PNC STAR:
PNC Systematic Tactical Asset Rotation
September 2013
E. William Stone, CFA CMT
Managing Director,
Investment & Portfolio Strategy
Chief Investment Strategist
Ryan Whidden
Senior Portfolio Strategist
Paul J. White, PhD, CAIA®
Director of Portfolio Strategy
pnc.com
The race is not always to the swift, nor the battle to the strong, but
that's how the smart money bets —Damon Runyon
Introduction
Momentum is a strategy that has many adherents in the asset management
community and academia. First on the academic scene were Jegadeesh and
Titman in 1993. 1 They found that zero-cost portfolios formed from buying past
winners and selling past losers realized significant abnormal returns. In 1997,
Carhart added their newly discovered factor as a fourth factor to the Fama-French
three-factor model and found that positive exposure to momentum was a
significant positive influence in the best portfolios and significant negative
influence in the worst.
Extensive additional research has expanded on the various iterations of the
momentum theme (Rouwenhorst in 1998, Grinblatt in 2004). And in 2006,
Bhojraj presented evidence on the existence of momentum for indexes.
Moskowitz et al in 2012 document significant strong and consistent momentum
performance across many diverse asset classes over 25 years, including for equity
index, currency, commodity, and bond futures. Also in 2012, Hurst et al
expanded upon their research to show momentum has “…delivered strong
positive returns and realized a low correlation to traditional asset classes each
decade for more than a century.” 2
In 2013, Asness et al found that momentum is a good complement to value.
While both value and momentum strategies have been vetted academically for
decades, they were the first to look at value and momentum strategies together
instead of each in isolation. They found that by combining a momentum strategy
with a value strategy in a portfolio, Sharpe ratios and average return increased, as
a result of the two strategies being negatively correlated and each having positive
expected returns. It is easy to understand why the two strategies are negatively
correlated when it is considered that:
 with value, an investor wants to buy stocks that have become cheaper
and have relatively lower prices, and
 with momentum, the investor wants to buy stocks whose prices have
risen over the past year and become more expensive.
However, current price is not the sole determinant of what constitutes a value or
momentum stock, which is why the two strategies are not contradictory and can
both have positive expected returns.
1
Referenced research is listed in the References section on page 10.
2
Brian Hurst, Yao Hua Ooi, and Lasse H. Pedersen, “A Century of Evidence on
Trend-Following Investing,” AQR Capital Management, working paper (Fall
2012): 1.
PNC STAR
smart beta is an approach
that attempts to enhance the
return from an asset class by
systematically deviating from
the traditional market-
capitalization-weighted
approach. Quantitative
analysis has shown that some
portion of outperformance by
active managers comes from
investment processes that
can be identified and
replicated systematically.
2 September 2013
Many reasons have been proposed for the existence of abnormal returns for
momentum in the marketplace. Behavioral biases and arbitrage difficulty
generally top the list.
 Investors often overreact to news or information and behavioral
analysts point out fear and greed play a role; investors are more
inclined to buy recent winners and sell recent losers, regardless of
the underlying fundamental picture.
 Recent performance also confirms previously held convictions and
causes investors to buy or sell more of a stock.
 Anchoring is another behavioral bias in which individuals latch onto
outdated prices and beliefs and are hesitant to update their views
until some later time.
 And even in a world of high-frequency trading and rapid-fire
information, absorption of information is still slow to propagate
through the mass of investors. As more investors absorb the new
information, they will make buy and sell decisions that will affect the
price of a security.
 Finally, since momentum strategies generally have a high amount of
turnover, transactions costs make it difficult to arbitrage away the
momentum effect, especially for baskets involving hundreds of
securities.
Momentum is a form of smart beta that tilts the portfolio to include some
exposure to a factor that does not exist in a static, passive portfolio.
Traditional beta portfolios weigh constituents by market capitalization, but
PNC STAR re-weights sectors and styles dynamically from month to month,
depending on which have strength behind them. Smart beta provides a way to
capture some of the exposure to an outperformance factor that can be
systematically recreated but often is accredited to active management.
The PNC STAR Strategy
The PNC STAR strategy is a combination of momentum and trend following
at the index level. It does not use individual stock baskets representing
thousands of stocks as most momentum strategies do, but instead uses a
small subset of sector and international exchange-traded funds (ETFs) as its
representative universe. Moskowitz and Grinblatt found in 1999 that industry
momentum accounts for most of the abnormal returns gained through the
classic momentum strategy, and Chen et al in 2012 found that style indexes
exhibit strong price momentum. Therefore, the PNC STAR strategy is not
disadvantaged by using ETFs and instead gains some advantages, including
reduced trading costs and prevention of overrepresentation of illiquid
securities.
We use total return 3 price return history collected from Bloomberg for 15
ETFs that PNC Investment Advisor Research (IAR) has approved for the
3
We also examined simple price history with the dividends stripped out and
came to similar conclusions.
 Systematic Tactical Asset Rotation

platform 4, collectively referred to as the model Table 1

universe: 14 tactical ETFs—9 representing the Current PNC STAR Investment Options
U.S. sectors, 2 representing domestic small- and
mid-cap stocks, 1 representing international small- Ticker Description
cap stocks, 1 for emerging markets, and 1 for XLY Consumer Discretionary Select Sector SPDR® Fund
EAFE 5 stocks—and, for allocation when the XLP Consumer Staples Select Sector SPDR® Fund
XLE Energy Select Sector SPDR® Fund
model is agnostic, the SPDR® S&P 500® ETF.
XLF Financial Select Sector SPDR® Fund
We include international and smaller market XLV Health Care Select Sector SPDR® Fund
capitalization funds because the U.S. sector funds XLI Industrial Select Sector SPDR® Fund
represent only domestic large-cap stocks; the XLB Materials Select Sector SPDR® Fund
additional funds increase the reach of the strategy. XLK Technology Select Sector SPDR® Fund
Our back-testing process showed that the strategy XLU Utilities Select Sector SPDR® Fund
is most successful when expanding the breadth of IJR iShares Core S&P Small-Cap ETF
domestic and international options and providing IJH iShares Core S&P Mid-Cap ETF
momentum exposure to size and international SCZ iShares MSCI EAFE Small-Cap ETF
factors. EEM iShares MSCI Emerging Markets ETF
EFA iShares MSCI EAFE ETF
PNC STAR may be expanded to include more
Source: PNC
investment options in the future. Table 1 shows
the current investment options amongst which PNC STAR allocates.

Methodology
PNC STAR is a proprietary model with a two-stage process that is
rebalanced monthly.
First, all ETFs under consideration (Table 1) must be in a positive price
trend.
Second, the three top performing ETFs over the past 12 months are equally
weighted.
 If fewer than three ETFs pass the first screen, then the remaining
ETFs are equally weighted.
 If no ETFs pass the first screen, the allocation stays in the
benchmark, the S&P 500.
Currently, three ETFs are chosen, but in the future, we may expand the
eligible ETF universe, and the number of choices may change as a result.

Results
Table 2 (page 4) shows some of the results from a Pertrac analysis provided
by IAR against the S&P 500 Total Return index benchmark. The annualized
return since 1990 has been 14.74% with a standard deviation of 16.50%,
bringing the Sharpe Ratio to 0.77. The table also shows that annualized alpha
over the back-test period was 5.34%, with 73% of the return explained by the
benchmark. The up capture ratio of 200% and down capture ratio of 99%
shows that outperformance for the strategy historically came from the upside,
which is a natural consequence of a momentum strategy. The active premium

4
SPDR® MidCap 400 ETF (MDY) and SPDR® Small Cap 600 ETF (SLY) were
also tested and can be used in place of or in conjunction with IJH and IJR.
5
International sector ETFs exist, but have been trading only for about five
years.

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PNC STAR

Table 2
Returns and Statistics
Annualized Sharpe Annualized Tracking S&P 500
Return Ratio Alpha Alpha Beta R R Squared Error Return
14.74% 0.77 0.43% 5.34% 0.95 0.86 0.73 8.69% 9.83%
Standard Gain/Loss Treynor Jensen Active Information Up Down S&P 500
Deviation Ratio Ratio* Alpha** Premium§ Ratio Capture Capture Std Dev
16.50% 1.79 12.94% 0.42% 4.93% 0.57 200.74% 99.01% 14.85%
*Treynor Ratio = (Portfolio Return - Risk Free Rate) / Portfolio Beta
**Jensen's Alpha = Portfolio Return − [Risk Free Rate + Portfolio Beta * (Market Return − Risk Free Rate)]
§Active Premium = Annualized Portfolio Return – Annualized Benchmark Return
Source: PNC Investment Advisor Research

of just under 5% is the annualized advantage of this strategy compared with

the benchmark. And finally, the tracking error comes in at just under 9%.
This is not unexpected, given that the strategy rotates into different sectors
and international indexes each month and matches only about a third of the
benchmark in any given month. We believe risk and tracking error can be
managed with tactical position sizing.
The total return wealth curves are shown in Chart 1.

Chart 1 Chart 2
Strategy versus S&P 500 Strategy versus S&P 500

Source: Bloomberg L.P., PNC Source: Bloomberg L.P., PNC

Since back-tested inception, the strategy has returned more than 20 times the
original investment compared with the benchmark S&P 500 Total Return
index return of 8 times. The strategy moved mostly in lockstep with the
benchmark during a strong bull market until 1999, when it broke away from
the underlying index. Perhaps coincidentally, this is also the time when the
ETFs started trading on the market (prior to this date, the back-test uses the
underlying index returns). Chart 2 shows the strategy returns from 1999
onward, after the ETFs started trading. From this we can see that the strategy
has returned more than 4 times the original investment compared with less
than 2 times for the benchmark.

4 September 2013
 Systematic Tactical Asset Rotation

Table 3
Top Drawdowns
Length PNC STAR S&P 500 Total Return
(months) Peak Valley Depth Recovery Depth Recovery
16 10/07 2/09 -43.08% 47 -51.95% 38
25 8/00 9/02 -29.82 25 -44.73 61
2 6/98 8/98 -16.75 4 -15.37 3
2 3/00 5/00 -9.38 3 -5.00 3
5 1/94 6/94 -7.33 2 -6.56 2
1 9/05 10/05 -7.26 2 -1.67 2
Source: Bloomberg L.P., PNC

Chart 3
PNC STAR Holdings across Time

Source: PNC

Table 3 shows the largest historical drawdowns. For the largest two
drawdowns over the 23-year period, PNC STAR had a softer landing. For the
technology bubble recession of 2000, the recovery to old highs took less than
half the time as it did for the S&P 500 Total Return index. For three of the
four remaining drawdowns, recovery to prior highs took the same number of
months as the benchmark. For the bottom four drawdowns in Table 3, PNC
STAR underperforms because of the short duration of the drawdowns. The
strategy cannot perfectly time peaks or troughs and, coupled with the
monthly rebalance period, there will usually be an underperformance on the
dips and turning points for short drawdown periods.
Chart 3 shows the holdings across time. Some of the classic historical
momentum themes are exemplified in this chart, including the tech bubble of
the late 1990s and the emerging markets boom of the mid-2000s.
Turnover from a dynamic strategy is expected, but as one can
Table 4
infer from Chart 3, since PNC STAR follows a trend, turnover is
Monthly Turnover
not excessive by any means, as shown in Table 4. In fact, only
one or fewer changes are made from month to month 90% of the Changes 0 1 2 3
time. As Table 5 (page 6) shows, the average trade length is Frequency 37.73% 51.65% 7.69% 2.93%
about four months long. Only in 3% of the months does the Source: PNC
model make a full three changes. However, tax efficiency should

5
PNC STAR

Table 5
Individual Trade Analysis
Average Return Percentage
Number Length Mean Minimum Maximum Profitable
Long Term 15 18.00 58.97% 4.74% 168.96% 100.0%
Short Term 177 2.71 3.93 -13.75 43.42 66.1
Total 192 3.90 8.23 -13.75 168.96 68.8
Source: PNC

Table 6 not be expected, even for long trends, because

Long-Term Trades there are many breaks in the segments as
Length evidenced in Chart 3 (page 5) and shown in
Start End (Months) Name Return Table 5.
8/98 8/00 24 Information Technology 168.96% Table 5 also shows the breakdown of the
8/94 11/96 27 Health Care 100.36 individual trades. Of the 192 total trades
6/04 5/06 23 Energy 80.47 completed, about 69% were profitable. Only 8%
6/94 3/96 21 Information Technology 78.71 of the trades classified for long-term capital gains,
8/03 3/05 19 Small International 64.83 but these trades had the largest return, which
11/97 7/99 20 Health Care 61.50
would be expected when a trend is being followed
2/05 12/06 22 Emerging Markets 59.53
for a long period of time. Every long-term trade
9/96 1/98 16 Financials 59.22
was profitable, with an average return of 59% over
9/90 2/92 17 Health Care 55.04
4/03 6/04 14 Emerging Markets 54.02
an average period of 18 months. The average
5/06 5/07 12 EAFE 26.46 short-term trade length was less than three months
11/96 12/97 13 Information Technology 24.69 with 66% of them being profitable and a mean
9/92 10/93 13 Financials 24.49 return of just under 4%.
4/93 8/94 16 EAFE 21.54 Table 6 shows all of the long-term capital gains
5/07 6/08 13 Materials 4.74 trades completed over the back-test period. The
Source: PNC largest gain of 169% was a result of riding a two-
year Information Technology trend and the
Chart 4 second-largest gain of 100% was from riding a two-year
Density of Short-Term Returns Health Care trend in the 1990s. About half of the long-
term trends ended in the 2000s, and the last long-term
trend that was captured was in 2008. This coincides with
the earlier discussion involving Table 3 (page 5) about
capturing peaks and troughs, since the market has
whipsawed quite a bit since the March 2009 trough and the
model has not been able to lock on to a consistent long-
term trend.
There are too many short-term trades to list, so instead we
provide a distribution of past round trip trade performance
(Chart 4). The density shows that the distribution is
skewed to the right with a positive mean return, which is
what we would hope to find.

Source: PNC

6 September 2013
 Systematic Tactical Asset Rotation

Additional Discussion
We use a 12-month price return as the core of our momentum strategy.
However, nothing is particular to the 12-month time period that we use. In
fact, our testing showed that other periods from 3 to 15 months lead to
similar outcomes. We settled on 12 months because:
 a year is a natural unseasoned time period that investors generally
use to gauge relative performance;
 most of the academic literature also focuses on the 12-month period;
 we wanted to mitigate any data mining through over-optimizing the
dataset; and
 turnover is reduced for longer time periods.
Furthermore, in 2010, Hancock showed price momentum
Chart 5
performance results for the 1- to 15-month periods for
Relative Performance: PNC STAR versus S&P 500
1927-2009 and found that holding periods between 5 and
15 months led to abnormal returns, but that 12 months was
the period with peak outperformance 6.
Like most strategies, there can be periods of
underperformance for the PNC STAR strategy because
performance tends to wax and wane; most strategies do not
work at all times. Momentum has been known to suffer
when the overall market reaches an inflection point and
peaks. Our findings are consistent with those of Wilson
(2010) that the past several years have not been as
profitable as in the more distant past for momentum. For
PNC STAR, it is not absolute performance that has
suffered—the strategy has still continued to show positive
returns on average, but PNC STAR has not been able to
Source: Bloomberg L.P., PNC
match the relative strong performance of the benchmark
since the recession. For a graphical representation of the
monthly performance, Chart 5 exemplifies this. Each Chart 6
column represents the monthly performance relative to the S&P 500 versus AQR Momentum Index
benchmark and the blue line is the rolling six-month
average. The relative performance has dipped since the
2008 recession, but is starting to make a comeback.
However, it should be noted that this underperformance is
not unique to PNC STAR. A momentum index by AQR
Capital Management has shown similar underperformance
relative to the benchmark. Chart 6 shows the AQR
momentum Index compared with the S&P 500 Total
Return index. Underperformance for this index has been
about 25%. Over the same time period, PNC STAR has
underperformed by a much lower 7%.
Another performance metric we find informative is the
rolling alpha and beta chart. Alpha and beta are defined in
the traditional CAPM sense, where a strategy’s excess Source:Bloomberg L.P., PNC

6
No statistics of significance were provided for comparison between the
neighboring months.

7
PNC STAR

Chart 7 Chart 8
Three-Year Rolling Alpha and Beta One-Year Rolling Alpha and Beta

Source: PNC Source: PNC

return above the risk-free rate is regressed against the benchmark’s excess
return. Beta shows how the strategy moves with the market and alpha shows
the part of the return not correlated with the market. Over the full sample, the
robust beta is 0.977 and the robust alpha is 39 basis points per month. Chart 7
shows the robust regression using a three-year rolling window across time.
In the chart the alpha dipped in the late 90s (while the general market was
roaring) and after 2011 (capturing years 2008-10).
However, if the rolling window is shortened, it can be seen that the alpha is
slowly turning positive again (Chart 8).

The Case for Momentum Investing

We believe adding a small allocation of the PNC STAR strategy to a
portfolio can increase return without increasing risk (and with small
allocations can marginally reduce risk). Table 7 shows the return and
Chart 9
standard deviation of the combined portfolio. Return
10% PNC STAR/90% S&P 500 Combination Total
increases by approximately 0.5% per year, but the standard
Return deviation marginally decreases. Over a long investment
holding period, the return impact can be significant, as
shown in Chart 9. The S&P 500 Total Return index turns
$1 dollar into $8 over the 21-year investment holding
period, while the 10% PNC STAR/ 90% S&P portfolio
turns $1 into more than $9, reflecting an approximate 12%
increase in total return over the benchmark.

Table 7
10% PNC STAR and 90% S&P 500 Combination
PNC STAR S&P 500 TR Combined
Annualized Return 14.74% 9.83% 10.35%
Annualized Std Dev. 16.50% 14.85% 14.80%
Source: Bloomberg L.P., PNC Source: Bloomberg L.P., PNC

8 September 2013
 Systematic Tactical Asset Rotation

Conclusion
Adding momentum exposure to a portfolio has been shown to be a good
diversifier to portfolios. The PNC STAR strategy uses broad ETFs to apply
momentum exposure to industries, size, and international factors in a
systematic way. It has shown excess returns with a level of volatility similar
to the benchmark S&P 500, resulting in a higher Sharpe Ratio. While past
performance is not indicative of future performance, historically this model
has led to alpha of just under 0.40% per month. In addition, the drawdown
analysis has shown that the strategy has handled periods of crisis better than
the benchmark index and was usually quick to recover.
Furthermore, to reduce risk, PNC STAR has a built in a safeguard that
considers for rotation only the indexes that are in an uptrend, and the overall
positions in the portfolios will be sized appropriately by Investment Strategy.
Momentum performance has dipped since the recession, but appears to be
coming back. If momentum continues to work in the future as it has
historically, the strategy may lead to excess returns that will improve the
tactical allocation portfolios.

9
PNC STAR

References
Asness, Clifford S., Tobias J. Moskowitz, and Lasse H. Pedersen, “Value and
Momentum Everywhere.” The Journal of Finance 68, no. 3 (2013): 929-985.
Bhojraj, Sanjeev, and Bhaskaran Swaminathan, “Macromomentum: Returns
Predictability in International Equity Indices.” The Journal of Business
79, no. 1 (2006): 429–451.
Carhart, M. Mark, “On Persistence in Mutual Fund Performance.” The Journal
of Finance 52, no.1 (1997): 57-82.
Chen, Linda H., George J. Jiang, and Kevin X. Zhu, “Momentum Strategies for
Style and Sector Indexes.” The Journal of Investment Strategies 1, no. 3
(2012): 67-89.
Grinblatt, Mark and Tobias J. Moskowitz, “Predicting Stock Price Movements
from Past Returns: The Role of Consistency and Tax-Loss Selling.” Journal of
Financial Economics 71, no. 3 (2004): 541-579.
Hancock, Tom, “Momentum—A Contrarian Case for Following the Herd.”
GMO white paper (2010).
Hurst, Brian, Yao Hua Ooi, and Lasse H. Pedersen, “A Century of Evidence on
Trend-Following Investing.” AQR Capital Management, working paper (2012).
Jegadeesh, Narasimhan, and Sheridan Titman, “Returns to Buying Winners
and Selling Losers: Implications for Stock Market Efficiency.” The Journal of
Finance 48, no. 1 (1993): 65-91.
Moskowitz, Tobias J., and Mark Grinblatt, “Do Industries Explain
Momentum?” The Journal of Finance 54, no. 4 (1999): 1249-1290.
Moskowitz, Tobias J., Yao Hua Ooi, and Lasse H. Pedersen, “Time Series
Momentum.” Journal of Financial Economics 104, no. 2 (2012): 228-250.
Rouwenhorst, K. Geert, “International Momentum Strategies.” The Journal of
Finance 53, no.1 (1998): 267-284.
Wilson, Scott M., “Are Momentum Strategies Still Profitable For U.S. Equity?”
University of Texas, working paper (2010).

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