After my last post on using trend following in Crypto markets I thought I’d continue on that thread and look at applying trend following on a newish concept (similar concepts have existed at the institutional level for a long time) in creating diversified portfolios, called return stacking.
First, what is return stacking? The term return stacking was coined by the team at Newfound research and Resolve Asset Management. At its core return stacking is using leverage (at the institutional level) to obtain access to different sources of return for a portfolio without sacrificing the original investment. In other words getting more than $1 of exposure to an investment strategy for every $1 invested. When this concept is used to gain access to diversified return streams to complement the original investment, the sum can be greater than its parts. Diversification sounds great to most investors until they actually go try and implement it and then realize they hate it. Why? Because it means always being disappointed, because it means selling something, e.g SPY, to invest in a diversified strategy, e.g managed futures, to improve risk-adjusted returns in the long run that in the short run can and often underperforms. The long run can be too long for most investors and thus most don’t diversify enough. Let’s take a look at the example product I’ll use for this post and it will make it all clear. Also, check out the link above to the return stacking website which does a great job of laying out all the data and the reasons for the approach.
I’m going to use the ETF RSST for this post. RSST invests in a 100% SP500 position and a 100% Managed Futures position. It is a leveraged ETF, like SSO for example, but uses the leverage to take a managed futures positions instead of leveraging the stock position. Managed futures historically are a great diversification return stream for stocks and bonds. RSST started trading on Sep 6, 2023 and has gathered $115M of AUM. It’s off to a good start. For historical returns I used the data provided in a white paper from the Resolve guys. First let’s take a look at returns and drawdowns for the Return Stacked Stocks and managed futures strategy vs the SP500 and a 60/40 diversified portfolio.
Not too bad. Higher returns, lower drawdowns, and better risk-adjusted returns than 100% stocks, or the classic 60/40 diversified portfolio. Managed futures really work to diversify the portfolio of stocks. Now that we have the baseline out of the way, lets see if trend following or some other form of risk reduction can improve things even more. For this analysis I will use the classic 10 month simple moving average as I did in my last post plus I will use a market breadth measure I use in my Econ Pulse newsletter, to hedge of the trend following strategies I use. It is called the GPM hedge and it hedges the risk on position using a measure of how many markets are exhibiting a postive trend. This is a slightly different concept than the 10 month SMA but at its core it is a still a trend measure. Also, this time I’ll only use the 60/40 portfolio as the benchmark. The results are shown below.
In this case the SMA trend filter and the trend Hedge both further reduce risk and increase risk adjusted returns, while only reducing returns a bit. In summary, another great use of trend following.
For my next posts I’m going to launch on a re-introduction to quantitative investing using individual stocks. I first wrote about these types of strategies in 2013 and I think it’s time for a massive update on the concept, the strategies, and of course all the performance data. Stay tuned.