New Technical Leaders Indexes

March 31, 2011

The Technical Leaders Indexes are indexes created by Dorsey Wright Money Management and are constituted with high relative strength securities from a given universe.  We currently run three indexes:  Domestic mid to large cap equity, Foreign Developed Markets Equity, and Emerging Markets Equity.  These three indexes are licensed by PowerShares and can be purchased in an ETF format (Tickers: PDP, PIZ, PIE).

We are expanding the number of indexes we create.  We are adding two more indexes to the Technical Leaders family.  (Please note that these indexes are not licensed by any ETF sponsor so there is no vehicle to purchase them directly.)

One of the new Technical Leaders indexes will cover the Domestic Small Cap space.  All of our other indexes are constituted with 100 securities, but the Small Cap Technical Leaders Index will have 200.  This will still allow us to select the top decile from a small cap index like the Russell 2000, while keeping liquidity constraints in mind.  To see a list of the current constituents you can click here:

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The second index we are beginning to publish tracks 100 high RS securities traded on the NASDAQ exchange.  As you can imagine, the selection process will pull out a lot of emerging growth companies so we think this index will be very interesting to follow.  For a list of the current constituents you can click here:

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Over the next couple of days I’ll post some more information about what is in the indexes.  If you have any questions feel free to post them in the comments section and I’ll try to respond to them.

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Investors Behaving Badly

March 31, 2011

Another reminder to stay the course comes from the article at Yahoo! Finance.  It mentions a study of mutual fund returns and flows performed at Baird:

Baird looked at top-performing funds, a group that had outdone the benchmarks during the past 10 years while recording less volatility.  Of the top funds, 85% had at least one three-year period when they lagged the benchmark…

It’s always good to be reminded that even the top funds go through periods when they struggle, but what tends to compound the problem is investor behavior.

Baird concluded that to succeed over the long term, investors must patiently hold funds through good times and bad. But all too often shareholders follow a self-defeating pattern. The investors buy after a fund has recorded a hot streak. When the inevitable slump occurs, the shareholders lose patience and sell at the wrong time. Consider Yacktman, which returned 12.5% annually during the past 10 years, outdoing 99% of large value peers.

Portfolio manager Donald Yacktman buys undervalued stocks with strong balance sheets and rich cash flows. During the market downturn that began in 2000, Yacktman excelled. But with stocks rallying in 2004, he slipped into the bottom quarter of the standings and stayed there for three consecutive years. Figuring that the manager had lost his touch, angry shareholders dumped the fund. Assets in the portfolio dropped from $441 million in 2005 to $293 million in 2007.

Never wavering from his style, Yacktman roared back. The fund outdid 98% of competitors in 2008 and 99% in 2009. Since then, investors have been pouring into the fund, which now has $4.2 billion in assets.

This is a very typical issue.  After a year or two of subpar performance, investors often assume that a manager’s process is broken.  Usually it is not.  I put the key takeaway in bold: you must be patient to get outstanding results, even with excellent managers.  A recent presentation I made on Ten Ways to Radically Improve Your Investment Results at a Broker Institute in Richmond counted down factors that in my estimation had the most impact on investment results.  #1 was patience. 

Patience is easy when things are going well.  Patience is difficult when results are temporarily poor.  Here’s a radical suggestion that may end up being very profitable: when you are considering dumping a strategy, turn the tables and add money instead.  You’ll probably be adding somewhere near the low–exactly when investor patience is frayed–and you may have a chance of capturing both the inherent returns in the strategy and the extra bounce from a rebound.

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“Dangerous Game of Probability Chicken”

March 31, 2011

We’re all aware that the US stock market has gone through numerous bear markets and has rebounded in each case.  In fact, from 1802-2010 U.S. stocks generated a 7.9% annual return despite periodic set-backs (Research Affiliates, 2011.)  What probably doesn’t get enough attention is a point that Rob Arnott makes in his March 2011 Newsletter:

The United States and its equity markets enjoyed good fortune. It was not invaded and occupied by a foreign power. It did not suffer a government overthrow… just ask Russian investors their return on capital after the Bolshevik Revolution! As Ben Graham might caution, beware the difference between the loss on capital (a drop in price, from which we can recover) and a loss of capital (100% loss, from which we cannot). Russia’s stock market wasn’t alone in the 20th century as three additional top 15 markets in 1900—Egypt, Argentina, and China—suffered a 100% loss of capital while Germany (twice) and Japan (once) came very close.

One of the points that Harold, John, and I discussed on our recent podcast on “Under-appreciated Risks” was the risk of having too narrow of an investment universe.  Arnott makes much the same point by stating the following:

Concentrating the majority of one’s investment portfolio in one investment category, based on an unknowable and fickle long-term equity premium, is a dangerous game of “probability chicken.”

The ability to adapt and seek out the strongest trends, regardless of their geographical location or asset class, is the primary reason that I believe that our Global Macro portfolio makes so much sense to be used as a core piece of a client’s portfolio.  Click here to access a 14-minute video presentation on this global tactical asset allocation strategy (financial professional only).

To receive the brochure for our Global Macro strategy, click here.  For information about the Arrow DWA Tactical Fund (DWTFX), click here.

Click here and here for disclosures.  Past performance is no guarantee of future returns.

 

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Fund Flows

March 31, 2011

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs).  Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders.  Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

Taxable bond funds again pulled in the most new money last week, bringing its YTD total to $37 billion.  Hybrid and foreign equity funds had another week of steady inflows.  Municipal bonds continue to bleed.  And the aversion to domestic equity funds continued last week with $2.5 billion in redemptions.

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Podcast 13 Under-appreciated Risks

March 30, 2011

Podcast 13 Under-appreciated Risks

Harold Parker, John Lewis, Andy Hyer

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The Changing Size of World Stock Markets

March 30, 2011

The following figures from the Credit Suisse Global Investment Returns Yearbook 2011 will be nice additions to your “Yes, the markets really are fluid” file.  Empires, countries, asset classes, and companies are always in a state of flux.  The enduring principle that money always goes where it is treated best means that investors must remain nimble.

What will this chart look like in 10, 20, or 50 years?  We don’t know, but we think relative strength is ideally suited to provide the framework to effectively adapt to the inevitable changes.

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Drawdowns: Equities vs. Bonds

March 30, 2011

It is no wonder that bond investors have felt pretty good about the last three decades.  From the start of 1980 to the end of 2010, the annualized real (inflation adjusted) return on government bonds was 6.0% in the USA, broadly matching the 6.3% long-term performance of equities (Credit Suisse Global Investment Returns Yearbook 2011.)  Bond investors have almost forgotten that over the preceding 80 years, US government bonds had provided an annualized real return of only 0.2%.  “Well, at least bonds don’t have equity-like drawdowns” some investors might say.  They would be correct — they’re worse!

From Credit Suisse:

A crucial question is how deep portfolio drawdowns can be, and how long it takes to recover from them.  To answer this question, we compute the cumulative percentage decline in real value from an index high to successive subsequent dates.  This indicates just how bad an investor’s experience might have been if the investor had the misfortune to buy at the top of a bull market.  As we shall see, although equities have provided a higher return than bonds, they can experience deeper drawdowns — yet there have also been long intervals of deep bond drawdowns.  All returns include reinvested dividends and, unless stated to the contrary, are in real (inflation adjusted) terms.

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How well do bonds protect an investor’s wealth?  Figure 2, shown above, plots the corresponding drawdowns for government bonds (red) and equities (blue).  Historically, bond market drawdowns have been larger and/or longer than for equities!

In the US bond market, there were two major bear periods.  Following a peak in August 1915, there was an initially slow, and then accelerating, decline in real bond values until June 1920 by which date the real bond value had declined by 51%; bonds remained underwater in real terms until August 1927.  That episode was dwarfed by the next bear market, which started from a peak on December 1940, followed by a decline in real value of 67%; the recovery took from September 1981 to September 1991.  The US bond market’s drawdown, in real terms, lasted for over 50 years.

Given the massive flows into fixed income and out of equities over the last couple of years, this information is completely off investor’s radars.

HT: World Beta

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Momentum and Value Chronicles

March 30, 2011

Cliff Asness of AQR Capital has a new white paper out, Momentum in Japan: The Exception that Proves the Rule, that is well worth the read.  He convincingly makes the case “that because value and momentum strategies are strongly negatively correlated, they need to be studied as a system.” See the table below for value and momentum correlations around the world over the past 30 years.

As is detailed in the paper, both value and momentum strategies have been able to generate excess return all over the world.  Even in Japan, where the returns to momentum strategies have not been nearly as large as they have been in the rest of the world, the benefits of combining value and momentum remain robust.

Those advisors who are seeking to construct asset allocations that are likely to provide excellent risk-adjusted returns over time should be all over this concept of mixing value and momentum.

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Top ADR Performers Over Trailing 12 Months

March 30, 2011

Although U.S. investors often focus on U.S.-based companies because of greater familiarity, I suspect that many would be interested in learning more about international companies that trade on U.S. exchanges in the form of American Depository Receipts (ADRs).  The top ten performing ADRs over the past 12 months, out of our universe, are shown in the table below.  As of 3/29/11.

To learn more about Dorsey Wright’s Systematic Relative Strength International portfolio, click here.

Dorsey Wright’s ADR universe is a sub-set of the entire universe of ADRs.  Dorsey Wright currently owns AMRN, GENT, and SPRD.  A list of all holdings for this portfolio over the past 12 months is available upon request.

 

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High RS Diffusion Index

March 30, 2011

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 3/29/11.

The 10-day moving average of this indicator is 73% and the one-day reading is 87%.  This index briefly dropped to a recent one-day low of 46% on March 16, but has since shot higher.  The vast majority of high relative strength stocks continue to trend higher.

 

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DWTFX: Best of Class

March 29, 2011

As we approach the end of Q1, The Arrow DWA Tactical Fund (DWTFX) is ouptperforming 99% of its peers YTD:

Source: Morningstar. As of 3/28/11.

Holdings (delayed) are shown below:

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Please see www.arrowfunds.com for more information.

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What’s Hot…and Not

March 29, 2011

How different investments have done over the past 12 months, 6 months, and month.

1PowerShares DB Gold, 2iShares MSCI Emerging Markets ETF, 3iShares DJ U.S. Real Estate Index, 4iShares S&P Europe 350 Index, 5Green Haven Continuous Commodity Index, 6iBoxx High Yield Corporate Bond Fund, 7JP Morgan Emerging Markets Bond Fund, 8PowerShares DB US Dollar Index, 9iBoxx Investment Grade Corporate Bond Fund, 10PowerShares DB Oil, 11iShares Barclays 20+ Year Treasury Bond

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Weekly RS Recap

March 28, 2011

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return. Those at the top of the ranks are those stocks which have the best intermediate-term relative strength. Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (3/21/11 – 3/25/11) is as follows:

Last week was excellent for high relative strength stocks — the top quartile outperformed the universe by 1.58%.

 

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Dorsey, Wright Client Sentiment Survey – 3/25/11

March 25, 2011

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll.  We’re also featuring a Dorsey, Wright Polo Shirt Giveaway Contest for the next few months.Participate to learn more.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions!  Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients.  It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good!  It’s painless, we promise.

 

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Sector and Capitalization Performance

March 25, 2011

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 3/24 /2011.

 

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Rational Optimism

March 25, 2011

This New York Times book review of Matt Ridley’s book The Rational Optimist takes exactly the right tone when discussing why optimism never sounds as intellectually compelling as the gloom-and-doom scenario:

…after surveying predictions from the mid-19th century until today, the historian Arthur Herman identifies two consistently dominant schools of thought.

The first school despairs because it foresees inevitable ruin. The second school is hopeful — but only because these intellectuals foresee ruin, too, and can hardly wait for the decadent modern world to be replaced by one more to their liking. Every now and then, someone comes along to note that society has failed to collapse and might go on prospering, but the notion is promptly dismissed in academia as happy talk from a simpleton.

Kind of funny, but true.  Apparently the end of the world is plausible enough that every generation has a cult that gives away all of their worldly possessions and waits for the apocalypse.  The willingness to contemplate disaster may also explain why investors are so flinchy and willingly pitch their long-term positions during a 3% pullback in the market.  Investor panic seems to be an enduring feature of the marketplace.

Maybe Armageddon will happen someday, but historically it has been a poor bet.  From an investor’s point of view, it is probably better to go with the happy talk from the simpletons.

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Fund Flows

March 24, 2011

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs).  Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders.  Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

Taxable bond funds continued to attract the most new money last week (again!) and have had inflows of over $30 billion for the year.

 

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Buying The Dips

March 22, 2011

Retail investors and hedge funds have taken opposing views on the most recent stock market correction.  Clusterstock has a short post on what Global Macro hedge funds did during the dip (click here for the original post).  The graph below (taken from the original Clusterstock post) was produced by BofA ML and shows net exposure to the S&P 500 Index for Global Macro Hedge Funds.

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You can see spike up in long exposure to equities over the last month.  Our own sentiment survey (the full results of the most recent survey can be seen here), and the most recent AAII survey both show retail investors have become more bearish over the last month.  These two surveys don’t measure actual exposure like the BofA survey does, but I think it is safe to assume that retail investors are not increasing equity exposure while they are becoming more bearish on stocks.

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In our survey we ask financial professionals whether their clients are becoming more fearful.  As equities rallied, their clients became less worried about a downturn.  But as the S&P 500 corrected over the last month their clients became more worried about getting caught in a downdraft.

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The AAII poll asks individual investors directly whether they are bullish or bearish.  This chart was taken from Bespoke and clearly shows individual investors became more bearish very quickly during the decline.

Only time will tell which group is correct.  However, I think it is a positive sign for equity markets that there are large pools of money ready to move into stocks during very small corrections.  It is also a positive sign that not everyone is buying the dips!  When everyone is excited to buy dips you are often closer to a top than a bottom.

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High RS Diffusion Index

March 22, 2011

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 3/21/11.

This index has spent the last six months above 50 percent, but has dipped back to the middle of the distribution.  The 10-day moving average of this indicator is 65% and the one-day reading is 77%.  Dips in this indicator have often provided good opportunities to add to relative strength strategies.

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Dorsey, Wright Client Sentiment Survey Results – 3/11/11

March 21, 2011

Our latest sentiment survey was open from 3/11/11 to 3/18/11.  The Dorsey, Wright Polo Shirt raffle continues to drive advisor participation — thank you for taking the time! Please remember, the first drawing will be held on June 1, so keep playing to increase your odds of winning.  We hit a new all-time high of participation, with 206 advisors chiming in.  If you believe, as we do, that markets are driven by supply and demand, client behavior is important.  We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients.  Then we’re aggregating responses exclusively for our readership.  Your privacy will not be compromised in any way.

After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample.  Most of the responses were from the U.S., but we also had multiple advisors respond from at least five other countries.  Let’s get down to an analysis of the data!  Note: You can click on any of the charts to enlarge them.

Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?

Chart 1: Greatest Fear.  From survey to survey, the S&P 500 fell by around -1.1%.  That was enough to send fear levels much higher, from 79% last round to 86% this round.  In the last two surveys, we’ve had total losses of -1.8%, yet we’ve seen fear levels move from 66% to 86%.  Classic!

On the flip side, the fear of missed opportunity group went from 21% to 14%.  It’s amazing how much a 2% market pullback can affect client sentiment.  And no, we’re not forgetting about the tsunami, the possible nuclear meltdown, the Arab revolts, or any other harbingers of the apocalypse.  That’s one of the great things about this survey — we are only using price points from one day per every two  weeks, so a lot of the “noise” gets cancelled out.

Chart 2. Greatest Fear Spread.  Another way to look at this data is to examine the spread between the two groups.  The spread continued to move higher, up to 73% from 57%.

Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?

Chart 3: Average Risk Appetite.  Average risk appetite finally succumbed to the pressures of the pullback, as average risk moved from 2.98 to 2.85.  Average risk appetite seems to be holding up much better than the overall fear numbers, given the relatively small move downward (compared to the huge jump in fear levels).

Chart 4: Risk Appetite Bell Curve.  This chart uses a bell curve to break out the percentage of respondents at each risk appetite level.  The most common risk appetite was 3 this round (again!), with just under half of all respondents.

Chart 5: Risk Appetite Bell Curve by Group.  The next three charts use cross-sectional data.  This chart plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups.  This chart sorts out as exactly as we would expect.  The fear group is looking for less risk than the missed opportunity group.  Also, note the relatively high percentage of 5’s in the upturn group.

Chart 6: Average Risk Appetite by Group.

The fear of missed opportunity group’s risk appetite continued to rise, even in the face of two consecutive down readings in the market.  On the other side, we see the fear of losing money lower their average risk appetite, in line with the market.

The upturn group is sticking to their guns, wanting to add risk despite a falling market.

Chart 7: Risk Appetite Spread.  This is a spread chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group.  The spread is one of the less volatile indicators found in the survey, and continues to rise with the market.

This round we saw a continuation of the S&P 500 pullback, with losses nearing a full -2%.  Unsurprisingly, more clients became afraid of losing money in the market, despite a relatively small market correction. Here’s the bottom line for this survey: the S&P 500 is up around 93% since its March ’09 lows, yet a -2% pullback is enough to get 86% of clients scared of losing money! Does that make sense?

No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride.  A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments.  Until next time, good trading and thank you for participating

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Economists Are Never Wrong

March 21, 2011

From the people who brought you Modern Portfolio Theory, an update via Paul Kedrosky on Bloomberg:

Two years ago I was at the Milken Global Conference in Los Angeles when Mike Milken, during an on-stage panel with Nobel-winning economists, asked the assembled augusts what they had been wrong about. The world had come unglued, economists were flailing, and it was clear that their models were wrong: Mike wanted to know what they had learned about themselves and their theories that had guided so many countries to the current disaster.

Their answer: Nothing. Well, not quite nothing, but close enough. No one would admit to having been shown wrong about anything. Instead, they mostly argued that if people had paid more attention to them — like literally, each of them individually — the credit crisis might not have happened. But what were they actually, you know, shown wrong about? Nothing. Nada.

It was a remarkable concession. Then again, I suppose it’s unsurprising from a discipline whose theorizing has long shown itself to be impregnable to assaults from data, the real world, or any other such irritating intrusions.

Are you really surprised?  I guess it doesn’t matter if you specialize in macroeconomics or finance—no one wants to be confused with the facts.  Fifty years after Markowitz, we’ve shown very little creativity in developing new theories about how financial markets work or how to think about portfolio construction.  Instead, we have ever more complicated versions of the original theories, painstakingly adjusted for all of the “anomalies.”  Finance theorists do not seem to notice that the anomalies now outnumber the things that appear to work.

Maybe investors should spend more time watching how the markets actually behave, instead of worrying about what some theory predicts will happen.

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Anne Hathaway

March 21, 2011

…is not the wife of Berkshire Hathaway.  But news about her may be affecting the price of Berkshire Hathaway stock!  The Atlantic explains how:

A couple weeks ago, Huffington Post blogger Dan Mirvish noted a funny trend: when Anne Hathaway was in the news, Warren Buffett’s Berkshire Hathaway’s shares went up. He pointed to six dates going back to 2008 to show the correlation. Mirvish then suggested a mechanism to explain the trend: “automated, robotic trading programming are picking up the same chatter on the Internet about ‘Hathaway’ as the IMDb’s StarMeter, and they’re applying it to the stock market.”

The idea seems ridiculous. But the more I thought about the strange behavior of algorithmic trading systems and the news that Twitter sentiment analysis could be used by stock market analysts and the fact that many computer programs are simply looking for tradeable correlations, I really started to wonder if Mirvish’s theory was plausible.

I called up John Bates, a former Cambridge computer scientist whose company Progress Software works with hedge funds and others to help them find new algorithmic strategies. I asked, “Is this at all possible?” And I was surprised that he answered, roughly, “Maybe?”

One more thing for Warren Buffett to worry about!

Source: The Atlantic

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Attention Asset Allocators

March 18, 2011

For this commentary on asset allocation I’ll start with the widely understood justification for asset allocation and then move on to a less well-known concept that has some important implications for those using relative strength strategies.

A fundamental justification for asset allocation is the notion that different asset classes offer returns that are not perfectly correlated, hence diversification reduces the overall risk in terms of the variability of returns for a given level of expected return.  Therefore, having a mixture of asset classes is more likely to meet the investor’s wishes in terms of the amount of volatility and possible returns.  Asset classes such as stocks, bonds, real estate, commodities, and currencies are typically employed to construct an asset allocation.

However, many financial advisors stop there.  Many think of US stocks as one asset class, bonds as one asset class, real estate as one asset class and so on.  Such thinking leaves a lot on the table. What if US stocks can be broken down into several viable asset classes?  Does this not have the potential to further improve the benefits of asset allocation?  For example, this must-read white paper by AQR Capital makes it clear that value and relative strength are two complementary strategies.  Remember that both strategies profiled in that white paper select securities from the same universe of U.S. stocks.

Anyone who goes to our website sees the following:

High relative strength stocks have historically provided high returns, but they often do not correlate very well with the broad market.  For that reason, high relative strength stocks frequently appear to act like a separate asset class.  From an asset allocation perspective, there is significant value in a high-return asset class that is uncorrelated with most other stocks and bonds.  Non-correlated performance can help smooth out the returns in a diversified portfolio.

To demonstrate this point, consider the R-squared of our Systematic Relative Strength Aggressive portfolio (which invests in U.S. stocks) to the S&P 500.

Remember that the R-squared statistic gives the variation in one variable explained by another.  It is computed by squaring the correlation coefficient between the dependent variable and independent variable (S&P 500 in this case).  As shown in the table, 60% of the variation in our Systematic RS Aggressive portfolio can be attributed to the S&P 500 (therefore, 40% of it is not). This means that even though we are fishing from the same pond (although this portfolio can also invest in mid-cap US stocks) the variation of the performance is quite different from that of the S&P 500.  In fact, this portfolio has a lower R-squared to the S&P 500 than the Russell 2000 (small cap US stocks), MSCI EAFE (developed international stocks), MSCI Emerging Markets, and the Dow Jones Real Estate Index!  This is not a typical result—where the S&P 500 is more correlated to foreign markets than it is to another portfolio composed entirely of domestic securities!  A more typical result may be found when looking at the five most popular equity funds, where their R-squared averages 0.96, according to Morningstar.

How can this happen?  Well, relative strength identifies those securities that have strong intermediate-term relative strength out of a universe of securities.  Often, those securities with the best relative strength are not the stocks that have the biggest influence on the movement of the S&P 500.

All financial advisors are in the asset allocation business.  Some do it well.  Some do it poorly.  I would suggest that including relative strength strategies in your asset allocations has the potential to be very helpful from a performance and diversification perspective.

Click here to receive the brochure on our Systematic Relative strength portfolios.  Click here for disclosures.

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Sector and Capitalization Performance

March 18, 2011

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s).  Performance updated through 3/17/2011.

 

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Taming the Savage Beast

March 17, 2011

Civilization is essentially a common set of rules or beliefs that a society holds to be important.  We feel like we are more civilized, for example, when we aren’t busy eating one another.  In that sense, rules are important—they provide a framework for controlling impulses we might otherwise act on.  Nowhere is impulse control more important than in the financial markets, a conclusion buttressed by recent research by Dr. Philip Maymin, soon to appear in the Journal of Wealth Management.

We’ve written on this before.  Don’t Trust Your Instincts was one of our most popular recent articles.  Another article I saw on Trader’s Narrative speaks to the importance of controlling emotions because the cost is staggering:

Not surprisingly, the urge to trade increases with market volatility. But surprisingly it arrives immediately after the volatile period has ended. And that can cost clients dearly in performance: up to 4% a year.

This is the behavior gap that DALBAR finds when they look at investor performance in mutual funds.  It’s also the behavior gap that the BCT study found for investors that were working with advisors.  Trader’s Narrative has a really smart graphic that points directly to the truth: advisors are just as susceptible to emotions as clients.

You may claim that the fault lies in the inability of clients to follow the guidance of advisors. But that doesn’t really explain what’s going on here. Consider, for example, an indicator that tracks the sentiment of financial advisors, the Rydex SGI Advisor Confidence Index:

As you can see, in its relatively short lifespan it exhibits the same tendency to swing from ebullient cheerfulness to despondency that we see in the weekly AAII retail investor’s sentiment metric. If you look closely there may be a few divergences here and there but overall, financial advisors are not really immune to the same emotional forces that buffet their clients.

The first reaction of every advisor is to look at this data and say, “Boy, those other advisors are really dumb!”  But as Pogo said, “We have met the enemy, and he is us.”  We are all susceptible to the same emotions—it all boils down to what rules we have in place to civilize ourselves.

Source: www.lakeworthmedia.com

One of the reasons that a Systematic Relative Strength process is so important to us is that it provides an unemotional framework for action.  A systematic process needs to answer what to buy or sell, when to buy or sell, and how much to buy or sell.  The rules need to be robust and tested over a wide variety of market conditions over an extended period of time.  Very importantly, we believe the rules need to be adaptive, for two reasons: 1) eventually you will face conditions different from any in the past, and 2) if you are not confident in the ability to adapt, you will emotionally short-circuit and circumvent the rules at the worst possible time.  Finally, discipline is essential.  Rules aren’t going to help you much if you can’t or won’t follow them.

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