Systematic Relative Strength

In an article in Smart Money with this title, author Reshma Kapadia advocates “go anywhere” funds as a useful component for investor portfolios. The global asset allocation fund has become much more popular over the past couple of years, possibly for reasons of diversification, flexibility, and performance.

Financial advisers say the flexibility of these go-anywhere funds is even more important at a time when markets are contending with so much uncertainty. “These managers are in the trenches,” says John Eckel, a fee-only planner at Pinnacle Investment Management. “We don’t want to tie their hands.” In the wake of the credit crisis, advisers are reassessing how they diversify assets, increasingly opting to delegate the task to professional money managers, says Loren Fox, senior research analyst at Strategic Insight.

For many of the funds, flexibility seems to be linked to the ability to extract returns from multiple asset classes, particularly when domestic equities have offered such low returns over the last decade.

… global flexible funds, a proxy for managers with the most latitude, have handily outperformed Standard & Poor’s 500 index. These funds returned an average of 4.5 percent a year over the past five years, while the S&P 500 was essentially flat, according to research firm Lipper. The go-anywhere funds lost money during the crash but still held up much better than the broader market, a fact not lost on some planners.

Both of the Arrow Funds managed by Dorsey, Wright (DWTFX and DWAFX) fall into the global allocation category. Another fund mentioned in the article is Blackrock Global Allocation (MDLOX), which has grown to be an enormous $36 billion fund.

Blackrock goes at global allocation from a valuation standpoint, while the Dorsey, Wright managed funds take a relative strength approach. The two methods complement one another unbelievably well. Andy wrote an earlier post, “Global is the New Core,” showing an extraordinary efficient frontier with returns from Blackrock Global Allocation and our Global Macro strategy (separate account and DWTFX). To see this piece of financial pornography, click here. WARNING: ADULT CONTENT-seasoned financial professionals only!

If you are doing portfolio construction or asset allocation, this chart is hotter than Brooklyn Decker in the Sports Illustrated swimsuit issue. Blackrock Global Allocation is an enormous fund and probably some financial advisor out there could spend an entire quarter adding the Arrow DWA Tactical Fund (DWTFX) to all of his or her accounts that owned Blackrock. [ Not that we would advocate such a strategy. ] The broader point is that investors are now open to considering a more flexible, more global approach than at any point in the past.

At the end of the Cultural Revolution in 1976, China’s planned economy was in ruins and its people barely surviving. Oh, how things have changed for the Chinese economy since reformer Deng Xiaoping initiated free market reforms beginning in 1978. China has developed from an economically desolate and ideologically driven country into an industrial powerhouse. From virtually an industrial backwater in 1978, China is now the world’s biggest producer of concrete, steel, ships, and textiles, as well as the world’s biggest auto market.

During the 1990s, Premier Zhu Rongji started a policy of privatizing money-losing state enterprises. In 1997, the CPC issued a verdict declaring that state-owned companies were now “people-owned companies” who would be subject to mergers and bankruptcy. Thousands of state companies were privatized or partly floated on the stock exchange. In 1978, more than 90% of GDP was produced in state enterprises, which, up to 1992, dominated China’s economy. That figure, not accounting for state assets that were contracted, had fallen to 30% by 2009.

With that context, consider today’s New York Times article “China Drawing High-Tech Research From U.S.” I have copied a few particularly interesting sections from that article below:

For years, many of China’s best and brightest left for the United States, where high-tech industry was more cutting-edge. But Mark R. Pinto is moving in the opposite direction.

Mr. Pinto is the first chief technology officer of a major American tech company to move to China. The company, Applied Materials, is one of Silicon Valley’s most prominent firms. It supplied equipment used to perfect the first computer chips. Today, it is the world’s biggest supplier of the equipment used to make semiconductors, solar panels and flat-panel displays.

In addition to moving Mr. Pinto and his family to Beijing in January, Applied Materials, whose headquarters are in Santa Clara, Calif., has just built its newest and largest research labs here. Last week, it even held its annual shareholders’ meeting in Xi’an.

It is hardly alone. Companies — and their engineers — are being drawn here more and more as China develops a high-tech economy that increasingly competes directly with the United States.

“If you really want to have an impact on this field, this is just such a tremendous laboratory,” he said.

Xi’an — a city about 600 miles southwest of Beijing known for the discovery nearby of 2,200-year-old terra cotta warriors — has 47 universities and other institutions of higher learning, churning out engineers with master’s degrees who can be hired for $730 a month. [my emphasis added]

Locally, the Xi’an city government sold a 75-year land lease to Applied Materials at a deep discount and is reimbursing the company for roughly a quarter of the lab complex’s operating costs for five years, said Gang Zou, the site’s general manager.

When Xie Lina, a 26-year-old Applied Materials engineer here, was asked recently whether China would play a big role in clean energy in the future, she was surprised by the question.

“Most of the graduate students in China are chasing this area,” she said. “Of course, China will lead everything.”

While I highly doubt that China will “lead in everything,” the economic development of China over the past 30 years has been breathtaking.

I don’t know how a U.S. investor today would even consider approaching their investment planning without broadening their personal investment universe to include China and the rest of the world. Perhaps, the biggest deterrent to expanding one’s investment universe beyond U.S. borders is fear of the unknown. Education about the rest of the world will certainly help overcome that hurdle. Furthermore, investors who use global relative strength strategies can take comfort in knowing that the allocations are determined by a very familiar relative strength factor which seeks out the strongest trends, regardless of where in the world they are found.