A simple, low-cost portfolio to ride the waves to profits

Momentum investing is a good, tried-and-tested strategy. David C Stevenson reveals a quick and easy way to follow it.

'Momentum investing' is a good, tried-and-tested strategy. Here is a quick and easy way to follow it.

Investing should be a simple affair. If you keep your costs low, diversify, stick to some trusted ideas, and spend a bit of time each month on diligent research, then investing in equities should pay off in the long run. Ah, but what are these "trusted ideas"?

They are strategies with a history of delivering decent risk-adjusted returns "persistent factors", as the academics put it. One such strategy is "momentum", which simply means buying whatever's going up and going with the flow, while trying to avoid getting caught out by any massive bubbles.

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So how do you do it? It's reasonably straightforward. You buy the stocks, sectors or markets that are outperforming the rest of the market most strongly. Various websites offer charting tools to track this, and as long as you're willing to spend a bit of time and money (in dealing costs) on monitoring your investments periodically, you can easily build a portfolio of funds based on this strategy.

In any case, it's worth noting that momentum investing is what most fund managers tend to do look beyond the marketing drivel about their "skill sets" and they generally just buy the most popular stocks. Yet very few advisers offer an explicit momentum strategy portfolio a one-size-fits-all fund-of-funds that would make life simple by allocating between different markets as necessary.

However, some evangelists for momentum have broken cover in recent years. Among the most persistent have been the folks at Saltydog Investor (saltydoginvestor.com). Their flagship portfolio, the Tugboat, is based on momentum investing. You have to subscribe (£25 a month) to receive the weekly email notes and monthly newsletters. The service offers two vital insights: firstly it lists four-week, 12-week and 24-week average returns for key sectors and asset classes, helping you figure out which sectors and themes to focus on.

It then takes the best sectors, and identifies the relevant funds with the best short-term returns, based on Investment Management Association statistics. Obviously, it's a bit more complicated than this. But you should quickly end up with a group of top-performing unit trusts (between eight and 12 funds) to stick in your portfolio.

You'll frequently trade in and out of sectors based on market trends, but as the site uses unit trusts, there is no switching or transaction costs. The company's numbers suggest the strategy has been working the Tugboat portfolio has returned 47% since November 2010.

Put your feet up

The Idle Investor

Secondly, passive funds usually exchange-traded funds (ETFs) are low cost and don't involve betting on an expensive active fund manager. Shing offers three very simple strategies for surviving market turbulence, including two that involve shifting out of equities during historically difficult months of the year (such as September and October).

But my favourite is a strategy that exploits momentum by using the moving averageto show which assets' prices are trending strongly. Shing's Multi-Asset Trending Strategy is a simple way to do this. You stay diversified by investing in four key geographic regions, and you switch between risky stuff (shares) and less risky stuff (bonds) based on what the moving average is telling you.

If shares have momentum behind them (they are trading above their moving average), then you stick with them. If shares are losing momentum (trading below their moving average), then you switch back into bonds.

This is done on a monthly basis. The four key target regions are the UK, the US, the eurozone and emerging markets. The table at the foot of the previous page shows each fund you use for each region, with your choice of either equity or bond ETF. (Shing uses iShares trackers, and one State Street ETF, but you could easily build the same portfolio using other providers' ETFs if you prefer).

Swipe to scroll horizontally
UKiShares FTSE 250 (LSE: MIDD)SPDR Barc. 15 years+ Gilt (LSE: GLTL)
EuropeiShares MSCI Europe Minimum Volatility (LSE: IMV)iShares Barc. Euro Aggregate Bond (LSE: IEAG)
USiShares US S&P Small Cap 600 (LSE: ISP6)iShares US Aggregate Bond (LSE: SUAG)
Emerging marketsiShares MSCI EM Minimum Volatility (LSE: EMV)iShares Barc. EM USD Gov't Bond (LSE: SEMB)

How does it work? The moving average is the key. In the UK, you check whether the FTSE 100 is above its three-month moving average or not. For Europe, you use the EuroStoxx 50 index; for the US, the S&P 500; and for emerging markets, also the S&P 500 , but this time look at the two-month average. At the end of each month, if the signal is positive (above the moving average), then you stick with the equity ETF. If not, you sell up and reinvest in the bond ETF.

Finally, at the end of April each year, you rebalance each of the four different regions back to accounting for 25% of your portfolio each. Shing says the strategy produced a compound annual growth rate of 27.6% between 1990 and 2012. The worst loss was between 2007 and 2009, when the portfolio fell by 9%. For 2013, the strategy returned 14.4% after costs, and in 2014, a more modest 4.2%. For 2015 so far, the portfolio is up 5.1% to the end of May.

Some caveats

Secondly, I doubt that future returns will run at 27% a year, mainly because the great bullmarket in bonds is almost certainly over. But as Shing points out, not only would the strategy have kept you invested in sectors with the most momentum, but it would also have kept you out of the worst market crashes in recent years by switching you into bonds. Overall, if you're willing to spend half an hour a month looking at charts on Yahoo Finance, then placing a bunch of trades,I think this strategy could be a goer.

David C. Stevenson

David Stevenson has been writing the Financial Times Adventurous Investor column for nearly 15 years and is also a regular columnist for Citywire. He writes his own widely read Adventurous Investor SubStack newsletter at davidstevenson.substack.com

David has also had a successful career as a media entrepreneur setting up the big European fintech news and event outfit www.altfi.com as well as www.etfstream.com in the asset management space. 

Before that, he was a founding partner in the Rocket Science Group, a successful corporate comms business. 

David has also written a number of books on investing, funds, ETFs, and stock picking and is currently a non-executive director on a number of stockmarket-listed funds including Gresham House Energy Storage and the Aurora Investment Trust. 

In what remains of his spare time he is a presiding justice on the Southampton magistrates bench.