Do FTSE 350 sectors display a quarterly reversal behaviour that can be exploited?
In a recent article we looked at a momentum strategy that aimed to exploit the price momentum of strong sectors from one quarter to the next. This article looks at whether there is a reversal behaviour, i.e. where poor performing sectors in one quarter bounceback the following quarter.
The following chart shows the performance of a portfolio that each quarter is fully invested in one FTSE 350 sector, that being the worst performing sector of the previous quarter. Elsewhere, the portfolio is similar to that of the previous momentum portfolio: at the end of each quarter, the portfolio is liquidated and a 100% holding established in the weakest sector of the quarter just finished. This is held for three months, when the portfolio is re-balanced again. Each year there will therefore be four re-balancings. Only FTSE 350 sectors with at least three component companies are considered. The period studied was from 2003 to the first quarter 2014.
In the chart below the reversal portfolio (Weak SMS) is plotted against the FT All Share Index (FTAS) and also the previous momentum portfolio (Strong SMS) for comparison. The three series are re-based to start at 100.
- As can be seen, the reversal strategy under-performed for the first few years and then out-performed. The volatility of the portfolio’s quarterly returns (standard deviation of 0.13) was higher than that of either the momentum portfolio (0.12) or the FTSE All Share Index (0.07).
- A refinement of the strategy would be to hold the two or three worst performing sectors from the previous quarter instead of just the one (which would likely have the effect of reducing volatility).
- Costs were not taken into account in the study. But given that the portfolio was only traded four times a year, costs would not have had a significant impact on the overall picture.
- Almanac articles on momentum.