Using Asset Class Rotation to Reduce Risk and Increase Return

January 21, 2017

Modern portfolio theory (MPT) has long been—and remains—the de facto standard for portfolio management since its inception in 1952. However, with the advent of numerous signal processing theory advancements in the last six decades, it’s time to examine how these developments can improve investment performance just as they have helped radio, cell phones, and digital TV achieve their superb performance today. This article reviews these new methods, develops a “relative risk” measure that is inherently industry-accepted, and shows how asset class rotation can radically reduce risk while improving returns for a set of ordinary asset class funds.

Motivation for Asset Class Rotation

While MPT was an important step forward for mitigating risk associated with market volatility, numerous subsequent developments can provide significant opportunity to extend MPT and further improve portfolio performance. The most important of these was the identification, confirmation and demonstration of momentum in market data:

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