The World’s Longest Trend-Following Backtest

The World’s Longest Trend-Following Backtest

November 9, 2015 Architect Academic Insights, Key Research, Tactical Asset Allocation Research
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Were in the middle of an academic research project and we ran a simple long-term trend-following model from January 1, 1801 to September 30, 2015.

Recently, there has been some research on the performance of trend rules over long periods here (and highlighted by CXO here).

Our trend-following methodology is further described in our downside protection piece.

  • Absolute Performance Rule: Time Series Momentum Rule (TMOM)
    • Excess return = total return over past 12 months less return of T-Bills
    • If Excess return >0, go long risky assets. Otherwise, go long alternative assets (T-Bills)
    • Concept made popular by Gary Antonacci
  • Trending Performance Rule: Simple Moving Average Rule (MA)
    • Moving Average (12) = average of 12 month prices
    • If Current Price – Moving Average (12) > 0, go long risky assets. Otherwise, go long alternative assets (T-Bills).
    • Concept made popular by Meb Faber
  • Robust Asset Allocation Rule: Combination of TMOM and MA (ROBUST)
    • 50% TMOM, 50% MA

Our study includes 6 asset classes and strategies assessed over the sample time period:

  • SPX = S&P 500 Total Return Index spliced with generic US stock market data in early years
  • LTR= 10-Year Treasury Total Return Index
  • SP_MA = SPX with MA rule applied
  • 60,40=60/40 SPX, LTR
  • SP_TMOM= SPX with TMOM rule applied
  • SP_ROBUST= SPX with ROBUST rule applied

Results are gross, no fees are included. All returns are total returns and include the reinvestment of distributions (e.g., dividends). Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.

First, the laundry list of domestic equity drawdowns over time that exceed 15%. I’ve highlighted the worst performer in red across the index, 10-years, and the index with MA:

The World's Longest Trend-Following Backtest_1800-2015 drawdown tables
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Takeaway:

  • MA rule, TMOM rule and ROBUST rule, historically, have reduced drawdowns
  • Treasury bonds, historically, act like insurance assets and serve as a “crisis alpha” instrument

Robustness

Here we look at top SPX drawdowns and the associated results across the different strategies over two sample periods:

Downside Protection: 1800-1926

The World's Longest Trend-Following Backtest_1800-1926
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Downside Protection: 1927-2015

The World's Longest Trend-Following Backtest_1927-2015
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Bottomline: asset allocation and tactial market timing are interesting subjects!

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Please remember that past performance is not an indicator of future results. Please read our full disclaimer. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.