# Tactical Asset Allocation Series: Part 3 (Equal-Weight with Moving Averages)

/Tactical Asset Allocation Series: Part 3 (Equal-Weight with Moving Averages)

## Tactical Asset Allocation Series: Part 3 (Equal-Weight with Moving Averages)

This is the third part in our series on tactical asset allocation.  In the series we highlight the equal-weight with moving average tactical asset allocation system (ew_index_ma)

### Equal-Weight Tactical Asset Allocation with Moving Average Rules

The equal-weight system with moving average rules is a simple model: an investor simply invests 1/n in each asset class, rebalanced monthly, and applies a long-term moving average rule to each asset category. Our asset classes are described below.

How does the moving average rule work?

Academic research on asset allocation clings to the tenants of mean variance optimization and concludes that investors should hold the market portfolio, or the portfolio of all risky assets weighted by their respective value in the market portfolio. But how does the theoretical answer actually stack up against the very simple equal-weight strategy?

Mebane Faber has a paper outlining the basics of the moving average trading rule. Here is how it works in a nutshell:

1. Calculate the long-term moving average for each asset class. Let’s take the 12-month as an example: Average(the last 12 month-end prices).
2. Compare the long-term moving average with the current asset class price. For example, look at the current price of the S&P 500, say 1,400, and compare that with the recent 12-month MA, say 1,200.
3. If current price > 12-month MA, maintain position; else, if current price < 12-month MA, move assets to cash and collect the risk-free rate.

Here are some additional pieces on the subject written by fellow bloggers/researchers:

Use our tool to generate the latest weights for the equal-weight with MA rule:

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.

Here are the performance stats over time (January 1, 1979 to August 31, 2012):

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.

The equal-weight strategy with long-term moving average rules reduces risk relative to all other benchmarks.A few takeaways:

• Drawdowns are cut in half–at least.
• Moving average rules have historically performed very well.

• Using fancier moving-average rules doesn’t add much at the margin. As long as you have something reasonably long-term (9+ months), the MA rule will work in your favor.
• Using total return prices or “normal” prices doesn’t matter.
• Eliminating particular asset classes from the basket doesn’t matter.
• Results aren’t contingent on LTR.

All our models and their basic explanations follow:

### Core 6:

• SP500=Standard and Poors 500 Total Return Index
• EAFE=The MSCI EAFE Total Return Index
• EEM=MSCI Emerging Markets Total Return Index
• REIT=FTSE NAREIT All Equity REIT Total Return Index
• GSCI=S&P GSCI Total Return Index
• US_10Yr=Merril Lynch US Treasury 10-Year Treasury Futures Total Return Index

### Models:

• ew_index=equal-weight Core 6.
• ew_index_ma=equal-weight Core 6 with 12-month moving average trading rule.
• mom=equal-weight Core 6 shifted by relative 12-month momentum.
• mom_ma=mom strategy with 12-month moving average trading rule.
• risk_parity=unlevered risk parity for Core 6.
• risk_parity_ma=unlevered risk parity for Core 6 with 12-month moving average trading rule.
• risk_parity_mom=unlevered risk parity weights for Core 6, adjusted by relative 12-month momentum.
• risk_parity_mom_ma=unlevered risk parity weights for Core 6, adjusted by relative 12-month momentum, with a 12-month moving average trading rule.
More details can be found here:

### Disclosure:

Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only.
Past performance is not indicative of future results, which may vary.
There is a risk of substantial loss associated with trading commodities, futures, options and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when trading futures, commodities and/or granting/writing options one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading futures and/or granting/writing options. All funds committed to such a trading strategy should be purely risk capital.