EzBacktest is a free backtesting program that shows investors the importance of diversification and helps them optimize their portfolio’s asset allocation for a desired risk and return. The program can backtest rebalancing rules, create a correlation matrix, calculate the risk and return of a portfolio using the Sharpe ratio and standard deviation, and more.
The most important factor in diversification is security selection because if the securities in a portfolio perform similarly, the portfolio is not diversified; the idea is to have securities offset each other’s volatility. For this reason, the correlation matrix is a great place to begin. A correlation matrix compares the performance of two securities over a historical period and generates a number between 1 and -1 that describes their correlation. The further the number is from 0 on the positive side, the higher the correlation, with 1 denoting identical performance, 0 indicating no correlation, and -1 being completely opposite performance.
For example, using EzBatcktest’s correlation matrix, Caterpillar (CAT) has a 0.8 correlation with the S&P 500 index while the SPDR Gold Shares (GLD) has no correlation with Apple (AAPL). This means that if the S&P 500 is positive, Caterpillar is likely to be positive, whereas gold’s performance has no bearing on Apple’s performance. Generally speaking, a weaker correlation is better for diversification purposes.
After choosing the securities for a portfolio, investors can use the program to backtest different asset allocation mixes and rebalancing rules. To begin, users might want to go to Edit on the main toolbar and select “distribute equally” to assign an equal portfolio allocation to each security, with the remainder as cash. From here, the percentages can be adjusted to find an allocation with the investor’s desired risk and return trade-off.
When backtesting a portfolio, users can adjust the number of months used in the test or set a start date and specify a rebalancing rule. Users should remember that a longer testing period generally produces more accurate results and that rebalancing rules do not take transaction fees into account.
Once a user has constructed a diversified portfolio with his or her desired asset allocation, it is important to rebalance the portfolio at certain intervals to maintain proper diversification. Rebalancing is often overlooked and can sometimes be difficult for investors because it may require taking equity out of winners and putting it into losers. This notion makes EzBacktest’s rebalancing feature all the more useful because it allows users to backtest a variety of rebalancing rules and to compare the historical results for themselves. Rebalancing should decrease the riskiness of a portfolio and often will generate better results than doing nothing over the long run. For more on rebalancing, check out Charles Rotblut’s article in the March 2012 AAII Journal.
EzBacktest is a free and easy-to-use program that provides an essential service for any investor’s portfolio.
EzBacktest by Sivan Segev
System Requirements: Windows OS and Microsoft .NET Framework 3.5
Size: Approximately 4 KB