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Bond Rotation Strategy Performance Since 1995

Summary

I want to find out the performance of bond rotation strategy using relative momentum since 1995.

Back testing using proxy mutual funds validates the strategy results.

Several limitations to the study exist. See below for details.

Introduction:

  • Momentum is the premier market anomaly. Fama and French called momentum "the center stage anomaly of recent years ... an anomaly that is above suspicion".
  • Momentum is defined as the tendency of investments to persist in their performance. Assets that perform well over a 6-12 month period, tend to continue to perform well into the near future.
  • Researchers have verified momentum existence in different asset classes including US stocks, foreign stocks, emerging markets, equity indices, global government bonds and corporate bonds.
  • Momentum has been shown to work out-of-sample going forward in time and back to the year 1866. Momentum works well across asset classes as well as within them.
  • For an excellent review about momentum, I would refer the reader to read a review by Gary Antonacci titled: Risk Premia Harvesting Through Dual Momentum www.optimalmomentum.com/RiskPremiaHarvesting.pdf.

Strategy

I compiled a list of mutual funds that dated back to 1995. I could not find an earlier date across all different bonds classes. The funds are listed below:

long term government bonds (MUTF:VUSTX)

High Yield bond (MUTF:PRHYX)

Intermediate bond (MUTF:PRCIX)

Intermediate government bond (MUTF:VFIIX)

Emerging government bond (MUTF:FNMIX)

Convertible bonds (MUTF:FCVSX)

International bond (MUTF:RPIBX)

The strategy calls for buying at the beginning of every month the best performing mutual fund over the previous 3 months. I used the free website portfoliovisualizer to get the results.

Performance (1995-2013):

CAGR 15.2%

Sharpe ratio 0.95

Stock market correlation 0.50

limitations

  • Unknown switching frictions such as potential upfront loads, early withdrawal penalties and one day delay in signal execution ( mutual funds are traded only once daily ). This can significantly worsen the performance.
  • Past performance is not a guarantee for future returns.
  • Bonds for the last 30 years has been in bull market which raises the concern about the performance of this strategy in a rising interest rate environment; however, the strategy has switched last year to convertible bonds which has equity like properties.

A credit goes to the work by SA contributor Frank Grossmann whose article about bond rotation ETF strategy has inspired this article.

Special thanks to Steve LeCompte, the editor of CXOadvisory.com (I am a subscriber to his site) who validated the results and provided critical feedback to the limitations of the study.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.