Sector allocation can be a very important determinant of portfolio returns. But which variables should quantitative investors look at?
This paper1 examines seven variables for global tactical sector allocation (GTSA) purposes. We construct 10 global sector indices over the extended sample period from 1970 to 2008, enabling them to test previously documented variables on a global basis and to examine whether they continued to work after their publication dates.
The study documents significant returns for the following strategies momentum (1-month and 12–1 month), earnings revisions, and sell-in-May seasonal, also after their publication dates. By contrast, monetary policy and valuation (mean reversion and dividend yield) fail to predict global sector returns. The out-of-sample tests reveal an average decay in performance of about one-third.
A long–short GTSA strategy that combines momentum with seasonal has an annual success ratio of 82% and delivers a compounded annual return of 9.9% after transaction costs. We believe that a global sector allocation study with such a long sample period and with such a broad range of variables has not been conducted before.
1 Doeswijk, R. and Van Vliet. P., 2011, ‘Global tactical sector allocation: a quantitative approach’, The Journal of Portfolio Management.