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
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