After two years of in-sample results and some tweaks to the first version of the system, the Fidelity Sector Fund Rotational System is ready to go live.
Based on the analysis I presented in Part 2, I have changed the inputs on system’s variables. Some were changed more than others. The goal was to set the inputs to areas that had proved to be robust over a 20 year time period and over the past 2 years. If one carefully observes the charts I present in Part 2, an educated guess can be made as to what was chosen.
I have also added a new feature which allows the primary variable, the rate-of-change (ROC), to adapt to volatility.
After re-setting the inputs, I ran a final optimization of the primary ranking mechanism, the ROC. I wanted to be sure that I had not curve-fit the system. The results are below.
Click on the graphs to enlarge…
The graph above uses over 20 years worth of data.
There is a large sweet-spot from about 105 to 135 where CAR and Maximum System % Drawdown are both very stable.
The graph above represents about 12 years worth of data.
It too shows a large sweet-spot from about 110 to 145.
These graphs demonstrate that the primary ranking mechanism still offers a large area from which to choose a setting. Warning: because I have made the ROC adaptable to volatility, simply choosing a ROC length from these graphs and using it is likely to generate a different (but still decent) future performance from this system.
I’m going to use 1.1.2000 – 1.27.2012. Starting the system back further yields better results (and you can get an idea of what they would be from previous and current graphs). The last decade or so has really been a brutal time to be in the market. Keep in mind that I can slightly alter a few inputs and make more recent performance look better. That was not my goal. Window dressing a system for the public is tempting but is ultimately ridiculous and maybe even reckless. My goal was to choose robust settings that will perform consistently well in the future, and I feel I have done so.
Equity Curve and Drawdowns:
One must expect performance to be worse and drawdowns to be larger than what they are in backtested historical results. That being said, ROC as a ranking mechanism has been unbelievably stable, as has the sector rotation model. Since I will be trading this on funds meant for retirement, I will be happy with a 10% annual return, and I believe this system will achieve it. Furthermore, it will require very little time to manage, and should have smaller drawdowns than a buy-and-hold strategy.
There are likely further tweaks or even outright changes that I have not considered, or even fathomed. I would appreciate hearing your thoughts if you think I have missed something, or if you just have a neat idea.
I did add Fidelity Bond Funds into the rotation, as suggested by MyBestFunds, but they hurt performance. I believe this is because the system punishes volatility. Since bond funds are typically less volatile than sector funds, the bond funds out-ranked and replaced sector funds from time to time in the rotation. Removing the moving average filter and including the bond funds (in hope they would be picked during bear market phases) only made things worse.