Rapach and Strauss and Zhou (2013) find that the US stock market leads the world markets even at the monthly frequency, so the supported options include specifying a single asset to be used for absolute momentum. As discussed in Gary Antonacci's Dual Momentum book, we can first apply absolute momentum based on the US stock market (. S&P 500 TR) and assuming the excess return over the risk free rate is positive, we use relative momentum to choose between US equity and international equity. If the absolute momentum excess return is negative, the model is invested in the selected out-of-market asset, ., Barclays . Aggregate Bond Index.
A more sophisticated approach is to start by performing the asset allocation with broad asset class indices as in the example. Once a target asset allocation with the desired risk return profile is selected from the frontier, we convert this into a “policy benchmark” by creating a composite (a “blend” in StyleADVISOR) made up of the various indices and their respective weights. For instance, a policy benchmark based on Mix 2 of Graph One is 21% . Corporate Bonds, 31% International Equities (MSCI EAFE), and 48% . Stocks (S&P 500). Next, using StyleADVISOR we search for the most skillful managers in each asset class. After selecting the individual managers or funds we use StyleADVISOR’s powerful “Optimize Managers to Track a Benchmark” feature. This tool finds the optimum mix of managers to track the policy benchmark. This results in a portfolio of managers that have outperformed their specific benchmarks with a very low tracking error to our policy benchmark.