Cash Equivalent Investments
We saw in the blog post "Using A Simple Moving Average Filter Used As An Investment Indicator" that investing only during periods of positive price momentum and holding cash equivalents during periods of negative price momentum can potentially improve performance and lower volatility.
Below is return data from 12/31/71 through 12/31/2017 comparing buying and holding the S&P 500 versus moving assets to cash equivalents during periods of negative price momentum (as determined by the 10-month simple moving average.
SP500 SP500/T-Bill SP500/Cash
Annualized Return 10.60% 11.23% 9.95%
Annualized Volatility 15.03% 11.49% 11.55%
Sharpe Ration 0.39 0.56 0.44%
The choice of cash or cash equivalent impacts overall performance. The average annual return can outperform the S&P 500 or underperform the S&P 500 depending upon the choice of cash investment.
The goal for the cash equivalent is to return closely match the return of the 90-day T-Bill. Possible cash equivalent investments include bank savings, money markets. Here is interest rate data for the 90-day T-Bill, national savings rate and money market rate for less than $100,000.
Clearly, current money market savings rates are a poor match for 90-day T-Bill rates. Some ETFs are specifically designed to match short-dated treasuries. The SPDR Bloomberg Barclays 1-3 Month T-Bill ETF, BIL, attempts to track short dated treasuries with and expense ratio of 0.14%.
The BIL ETF's monthly equivalent return is volatile, but is a better match to the 90-day T-Bill than either money markets or bank savings.
Disclosure:
The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.
The ProFolio model portfolio results presented here are based on simulated or hypothetical performance. Unlike an actual performance record, simulated results do not represent actual trading and there is no market risk involved in the results. The simulated trades use historical data and therefore the trading algorithms are designed with the benefit of hindsight. In a simulated performance record it may be difficult, if not impossible, to account for all factors which might affect an actual performance record. Additionally, any account that ProFolio manages will invest during periods with different economic conditions than those under which the trading programs were developed. There is no representation being made that any account will perform as the hypothetical results indicate. In fact, there are often sharp differences between hypothetical results and actual returns subsequently achieved. Due to the benefit of hindsight, hypothetical performance almost invariably will show attractive returns, while actual results going forward may not be as attractive.
The algorithm that created the trading signals for each of the portfolios used Exchange Traded Fund (ETF) historical data where possible. This ETF data had a limited history. To gain additional data history, the actual asset or index data was pre-pended to the ETF data. When this occurred, ETF expenses were subtracted from the asset or index data. Where asset or index data was not available, other correlated data, adjusted for expenses, was used. Model portfolio results include interest and dividends, but subtract ProFolio's management fee (0.5%) and third-party brokerage custody/trading fee (0.25%). Real returns are inflation adjusted. Higher returns generally come with higher risks. Model portfolio risk characteristics include maximum drawdown and volatility. Maximum drawdown is the portfolio's peak to trough prior to hitting a new peak and is a measure of downside risk. Volatility, or standard deviation, is a measure of the portfolio's price fluctuations both positive and negative. Sharpe ratio is a measure of return for a given risk. Sharpe ratio = (portfolio return - risk free return)/SQRT(portfolio return variance - risk free return variance). Where the risk free asset is the 90-day T-bill and the variance is the square of the standard deviation (or volatility). Tactical portfolios utilize cash or cash equivalents for risk management.
The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.
