Using Utilities to Time the Market -

Strategy Background

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.

Simulation Background

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

Summary Statistics:

The BRS strategy shows some evidence for out performance with higher Sharpe and Sortino ratios.

2014-07-02 12_33_05-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)

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.

Invested Growth:

Long term out performance
High correlation with broad market

2014-07-02 12_35_52-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)

Drawdown Summary:

Still extremely risky and can suffer large drawdowns

2014-07-02 12_39_11-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)

Rolling CAGRs:

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

2014-07-02 12_46_00-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)

Rolling Drawdowns:

Correlated drawdown episodes
Large drawdowns during market downturns

2014-07-02 12_47_00-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)

Rolling Alphas:

No evidence for value-add over time

2014-07-02 12_49_09-BRS_strategy - Microsoft PowerPoint (Product Activation Failed)