Dual Momentum on Steroids

Dual Momentum is a simple investing strategy that has historically beaten the S&P 500 while providing exceptional downside protection. It was published by Gary Antonacci in his book Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk.

I began my do-it-yourself (DIY) investing journey by investing in couch potato portfolios with a 60% exposure to global equities and 40% fixed income; this portfolio is commonly known as a balanced portfolio. To this day most of my liquid assets are held in this kind of portfolios. 

Then I met Dual Momentum and I felt in love with the strategy. The things I like the most about it are:
  • It is simple, simpler to implement than a couch potato portfolio. Anyone can do it. Chapter 8 of the book explains how to implement it; but I will go over it briefly later.
  • It has delivered great returns historically. Consider this table put together by Gary. The column "GEM Annual" shows the historical annual returns since 1950. GEM stands for Global Equities Momentum which is just an implementation of Dual Momentum.
  • It offers great downside protection when sh__ is hitting the fan. Consider the first chart in this link and draw your own conclusions.
  • This strategy is backed by lots of research and back-testing; not just from Gary but from many others. Hell, you can back test it yourself with sites like Portfolio Visualizer.
  • The strategy requires very little trading activity. It could potentially save you some trading fees.
  • The strategy is somewhat tax efficient (in non-registered accounts) because it generally triggers capital losses when transitioning to bonds in a downturn and it lets the money grow without triggering capital gains in an up trending market. 
In the book Gary covers a variant of the strategy where a 1.30x leverage is used. I decided to implement a similar approach given that the downside protection works pretty well even with leverage and the returns are goosed up by ~3% annually (historically).

For this purpose I decided to use PortfolioPlus ETFs PPLC, PPDM and PPEM offering a 135% daily market exposure to the S&P 500, Developed International Markets and Emerging Markets respectively. I am Canadian and these ETFs trade on the US Market; so I converted cheaply some of my loonies to greenbacks with Norbert’s Gambit.

Dual Momentum (DM) dictates that at any given time all the money in your portfolio should be invested in one (and only one) of these: American Equities, Internal Equities (75% Developed Markets ex US plus 25% Emerging Markets) or US Treasury Bills (you can use US Aggregate Bonds as well).  

At the end of each month I use PerfChart to evaluate the DM signal. I use VOO, ACWX and BIL as proxies for US Equities, International Markets and US Treasury Bills respectively. The look-back period I use is 253 days (1 year). Notice that I don’t trade VOO, ACWX and BIL; these are only used to determine the DM signal. From those ETFs the one with the highest total return in the last 253 days will determine where the money will be allocated.

If VOO wins, the money will be allocated into US equities. If ACWX wins, the money goes to International Stocks (both developed and emerging markets). If BIL wins, the money goes to US bonds. Given that I am using a leveraged implementation of DM, then the above translates as:

If VOO wins, 100% of the portfolio is invested in PPLC. If ACWX wins, the portfolio is invested in a 75% PPDM and 25% PPEM split. If BIL wins, 100% of the money is invested in SCHZ.

Dual Momentum is a great strategy for DIY investors. For those looking to juice up the returns while accepting some added risk (but not much) the use of leverage is at hand. For risk adverse investors there are other ways in which DM can be implemented. For instance, in the book Gary describes GEM 70: an implementation of DM where 30% is always allocated to an US Aggregate Bond ETF while the remaining 70% is allocated to equities as per the rules of DM.

(Disclaimer: I am an amateur DIY investor. What I say here should not be considered investment advice. Investing on the stock market comes with risks and you can lose money.)

The cost of converting Canadian Dollars to American Dollars with Norbert's Gambit

On Feb 26th, 2019, I initiated my first Norbert's Gambit at National Bank Direct Brokerage (NBDB).  The purpose was to exchange over 55k worth of Canadian Dollars (CAD) to American Dollars (USD) within my RRSP account. (Side story: I used the greenbacks to invest in a leveraged implementation of Dual Momentum)

My RRSP account at NBDB is segregated into two sub-accounts: a Canadian Dollar RRSP sub-account and a US Dollar RRSP sub-account.

The original funds were in my Canadian Dollar RRSP. There I bought 4,274 shares of DLR at $13.290 CAD; for a grand total of $56,801.46 CAD. 

I waited until the day after my trade settled (March 1st, 2019) and called NBDB requesting to transfer all 4,274 shares of DLR from my Canadian Dollar RRSP to the  US Dollar RRSP (resulting in 4,274 shares of DLR.U being transferred into the a US Dollar RRSP). I also asked them to include a note in the system so that I could sell all the 4,274 shares of DLR.U that same day. 

Shorty after the call I sold the 4,274 shares of DLR.U at $10.06491 USD for a grand total of $43,017.43 USD.

In summary, I got $43,017.43 USD for my original $56,801.46 CAD.

There were no transaction costs because trading more than a 100 shares of any ETF is free at NBDB.

The bid/ask spread when I bought DLR.TO was $0.01 CAD; incurring in a cost of $42.74 CAD because I bought at the ask price. 

The bid/ask spread when I sold DLR.U.TO was $0.01 USD; incurring in a cost of $42.74 USD because I sold at the bid price. Converted to CAD using the Bank of Canada (BoC) rate on March 1st ($1 CAD -> $0.7541 USD) this cost rounds to $56.68 CAD.

The MER of these ETFs is 0.56% annually; which translates to a cost of 0.0046% (3 * 0.56% / 365) of the market value for holding it 3 days.  For simplification let’s say we apply this tiny percentage to the initial dollar CAD amount: 0.0046% x $56,801.46 CAD = $2.61 CAD.

If the ETF was trading at a premium; then there would be a cost associated with such premium. I honestly don’t know whether the ETFs were trading for a premium or at a discount at the time I executed my trades.  If you execute Norbert's Gambit many times over your life as an investor; then this cost would probably balance itself.  So, I will assume this cost to be zero given that sometimes you would buy at a premium incurring in a cost or buy at a discount pocketing a gain.

Beyond the “typical” costs we need consider the capital gain or loss incurred by holding the ETFs for 3 days (the Forex market keeps moving). Here again I would simplify things by assuming that either the CAD/USD pair did not move significantly during these 3 days or that over a lifetime of executions of Norbert's Gambits the capital gains and losses would balance themselves.

So far the “approximate” “theoretical” cost of my Norbert's Gambit comes to $102.03 for exchanging 56,801.46 CAD. In percentage this cost rounds to 0.18% of the amount I exchanged.

That’s the theory, but what about in practice?

The BoC CAD/USD rate on Feb 26 was 0.7579 ($1 CAD -> $0.7579 USD). If we use this rate for our estimation, then we could have converted $56,801.46 CAD into $43,049.83 USD on Feb 26. This number is very close to the real amount of dollars I ultimately got converted ($43,017.43 USD). The difference is minus $32.40 USD; which could be interpreted as a “cost” of $32.40 USD ($42.97 CAD if we use the BoC exchange rate of March 1st). In percentage this cost rounds to 0.08% ($42.97 CAD / $56,801.46 CAD) of the amount I exchanged.

There are lots of simplifications and assumptions in the math above; but they are not outrageously out of place. My goal was not to calculate the cost of the Norbert's Gambit with scientific precision; but to show that it is a very cheap strategy to convert CAD to USD dollars and vice versa.