, Silver (SLV) has the highest 20-day standard deviation and is more volatile than even the 3x S&P 500 (UPRO).



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