Using Utilities to Time the Market
Beta Rotation strategy (BRS) is discussed by Charles Bilello and Michael Gayed in their new paper, “An International Approach to Beta Rotation: The Strategy, Signal, and Power of Utilities” The paper shows significant rolling out performance over a simple buy and hold strategy of the market throughout multiple time periods. They won the 2014 Charles H. Dow Award based on their research. At the core, the strategy is a simple buy and rotate of utility stocks based on the relative strength of the utility sector:
“When a price ratio (or the relative strength) of the Utilities sector to the broad market is positive over the prior 4-week period, position into Utilities for the following week. When a price ratio (or the relative strength) of the Utilities sector to the broad market is negative over the prior 4-week period, position into the broad market for the following week.”
“In order to achieve a more tactical strategy that is better able to adapt to intra-month volatility, we converted the monthly time frame into a weekly signal.”
We replicate the strategy and put it through a barrage of robustness tests. The results hold up, but are less impressive than those from the original paper (likely due to methodological changes).
As a thought experiment we looked at a long short strategy that maximally exploits any edge the BRS system might have in timing the market. There is no evidence the L/S system works, which suggests the timing model is not overly impressive. Nonetheless, we have never found ANY timing model that is overly impressive.
Overall impression on the timing system: definitely worth a look.
Simulated Historical Performance: 1/1/1927 to 12/31/2013.
- Instead of using weekly signal, we use monthly signal, which is more practical and serves as a robustness test to the original results.
- Broader stock market index: VW_CRSP
- Utility stock market index: Utilities data from Ken French Data Library
- We back test both BRS Long strategy and BRS Long + short strategy.
- BRS Long Strategy: When the relative strength of the Utilities sector to the broad market is positive over the prior month, position into Utilities for the following month; otherwise, position into broad market for the following month.
- BRS Long + Short strategy: When the relative strength of the Utilities sector to the broad market is positive over the prior month, position into Utilities and short broad market for the following month; otherwise, position into broad market and short Utilities for the following month.
BRS Long Strategy
- The BRS strategy shows some evidence for out performance with higher Sharpe and Sortino ratios.
- Long term out performance
- High correlation with broad market
- Still extremely risky and can suffer large drawdowns
- Strong long-term relative performance over 5-year cycles
- 70.02% chance of beating the VW_CRSP over 5-year cycles
- 77.34% chance of beating the utility sector over 5-year cycles
- Correlated drawdown episodes
- Large drawdowns during market downturns
- No evidence for value-add over time
BRS Long+Short Strategy
- The BRS Long + Short strategy under performs overall, and is worse than pure buy and hold strategy
- Relatively lower volatility
- Poor long-term performance
- Less risky than the market because of the hedged nature of the strategy
- Weak long-term relative performance over 5-year cycles
- Only 23.98% chance of beating the VW_CRSP over 5-year cycles
- Only 26.93% chance of beating utility stocks over 5-year cycles
- Non correlated drawdown episodes
- Less affected by market drawdown events
- No evidence for value-add over time
Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.
Join thousands of other readers and subscribe to our blog.
Please remember that past performance is not an indicator of future results. Please read our full disclosures. 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.
Definitions of common statistics used in our analysis are available here (towards the bottom)