Elastic Asset Allocation — Defensive (EAA-DEF)
Developed by Keller & Butler · Generalized Momentum · Med Risk
The defensive variant of Elastic Asset Allocation applies a more conservative parameterization to the same elasticity framework introduced in Keller and Butler's 2014 SSRN paper (#2543979). Where the offensive variant squares the return component to amplify momentum differentiation, EAA-DEF uses the square root of the return-correlation product, dampening the impact of extreme momentum scores and producing more balanced, less concentrated allocations. This mathematical adjustment shifts the strategy's risk-return profile toward lower volatility and reduced drawdowns at the cost of lower peak returns.
The square root transformation compresses the scoring spread between high and low-momentum assets. An asset with twice the momentum of another receives substantially less than twice the score in the defensive variant, compared to four times the score in the offensive variant (due to squaring). This compression produces portfolio weights that are more evenly distributed among qualifying assets, reducing the impact of any single position on the overall portfolio's performance. The result is a smoother equity curve with fewer large drawdowns — a profile better suited to risk-averse investors or those using the strategy as a core portfolio allocation.
Like its offensive counterpart, EAA-DEF applies the elasticity concept across the same seven-asset universe: US equities, international developed and emerging markets, commodities, real estate, aggregate bonds, and short-term Treasuries. The correlation adjustment and breadth-based absolute momentum filter operate identically. The only difference is the mathematical treatment of the return component in the scoring formula — a single parameter change that meaningfully alters the portfolio's behavior.
The philosophical distinction between the two variants reflects a broader tension in systematic investing: between conviction and diversification. The offensive variant expresses strong views — heavily weighting the strongest trend — while accepting the concentrated risk that comes with conviction. The defensive variant expresses moderate views — distributing weight more evenly among qualifying assets — while accepting that it will underperform the offensive variant during strong trending markets. Neither is objectively superior; they serve different investment objectives and risk tolerances.
How It Works
The Dampened Elasticity Score
Each asset is scored monthly using the formula: z = sqrt((1 - Corr) × R), where R represents trailing return and Corr represents average pairwise correlation with other universe members. The square root function compresses the range of scores relative to the offensive variant's squaring function, producing rankings where the gap between the highest and lowest scoring assets is substantially narrower.
This compression has a direct impact on portfolio construction. When the highest-scoring asset has a score only modestly above the second-highest — rather than dramatically above it, as in the offensive variant — the resulting score-proportional weights are more evenly distributed. The portfolio naturally holds more balanced positions, reducing the impact of any single asset's performance on total returns.
Score-Proportional Weighting
Capital is allocated in proportion to each qualifying asset's dampened elasticity score, the same proportional weighting mechanism used in the offensive variant. However, because the score compression produces a narrower range of scores, the resulting portfolio weights are inherently more diversified. In practice, the defensive variant rarely allocates more than thirty percent to any single position, while the offensive variant can concentrate forty to fifty percent in a single dominant trend.
This built-in diversification acts as an implicit risk management layer. Even when the momentum ranking is incorrect for one or two positions, the distributed weights limit the portfolio impact. The offensive variant, by contrast, amplifies ranking accuracy in both directions — significantly rewarding correct calls but also significantly penalizing incorrect ones through its concentrated positioning.
Identical Protection Framework
The absolute momentum filter, breadth-based defensive scaling, and defensive asset selection operate identically to the offensive variant. Assets with negative 13612U composite momentum are excluded from the ranking, and their absence increases the proportion of the portfolio allocated to intermediate bonds (IEF). The only difference between the variants is how qualifying assets are scored and weighted — the risk management infrastructure is shared.
This shared protection framework means both variants respond identically to the same danger signals — the same assets lose eligibility at the same time, and the same proportion shifts to bonds at each level of breadth deterioration. The difference in behavior between the variants emerges entirely during risk-on periods, when the offensive variant concentrates more aggressively in the strongest trends while the defensive variant distributes more evenly across the qualifying set.
Explore Elastic Asset Allocation — Defensive (EAA-DEF)
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