What is Relative Strength Investing?

Understanding Relative Strength Investing

Relative strength investing is a dynamic investment strategy that focuses on comparing the performance of different assets to identify leaders in the market. This approach helps investors capitalize on momentum by investing in assets that demonstrate superior performance relative to their peers. The core principle is simple: invest in winners and avoid or underweight losers.

The concept of relative strength dates back to the early 20th century, but it gained prominence in the 1990s with the advent of modern computing, which made tracking and analyzing multiple assets more feasible. Its roots can be traced to the notion that historical price movements can provide insights into future market trends.

Why Choose Relative Strength Investing?

1. Harnessing Momentum: This approach capitalizes on the continuation of existing market trends, aiming to ride the wave of success already established by certain assets.

2. Flexibility in a Dynamic Market: Relative strength investing adapts to market changes, making it a highly flexible strategy suitable for diverse market conditions.

3. Enhanced Risk Management: By focusing on assets that are currently outperforming their peers, the strategy can potentially reduce exposure to underperforming and riskier assets.

Testing a Simple Relative Strength Strategy

In the spirit of exploring this concept, let's back-test a straightforward Index using four major asset classes:

• US Equity - Russell 1000 Index

• International Equity - MSCI EAFE Index

• Fixed Income - Bloomberg US Aggregate Index

• Commodities - S&P GSCI Index

Strategy Design

• Measurement: We rank these asset classes based on their 1-year total return at the end of each month.

• Allocation: The top-performing asset is then overweighted for the following month with weights of 40%, 30%, 20%, and 10%. The rebalance takes place at the close of the first trading day.

• Benchmark: This strategy is benchmarked against an equal-weight distribution across these four indices.

Back-Test Analysis

Summary statistics and charts show a hypothetical representation of the Index versus the Benchmark from December 31, 1999 to October 31, 2023.

Performance Review

The strategy demonstrates an alpha of 2.3% over the benchmark, with a drawdown of 40.7% compared to the benchmark’s 46.2%. The Sharpe ratio stands at 0.41, outpacing the benchmark’s 0.21. These metrics underscore a stronger risk-adjusted performance relative to the benchmark, showcasing the efficacy of the relative strength approach.

Conclusion: Modelist's Advanced Relative Strength Strategies

At Modelist, we're committed to evolving the concept of custom model portfolios. While our discussion here revolves around a simplified version, we offer four sophisticated variations tailored to distinct market segments:

• Asset Class Relative Strength

• Equity Relative Strength

• Fixed Income Relative Strength

• Sector Relative Strength

Our strategies stand out for their flexibility and robustness, crafted to integrate smoothly into diverse investment models. We invite financial advisors to engage with us for a more in-depth understanding. Modelist is equipped to show how these strategies can enhance diversified asset allocation models and complement other investment methods we offer.

Contact Modelist to learn how we can help you design customized model portfolios, enabling you to provide sophisticated investment portfolios for your clients.