Industry Momentum and Tactical Asset Allocation: 24% CAGR — Does It Beat SPY?

Welcome back to Avalon QuantBrief, where we put legendary quantitative frameworks to the test against modern market realities. Today, we are exploring a powerful dual-force model that combines Jegadeesh and Titman's classic industry momentum with Meb Faber's tactical asset allocation. By adapting these academic concepts with modern volatility filters, we aim to build a highly resilient strategy for today's hyper-fast regimes.

Backtest Summary (2017–present)

📈 CAGR: 24.3%
📉 Max Drawdown: -19.8%
⚡ Sharpe Ratio: 1.20
💰 Total Return: 250.4%
🎯 Universe: XLK, XLF, XLY, XLP, XLV, XLI, XLE, XLU, XLB, IEF, SHY

The Core Mechanics of Tactical Momentum

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The foundation of this strategy relies on trading nine major sector ETFs while utilizing IEF and SHY as defensive havens. While rebalancing occurs monthly, we run daily regime checks to ensure we are only risk-on when the SPY is above its 200-day simple moving average and realized volatility is low. If these conditions fail, the system systematically rotates into safety to protect capital.

Enhancing the Model for Modern Markets

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To survive today's volatile regimes, we introduced three key enhancements to the classic academic framework. First, we apply an exponent penalty to high-volatility sectors using a volatility-adjusted momentum score, alongside a 50-day EMA stop-loss for early exits. Finally, the defensive sleeve dynamically scales between IEF and SHY based on SPY's realized volatility, transforming a rigid model into an adaptive system.

Analyzing the Performance Metrics

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Backtesting the adapted strategy from 2017 to the present yields outstanding results, including a compound annual growth rate of 24.3% and a total return of 250.4%. Crucially, the model kept the maximum drawdown to just negative 19.8%, resulting in a highly risk-efficient Sharpe ratio of 1.20. These metrics prove that combining momentum with smart volatility targeting can significantly boost risk-adjusted returns.

Equity Curve Resilience in Bear Markets

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A closer look at the equity curve reveals remarkable flatlining during the 2020 crash and the 2022 bear market, demonstrating the defensive sleeve's effectiveness. Instead of riding drawdowns, the strategy safely held cash equivalents until market conditions stabilized. Once the regime flipped back to risk-on, the volatility-adjusted momentum score quickly re-allocated capital into the strongest leading sectors.

The Final Verdict and Execution

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Bridging the gap between academic theory and real-world execution is entirely possible when you adapt classic momentum with modern risk filters. This volatility-adjusted sector momentum strategy proves to be a highly viable framework for navigating today's unpredictable markets. Stay tuned to Avalon QuantBrief for live portfolio updates and step-by-step execution guides in our upcoming sessions.

⚠️ Not financial advice. This is for educational purposes only. Always do your own research before investing.

📄 Original paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=299107

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