Morgan Housel recently shared an excellent way to think about one of the biggest challenges facing investors—failure to think outside their own viewpoint:
Statistics genius Nate Silver spoke at a conference in Seattle a few weeks ago. He made a point that stuck with me. Radar technology was in its infancy in the early 1940s. To protect U.S. interests like the Pacific Fleet in Pearl Harbor, Navy planes circled the Hawaiian Islands, searching for threats. “You were just sending a couple of planes that would go around a circumference until they ran out of fuel and then head back to base,” Silver said.
Alas, the Japanese military knew exactly how large that circumference was, and in November, 1941, sent its aircraft carriers just beyond the range our reconnaissance planes could fly. On December 7th, it attacked.
“My point is that everyone has a viewpoint,” Silver said, and that viewpoint usually shows just a fraction of the whole picture. There are important events sitting outside your viewpoint that, if you knew about them, would totally change how you view the world.
There’s a similar problem with investors and history. Your view of history is heavily influenced by your own experiences. But just like the Navy, your own experiences are an incomplete view of the world, arbitrarily blocked by when and where you were born — the equivalent of reconnaissance planes with limited fuel range. There are important events sitting outside your viewpoint that, if you experienced them, would totally change how you view the world.
This has important implications for how to design an asset allocation. If one looks at too narrow a slice of history when determining the exposure constraints for different asset classes an investor could easily optimize those constraints to fit just that last 20 or 30 years. Depending on what 20 or 30 year period you look at you may wish you had more exposure to U.S. equities, International equities, Inverse Equities, Currencies, Commodities, Real Estate, or Fixed Income. Since none of us have a crystal ball to know which asset classes will be most rewarding over the next 20-30 years, it makes sense to maintain flexibility. This is precisely the reason that we have given ourselves so much flexibility in The Arrow DWA Tactical Fund (DWTFX), which we sub-advise.
The Arrow DWA Tactical Fund (DWTFX) invests in various asset classes and market segments exhibiting positive relative strength. In essence, the model works by reallocating to various market segments in response to the changing patterns of returns available in the global markets. The table below shows the Fund’s potential allocation ranges.
Source: Arrow Funds
Investors may greatly benefit by not painting themselves into a corner when it comes to asset allocation.
A relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. See www.arrowfunds.com for a prospectus for DWTFX.
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