Resilient Market Timing Strategies For Global Equities

Abstract

The systemic impact of the global financial crisis of 2008 reveals that there are periods of uncertainty during which most asset classes experience substantial drawdown, rendering diversification an ineffective risk management tool. The desired exposures to risky assets such as stocks, bonds and commodities during these periods of systemic risk should be zero. This paper tests the effectiveness of two market timing strategies that intend to provide early signals for portfolio protection during turbulent times: a filter rule strategy based on the portfolio drawdown (DD) and drawup (DU) thresholds; and an exponential moving average (EMA) strategy based on the crossover of the fast moving average (FMA) and the slow moving average (SMA) of the fund values. The pre-specified market timing strategies are tested on the total return index of the Morgan Stanley Capital International World (MSCI World) Index since the inception of the index in 1997 through 2008. Both the optimal filter rule strategy and the optimal EMA strategy achieve Sharpe ratios that are higher than the Sharpe ratio of the unprotected MSCI World Index. The comparison of the historical risk-return characteristics reveals that the timing of protection is more accurate for the EMA strategy. As is the case for all market timing strategies, the signals provided by the protection mechanism lag the actual economic events. Thus, the market timing strategies tend to be more effective for prolonged economic downturn.