Premium Market Analysis, Trader Education, Software, and Trading Strategies

Asset Allocation

Reliance on a Single Strategy Poses High Risks

Photo by Rodnae Productions

In trading or investing, reliance on a single strategy may result in extended periods of lackluster performance or, worse, underperformance. Traders and investors require the flexibility provided by a diverse portfolio of strategies.

  • Buy and hold investing in the S&P 500 total return had a flat performance for 12 years, from 2000 to 2012, and two large drawdowns of over 45%.
  • Managed futures CTAs had a “lost decade” from 2009 to 2018 with flat performance.
  • The 60/40 portfolio had its largest loss last year due to both stocks and bonds in a bear market.
  • Mean-reversion had several shorter clusters of underperformance and flat periods.

The conclusion is that relying on a single strategy poses high risks.

Buy-and-hold investing is no different from gambling, although it is portrayed as safe.

The CTA space was about to undergo a massive consolidation after many years of flat performance before the pandemic event. Luck may not repeat anytime soon.

The 60/40 investors thought they were safe: if stocks crash, bonds will rally and provide a hedge. Well, they did not provide the hedge in 2022 because the worst-case scenario materialized: both stocks and bonds were down and correlated.

Mean reversion is a tricky concept and encompasses many different types of strategies. When I refer to mean-reversion, I consider its simplest and purest form: the negative autocorrelation of daily returns.

Below is a chart with the performance of four strategies and an equal allocation. The backtests range from 01/03/2000 to 08/08/2023. The strategies are:

  1. Buy and hold the S&P 500 total return.
  2. A 60/40 allocation in S&P 500 total return and Treasury Bond 7–10 year total return
  3. The SG CTA index (not a backtest)
  4. A mean-reversion strategy with Dow 30 stocks based on our PSI5 algorithm

The black line is the equity of the equal allocation (25%) to the four strategies (no rebalancing). Below is a chart showing the performance of the equal allocation.

Below is a table that summarizes the performance of the four strategies and the equal weight allocation.

B&H 60/40 Mean-Reversion Managed Futures EW
CAGR 6.8% 6.4% 8.7% 4.6% 6.8%
Max. DD -55.2% -29.6% -38% -16.5% -23.9%
Volatility 19.7% 10.0% 19.1% 8.2% 10.8%
Sharpe 0.35 0.64 0.46 0.56 0.63

The equal weight allocation (EW) is essentially an improvement of the 60/40 allocation: a higher annualized return but a lower drawdown, with about the same Sharpe ratio.

I am still not satisfied with the results. I need a lower maximum drawdown for EW and a much higher Sharpe, above 0.85. I will have to consider more strategies, possibly change the mean reversion strategy, and/or adjust with the weights, but this may increase the risk of overfitting. However, this was a first step to get an idea of the issues involved and offer a possible path towards a more robust allocation.

In the next article, I will change the mean-reversion strategy and also consider different weights for the allocation.

Free Book

Get a free PDF of the book “Profitability and Systematic Trading” (Wiley, 2008) by subscribing to the Price Action Lab blog’s free email notifications of new posts and updates.


Disclaimer:  No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.

Charting and backtesting program: Amibroker. Data provider: Norgate Data

If you found this article interesting, you may follow this blog via RSSEmail, or  Twitter