One of the popular momentum promoting strategies is Frank Grossman’s GMR strategy (logical-invest.com). It’s provided via subscription by Frank Grossman who provides several momentum strategies via a monthly subscription. It is also one of the few sites that publishes detailed monthly results “achieved” via the strategies. I applaud them for that. Too many sites publish a results graph and conveniently omit any of the associated detail. Mr. Grossman also published a series of articles at seekingalpha.com promoting/explaining the strategies. I’m going to examine one of the most popular, and most discussed, the “Global Market Rotation” or GMR strategy. The techniques and results I have achieved with this strategy generally apply to the others as well, although I have not examined each of the others in as much detail.
I’m not attempting to indict Mr. Grossman. In all of my dealings with him, he’s always been professional and courteous. As far as I know, he may well believe in the strategies and follow them himself. (According to his published newsletters, he often follows a variant of the strategies using futures and/or other instruments rather than purchasing the actual ETF’s).
Let’s talk a bit about the back-testing. If you’ve followed the discussions on GMR in SeekingAlpha, you’re aware of the difficulties in reproducing Mr Grossman’s published results. He has provided a “general” description of his method, but withheld certain specifics. Fair enough, he is selling a service. I can understand him wanting to keep certain value-adding components secret. He has stated that the method he employs is systematic – i.e. based on pre-determined performance and volatility percentages a specific “formula” is applied to arrive at a forecast for the next monthly selection. He has alluded to the performance as being the past three calendar months and volatility as a weighted 20 day volatility (It’s not clear if it is one month or three). These values being weighted at 70% and 30% (generally? Not clear either).
I’m not aware of anyone who has been able to duplicate his published results. Many have tried. Some have come close. But with the unknowns*, I’m not surprised.
One element of the strategy is buying/selling at a specific date, in this case start-of-month. Mr Grossman states in his SeekingAlpha article – (Authors reply) “I normally do the trade within the first 2 days of the month. You don’t have to time the trade and you should not trade at market at the open of the first day of the month.” Mr Grossman’s published results are based on a calendar month (only) strategy.
That said, there are those who subscribe to a “calendar month” effect as it relates to momentum strategies. Something to the effect “you must trade on the first/last day of the month due to the “calendar effect”. This is one of the logical fallacies we encounter regarding momentum back testing.
What limiting your testing to a single day or two on which to trade really accomplishes is to eliminate 90 to 95 % of the possible outcomes of the strategy, a clear case of selection-bias. (If the strategy is strategically sound, it should produce optimum results when employed on a signal-change basis. That is, change your investment on each signal change. There are other factors to consider such as trade costs, taxes, etc, but the strategy itself should produce optimum results under those conditions. I’ll have more on this in a future post).
While there may be a so-called “Turn-of-the-Month Effect”, if you read the papers and understand the study and the conclusion you should realize it has nothing to do with selecting a trading day for a momentum-based ETF strategy. “Return variability (standard deviation) is no higher during the turn of the month than during other days.” In fact, a logical interpretation of the results would suggest you buy during the second half of the month and sell during the turn-of-the-month period for a potential increase in return of .1% – .2%. Even if a turn-of-the-month effect applied, which it doesn’t, we should be able to implement a GMR strategy on any day of the month with a maximum performance penalty of .2%.
In fact, back-tests of an approximation of Mr Grossman’s GMR strategy (as mentioned, no one except Mr Grossman is sure just what his strategy is, but I can come close) from 2003 through 2013 yield variations in return, depending on the day-of-the-month selected, of between 19% CAGR and 34% CAGR, or a variation of well over 50%, depending on the trading day selected.
OK. Let’s criticize my own results. My best return over the period (using a single performance/volatility combination) is 34% where Mr Grossman’s is 40+% so his strategy is obviously better than mine. I am able to achieve 40%+ in back-tests, IF I adjust the volatility percentage calculation during periods when there was high volatility in the market. However this is another example of bias, data-fitting. If Mr Grossman has some valid formula for determining, in advance, not retrospectively, which volatility factor to use, that may account for the difference between his 40% CAGR and my 34%. I’m still working on a method for pre-determining which volatility results in the best results. It’s rather easy to determine it after-the-fact, but my best predictions have so far yielded mixed results.
Another point before I conclude this post. The period from 2003 through 2013 was a very good period for a momentum based strategy. This is another “selection” bias. ILF (or any ETF including Brazil, e.g. EWZ) was on fire from 2005 to early 2008. EDV was a safe-haven during the 2008 crash and momentum had been strong since the crash, through the end of 2013. As I’ve stated before, momentum strategies do work in a market exhibiting momentum. However, this is much easier to see in hindsight than to predict. Mr Grossman registered the Logical-Invest.com domain in mid July 2013. Since this registration and his subsequent SeekingAlpha articles, the only “real-world” demonstrations of his strategy I’m aware of, his predictions (GMR) have trailed SPY.
As I’ve stated, a good momentum based strategy will likely exceed a single ETF buy-and-hold strategy during periods where the market is exhibiting momentum. It may even beat “buy and hold” in the long-term, since the market does exhibit momentum in the long term. However, there will be periods where the momentum-based strategy will trail the buy and hold strategy, sometimes significantly e.g. a momentum based return of 2% (or even negative) during a year when the “market” returned much higher (20%-30%). While the momentum strategy may be better over a decade or longer, most people are not willing to accept the periods of under performance.
I’ll be speaking to these and other issues and results in future posts.
*for additional discussion on the “unknowns” see the post “Black swans and albinos” (above).