In the spirit of wrapping up the FAA model investigation, I thought I would extend the backtest further back to 1926. Data used are all monthly total return series from proprietary databases and they are the best estimates that I have to work with. Looking back so far offers a LOT of insights. One will be able to stress test how the specific strategy performed in different environments.
I employed 7 different asset classes: commodities, emerging market equities, US equities, US 10 year bonds, US 30 year bonds, short term treasuries and European equities. For benchmarking purposes, I constructed a simply momentum portfolio that holds the top 3 assets, an equal weight portfolio, and a traditional sixty-forty portfolio. Lookbacks for momentum are 4 months, in line with what Keller and Putten used.
One very interesting aspect I found from this extended backtest is to see how the strategies performed during the Great Depression. While equal weight and sixty forty suffered large draw downs, FAA and relative momentum did comparatively well. Below is a deeper analysis into the Great Depression. As you can see, momentum strategies in general provided a great buffer against drawdown.
The main reason for this is that during the drawdown period, the FAA strategy were all loaded with bonds:
When I am researching trading systems, I really like to break down its components apart and analyse it as much as possible. It is only by understanding how they fit together will you be able to judge its future viability. When it will work and when it won’t work. And since these days TAA strategies have become so pervasive, it begs to questions whether we are taking appropriate precautions to its future performance.