NAAIM Exposure Index (Backtest Trading Strategy)

Last Updated on July 17, 2022 by Oddmund Groette

The NAAIM Exposure Index is becoming a popular indicator for tracking investor sentiment. But what is it about?

Compiled by the National Association of Active Investment Managers (NAAIM), the NAAIM Exposure Index represents the average exposure to US Equity markets reported by its members. The indicator line is a two-week moving average of the NAAIM managers’ responses. Our backtests indicate there are better indicators for contrarian trading strategies.

After we explain the NAIIM Exposure Index, we make some backtests to see how it performs as a contrarian trading indicator.

What is the NAAIM Exposure Index?

The National Association of Active Investment Managers (NAAIM) is an association of companies that specializes in the management of active funds in the United States. It surveys its members weekly concerning their firms’ overall equity exposure as of each Wednesday, and this is used to compute the NAAIM Exposure Index.

Thus, the NAAIM Exposure Index is an indicator that shows the average exposure to US Equity markets reported by members. The indicator line depicts a two-week moving average of the NAAIM managers’ responses.

Responses can vary widely. Here is a range of the responses:

  • 200% Leveraged Short
  • 100% Fully Short
  • 0% (100% Cash or Hedged to Market Neutral)
  • 100% Fully Invested
  • 200% Leveraged Long

The responses are then tallied and averaged to provide the average long (or short) position of all NAAIM managers, as a group. See the table below:

NAAIM Exposure Index

Source: NAAIM.ORG

From the table above, you can see that for the week that ended on May 25, 2022, the NAAIM Exposure Index number was 33.19, while the preceding quarter’s average was 57.97.

What does the NAAIIM measure and capture?

The NAAIM Exposure Index is used to estimate investors’ sentiment in the U.S. stock market. Generally, high readings imply that investors (as represented by active investment managers) are quite bullish, and low readings suggest that investors are bearish. Thus, it might work as a contrarian indicator.

Even though these investment managers are professionals, they are still subject to crowd-like behavior and prone to trading biases. So, extreme bullishness could be a sign of a market top, while extreme bearishness could be a sign of a market bottom. Please see our backtest below for results.

What does the NAAIIM measure and capture?

The green line shows the close of the S&P 500 Total Return Index on the survey date. The blue line depicts a two-week moving average of the NAAIM managers’ responses.

However, you should note that the NAAIM Exposure Index is not predictive in nature and is of little value in attempting to determine what the stock market will do in the future.

Primarily, the goal of most active managers is to manage the risk/reward relationship of the stock market and to stay in tune with what the market is doing at any given time. So, the NAAIM Exposure Index only provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks.

What is meant by investor sentiment?

Investor sentiment refers to the general mood of investors regarding a given market. Analysts usually gauge investor sentiment by reviewing the trading activity and direction of prices within a particular market. For instance, rising prices might indicate positive investor sentiment.

But sometimes, analysts use the activities and overall position of fund managers to gauge the sentiment in the market. This is where the NAAIM Exposure Index comes in.

NAAIM Exposure Index backtest – trading strategy

We downloaded the data from NAAIM’s website and performed several backtests, both with different variables and lengths.

Our conclusion is that it’s very hard to find anything that is worthwhile, and there are many more contrarian indicators that are better, for example, the VIX indicator that has given us a few good VIX trading strategies.

The NAAIM backtest

In our backtest we make the following rules in plain English (actually it’s two backtests):

  1. Make a 10-week moving average of the NAAIM index.
  2. If the last weekly NAAIM reading is below the 10-week average, stay long S&P 500 the following week. Sell when reading ends up above its average.
  3. If the last weekly NAAIM reading is above the 10-week average, stay long S&P 500 the following week. Sell when reading ends up below its average.

If we invest 10 000 in July 2006 and reinvest the proceeds up until today, we get the following two equity curves:

10 000 invested in S&P 500 and compounded. The blue line is when the NAAIM weekly close is below the 10-week average. The red line is when the close is above the weekly average.

The blue line in the chart above is being invested when the weekly reading of the NAAIM is below its 10-week moving average. As you can see, the returns are better when readings are low compared to “high” (above its average). The CAGR is 4.4% and 2.5% excluding dividends.

We backtested many different numbers of weeks in the moving average, but the results didn’t differ that much. Moreover, extreme readings were not particularly helpful either.

NAAIM Exposure Index – summary

The NAAIM Exposure Index, which measures the average exposure to US Equity markets reported by its members, is published weekly and is often used as a contrarian indicator. Visual overlays and graphs are often used as arguments for why the stock market should go up or down.

However, our backtests reveal that the NAAIM index is not the best contrarian or sentiment indicator (?). The potential NAAIM trading strategies we backtested showed rather poor performance.

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