The recent evolution of ETFs as trading vehicles has expanded the available opportunities for traders and trading systems. In a recent post on his blog, Jay Kaeppel took a creative look at the good and bad aspects of international ETFs. He also put together a simple system that traded either a collection of international ETFs or the S&P 500.
He starts with some of the positive and negative aspects of international stock and ETF trading:
The bad news is that picking individual stocks is never an easy thing even if you focus only on domestic U.S. companies. For the average investor to successfully pick and choose among individual stocks around the globe is simply too much to expect.
The good news is that the proliferation of international ETFs – Single country funds, regional funds, global funds, etc. – has made it much easier for investors to diversify across the globe than it used to be.
The bad news is that the proliferation of ETFs has also reached a point where choosing an international ETF is getting to be almost as confusing as choosing a phone plan.
The good news is that there are ways to simplify and systematize things.
Jay goes on to describe building what he calls the BRIC index. This is a collection of four international ETFs that represent Brazil, Russia, India, and China. His BRIC index is comprised of an equal part of the single country ETF for each of those four countries.
He then puts together a strategy that will compare the relative strength of his BRIC index to that relative strength of the S&P 500. Here is how he sums up the relative strength strategy:
I will use a method I learned a long time ago from David Vomund, President of Vomund Investment Management, LLC and the author of “ETF Strategies Revealed.”
The measure calculates the relative strength between two assets on a weekly basis.
When the trend of relative strength reverses in a particular direction for two consecutive weeks it signals a switch into the stronger index.
Jay produces thorough backtesting results for this system from 2001 through 2013. Investing half of a portfolio in his BRIC index and the other half in the S&P 500 would have returned a total profit of 189.3%. Using his switching system on the same indexes would have returned a total profit of 490%.
One obvious hole in this strategy is that the trader is still 100% long equities at all times. This means that the system would be extremely exposed to a global black swan event.
Jay doesn’t dodge this flaw, though. He makes a point to close by saying that this is not a system you should run out and start trading.
It is just an idea that appears to have an edge. It also allows traders to gain exposure to international markets without becoming an expert in them. I suggested to Jay that it would be interesting to see what would happen if he tested the same strategy using commodity or bond ETFs as well.