ETFRot performance update

I posted backtested performance figures for an ETF rotational trading system back in November 2010. Here’s the forward tested performance (orange representing the start of the forward testing period):

9-2011_longshort_etfrot_performanceupdate

Ouch. For a refresher on how the system works, see the old post. It looks like momentum failed to anticipate the precipitous drop in the markets during August 2011. Which makes sense, as the market truly seemed to be in panic mode during that time.

Lesson: don’t put all your eggs in one basket (in this case, in one ETF), no matter how good you think your “timing” is. Because anything can happen that throws your model out the window. 

August 2011 was just another example of asset class correlations all going towards 1 during a panic selloff; historical correlations were not a good predictor of future correlations. Then I wonder if historical correlations conditional on whether the market is in crisis mode or not is predictive (eg if these two asset classes weren’t correlated in the past during market crises, does that mean that they have a good chance of remaining uncorrelated in future market crises?). Perhaps in “most cases”, but then again, if you have a chance of being completely wrong and losing all your money, do “most cases” even matter? 

So the search for uncorrelated returns continues… reminds me of AQR’s new reinsurance group.