Quarterly sector momentum strategy (update)

Do FTSE 350 sectors display a quarterly momentum behaviour that can be exploited?

This analysis updates the performance of two strategies, defined as:

1. Strong quarterly sector momentum strategy (Strong QSMS)

The portfolio comprises just one FTSE 350 sector, that being the sector with the strongest performance in the previous quarter. So at the end of each quarter, the portfolio is liquidated and a 100% holding established in the strongest sector of the quarter just finished. This is held for three months, when the portfolio is liquidated and re-invested in the new sector. Therefore the strategy will trade four times a year.

2. Weak quarterly sector momentum strategy (Weak QSMS)

As above, but in this case it is the weakest sector of the previous quarter that is held by the portfolio. (Strictly, perhaps, this should be called a bounceback, or reversal, strategy and not a momentum strategy.)

Only FTSE 350 sectors with at least three component companies are considered. The period studied was from 2005 to the third quarter 2015.

The accompanying chart compares the performance of the two strategies, and adds the FTSE All Share Index as a benchmark. All series are re-based to start at 100.

Quarterly (strong and weak) sector momentum strategies [2005-2015]

Notes-

  1. As can be seen, both the SMS strategies out-performed the index over the period of the study. However, they did so with greater volatility (the standard deviation of the Strong SMS quarterly returns was 0.11, against comparable figures of 0.13 for the Weak SMS and 0.07 for the FTSE All Share Index).
  2. From 2012 the reversal portfolio (Weak SMS) started strongly out-performing the Strong SMS.
  3. A refinement of the strategy would be to hold the two or three best/worst performing sectors from the previous quarter instead of just the one (which would likely have the effect of reducing volatility).
  4. 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 performance.

Extract taken from the newly published The UK Stock Market Almanac 2016.

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