Dividend & Interest AssumptionsLarge Cap, Small Cap and High-Turn Momentum Strategies versus Buy & HoldWe use the S&P 500 Total Return Index as a benchmark to assess the return and risk performance of our momentum strategies. The S&P Total Return Index calculates the total return before taxes assuming all dividends are received and reinvested. Neither dividends paid on holdings while the Momentum Strategies are in the market, nor interest earned while these strategies are in cash (Safeguard 1st Risk Model on sell) are included in the total returns for these strategies. This is so for three reasons: 1) it is the most conservative case, 2) more importantly, historical total return (which includes dividends) data for all stocks is not widely available for many smaller stocks, nor is it as reliable as historical end of day stock close data, and 3) we wanted to simplify the modeling. The assess the impact the inclusion of dividends for the benchmark and the exclusion of both dividends and interest for our strategies, considering the following will be useful: - The average dividend yield on the S&P 500 from 7/2/1987 to 7/1/2016 was 2.24%. The average holding period for the Small Cap Momentum Strategy and Large Cap Momentum Strategies during this period was 24.9 and 26.5 weeks, respectively, which means our Momentum Strategies would have captured between 25% and 50% of the dividends offered by the individual stocks held. These dividends are not included in the calculated returns for the momentum strategies, which likely would have added between 0.5 and 1.0 percent annually. Because the High Turn Momentum Strategy invests in small cap stocks and sells its positions every 8 weeks, dividends earned by this strategy can be ignored.
- The average interest rate on 3 Month T-Bills from 7/2/1987 to 7/1/2016 was 3.26%. When the Safeguard 1st Model signal goes to sell, we liquidate all stock positions and go to 3 Month T-Bills. As such we can assume that these strategies would earn close to the 3 Month T-Bill Yield when out of the market; however, as explained above, interest earned when the strategies are out of the market is not included in the strategy returns. This also understates the annualized return of our momentum strategies.
Safeguard 1st Strategy versus Buy & HoldThe Safeguard 1st Strategy invests solely in the SPDR S&P 500 EFT Trust (SPY) as a proxy to the S&P 500 Total Return Index our benchmark for Buy & Hold. Our key assumptions when comparing our strategy the S&P 500 TR Index are that 1) when the strategy is fully invested, it is earning the same dividends as the benchmark and 2) when the strategy is out of the market and in 3 Month T-Bills, it is earning interest. Assuming that the strategy earns the same dividends as the benchmark is incorrect in that the strategy may exit the market before SPY ex-dividend dates. However, excluding interest earned on 3 Month T-Bill investments when the strategy is out of the market (the Safeguard 1st Risk Model is on sell) while the benchmark continues to earn dividends more than corrects for this. Safeguard 1st Risk Model versus Buy & Hold (Also Applies to Individual Indicators)We used the TradeStation platform to backtest and develop our Indicators and Safeguard 1st Risk Model. A technical issue prevented us from using the S&P 500 Total Return Index as our benchmark. Instead, we used the simple S&P 500 Index. We ensured our methodology was consistent with the following assumption: dividends and interest earned were excluded from the analysis. Since the Safeguard 1st Risk Model is investing in the S&P 500 Index Benchmark during its Buy Signals, relative performance is exactly the same with or without dividends when the model is on buy. The only time performance could be different is when the Risk Model is out of the market earning interest and the Benchmark is earning dividends. A difference would only occur to the extent that the Benchmark dividend yield is significantly different from the interest rate earned by the Risk Model. If we were to assume that during sell periods, the interest earned by the Risk Model is equal to the dividends earned by the Benchmark, then returns would be the same. As stated above, this assumption is reasonable as the average dividend yield on the S&P 500 was 2.24% and the average interest rate on 3 Month T-Bills was 3.26% from 7/2/1987 to 7/1/2016. You will notice that our Performance Tables for our Indicators, Risk Model and Strategies all include the dividend yield for the Benchmark and the 3 Month T-Bill interest rate for each period analyzed, so this assumption can be assessed for all periods. |