Protective Asset Allocation (PAA) + Regime Switching: 35% CAGR — Full Backtest Results

Welcome back to Avalon QuantBrief, where we backtest and optimize institutional-grade quantitative strategies for the modern retail investor. Today, we are exploring a powerful combination of Protective Asset Allocation (PAA) and dynamic regime switching designed to capture explosive growth while systematically dodging market crashes. By applying this legendary defensive framework to a high-octane ETF universe, we aim to solve the ultimate trader's dilemma: maximizing returns while minimizing drawdown.

Backtest Summary (2017–present)

📈 CAGR: 34.7%
📉 Max Drawdown: -14.6%
⚡ Sharpe Ratio: 1.52
💰 Total Return: 503.5%
🎯 Universe: TQQQ, SCHD, TLT, PFIX

The Core Mechanics of Protective Asset Allocation

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The foundation of this strategy relies on a simple yet elegant regime-switching rule tied to the SPY 20-day moving average. When SPY trades above this line, the system enters bull mode, allocating capital to high-performing growth assets like TQQQ and SCHD. Conversely, crossing below triggers bear mode, systematically shifting capital into protective safe havens like TLT and PFIX on a monthly rebalancing schedule.

Optimizing PAA for Modern Volatility

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To adapt this classic framework for today's highly volatile markets, I introduced three critical risk-management enhancements. First, a strict 10% trailing stop on TQQQ forces an immediate shift to bear mode, while 200-day and 140-day moving average filters dynamically scale position sizes. Finally, intra-month stop-losses on individual ETFs prevent catastrophic mid-month drawdowns, completely transforming the strategy's risk profile.

Staggering Backtest Performance (2017–Present)

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The results of this adapted strategy from 2017 to the present are nothing short of spectacular, delivering a total return of 503.5%, which translates to a 34.7% annualized return. More importantly, the system kept the maximum drawdown to a mere -14.6%, resulting in an exceptional Sharpe ratio of 1.52. These institutional-grade metrics prove that retail traders can achieve massive outperformance without taking on reckless levels of risk.

Deconstructing the Equity Curve

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A closer look at the equity curve reveals how effectively the strategy navigated major market crises like the 2020 crash and the 2022 bear market. While the S&P 500 plummeted, our portfolio flatlined or gained ground, aided by PFIX acting as a brilliant hedge against rising interest rates. The smooth, upward compounding curve demonstrates the flawless execution of the regime filter and intra-month stops.

The Final Verdict: A Masterclass in Risk Management

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Ultimately, this adapted PAA strategy is highly worth running, offering market-beating returns without the sleepless nights of traditional buy-and-hold. By overlaying modern risk management onto a structurally sound defensive framework, we achieve the holy grail of systematic trading. Subscribe to Avalon QuantBrief to track this live strategy, access code implementations, and receive weekly performance updates.

⚠️ 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=3002624

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