A Better Approach for Tactical Allocation? Looking at Last Year's Winner

Garrison, Michael M.; Cribbs, Jeffrey G.
August 2011
Journal of Financial Planning;Aug2011, Vol. 24 Issue 8, p48
Academic Journal
• This paper examines annual returns of U.S. large-cap equities and U.S. small-cap equities to see if there is return persistency (momentum) over annual periods between the two asset classes that generates excess return. • Five portfolios are created using historical data (1926-2010) from these two asset classes. The returns of the five portfolios were analyzed from 1927-2010 and rolling annual 5-, 10-, 15-, and 20-year periods. • The five portfolios are: 100 percent large-cap equity portfolio (LC), 100 percent small-cap equity portfolio (SC), 50/50 large-cap/small-cap equity portfolio rebalanced annually (50/50), last year's winner portfolio (LYW), and last year's loser portfolio (LYL). The LYW portfolio invests 100 percent in the previous year's best-performing asset class, and the LYL portfolio invests 100 percent in the previous year's worst-performing asset class. • For the entire period examined, the LYW portfolio had higher compounded annual returns as well as higher risk-adjusted returns than all other portfolios examined, and the LYL portfolio consistently had the worst. • As the length of the annual rolling periods increased, the frequency of the LYW portfolio having the highest rates of return increased. • In the annual rolling periods for which the LYW portfolio was not the top-performing portfolio, its worst underperformance and median underperformance were consistently less than the underperformance of all other portfolios. • This paper concludes that annual investment return persistence has existed between large-cap equities and small-cap equities, and this persistency effect can be easily captured.


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