This year showed some of strengths and weaknesses for the Forte Strategy and unveiled two strong new ideas that we have been performing extensive research around to make sure we are in a strong position for 2021.
After a year of consistent development of Forte Strategy, we landed on a math model that excels at exiting the market at the start of sell-off (marked by an increase in volatility) and then, if the rate-of-change in volatility is high enough, it will enter into “hedging” positions with the VIXY and UVXY to profit from any downside moves. For example, our last pre-crash long-equity position (TQQQ) was sold at the opening bell on February 28. At that point, the S&P 500 had declined 14.7% on its way to a total 33.5% drop. For another example, the market went through correction in September and October for a net loss of 6.5% while the Forte Strategy gained 2.6% in both months through a combination of market timing and VIX hedging trades. The strategy also does well to intensify gains during low-volatility periods of steady market declines as shown by a run of four consecutive positive months in July through October for a gain of 9.2%; however, the Forte Strategy has several shortcomings that we performed extensive research and development over the past months to overcome for improved results in 2021.
First, the strategy spends too much time in cash with nearly 55% of the account idle on average. This misses a portion of the natural upward bias of the market driven by innovation, inflation (central bank money-printing) and population growth. We’ll address this by simply allocating a portion of the strategy to a classic buy-and-hold approach using the highly liquid S&P 500-tracking ETF, SPY. We proved this idea (covered in our October 10 blog and restated below) using portfolio analysis:
We both listened to The Systematic Investor podcast last week hosted by Niels Kasstrup-Larsen in Switzerland and hit the reverse-replay button a few times to make sure we understood what was said. He shared some recently completed analysis comparing the long-term returns of the S&P 500 from November 1984 through August 2020 versus his performance using a mechanical trend-following system over a wide-range of markets which provides returns uncorrelated to the S&P 500.
A $1,000 investment in the buy-and-hold S&P 500 strategy would have grown to $48,000 during this 36-year period while using a mechanical trending system, it would have grown to $68,000.
However, the hard-to-believe part was that he went on to say that if you had allocated the capital 50% to the S&P 500 buy-and-hold strategy and 50% to the mechanical trending system and rebalanced monthly, the amount grew to $102,000 – so the mixed allocation strategy improved results by 30-50% for both strategies. If proven in our applications, this seems like a simple way to significantly improve returns.
Secondly, the sensitivity to volatility that makes Forte an effective hedging strategy also may cause it to miss large energetic upward movements like we saw in April and early November of this year. We were able to develop a new strategy, Adagio, that is a slow-trading system with about half the sensitivity to volatility compared to Forte and takes advantage of the volatility profile curve we covered in several of our prior blogs. We first wrote about this concept on August 10 of this year with excerpts following:
A simple model that may work would be to buy the Dow Jones 30 tracking ETF (DIA) when the market volatility is no more than 10% above the long range average and sell it when volatility exceeds 10% of the average. Then, if a large spike 4-7X higher than average occurs, then buy back in when the slope of the 10-day moving is down and some type of inflection point in the line occurs. It’s one approach that we’ll consider to have a model in place for the next sell-off.
Lastly, given the Forte Strategy would occasionally move to a 100% hedged position and by nature the VIX trades are quite volatile, subject to swings of plus/minus 20% or more, we would only take small positions with these; however, when these are applied in the context of an account with a sizeable buy-and-hold position, we can take larger positions on the VIX trades without worrying about the hedging trades themselves contributing to a large drawdown (as we experienced in August 2019).
We have constructed a comprehensive portfolio strategy that blends these three strategies together into one that we simply call the Maestro Strategy which we’ll be setting up on the Collective2 website on January 1 for subscriptions and direct account linkages. We’ll cover the details of the portfolio analysis and a summary of the full-year Forte performance in our blog next week.
More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.