As we approach the 12-year anniversary of the launch of our family of Systematic Relative Strength Portfolios, we check in with Senior Portfolio Manager, John Lewis, CMT for an update.
Q: How much of your own personal net worth have you invested in the Systematic Relative Strength Portfolios?
A: The majority of my personal net worth is invested in the same strategies we run for our clients. I do have some other investments where DWA investment strategies are not available, such as my 401k, but for the most part we believe in eating our own cooking.
Q: What do you think is the single biggest benefit to a person who commits money to one of our Systematic Relative Strength Portfolios?
A: The discipline in which the strategies are implemented is a huge part of what makes the SRS series so special. Day in and day out we are using the same models to harness the power of the momentum factor. The momentum factor isn’t always in favor, but the process is designed to just cut through the noise and keep tilting the portfolio that way so when momentum is in favor we are there to capture it. These also tend to be concentrated portfolios so the disciplined sell process we use is very important. We take high conviction positions and if you don’t manage those properly the entire portfolio can quickly get away from you.
Q: What are you most proud of as you look back at the past 12 years of running these portfolios?
A: The performance of the strategies has been very solid over a time period that hasn’t always been the best for the momentum factor. But more importantly, we are very proud of the fact that the original design of the strategies has been robust enough to handle a number of wildly different markets we have had over the last 12 years. We shy away from constant tweaking of our models. That is something we feel is actually detrimental to performance because you are constantly fighting the last battle. Doing so much research up front has given us tremendous confidence in the strategies going forward, and being able to stick with them through all types of conditions has been one of the big reasons for their success over the years.
Q: The Aggressive portfolio has come on very strong in the last couple of years. What do you think is going on with that strategy?
A: The aggressive strategy is designed to be a more aggressive application of the momentum factor. We are taking the highest rated stocks in our rankings and kicking them out quickly if the fail to perform. When the momentum factor is performing well, the aggressive strategy tends to outperform the other strategies. We have had a good environment for the quick rotation over the last year or so. That isn’t always the case. Also, since the aggressive strategy is very concentrated (20-25 positions) stock picking can play a larger role than in some of our index based strategies. We have had some very good performance out of a few of our holdings over the last year, and that has really been a key driver of performance.
Q: Why does the Core portfolio tend to have a little lower volatility and a little lower turnover than some of our other portfolios?
A: The Core strategy is also a concentrated strategy (20-25 names), but we don’t kick stocks out as fast as they fall in our ranks. This allows the portfolio to be more diversified over time, and it also allows for positions to recover in choppy markets where they might get sold our of the Aggressive strategy. When the momentum factor isn’t in favor the Core strategy tends to perform better than the Aggressive strategy. That is what we say over a 3 to 5 year period that ended about a year or so ago. The market (in terms of momentum stocks) was rather choppy, and the Core strategy was able to weather that better than a strategy like Aggressive that rotates more rapidly.
Q: The Growth portfolio has a unique capacity to raise cash in certain types of markets. Describe what can cause that portfolio to raise cash?
A: The Growth strategy will raise cash in bear markets. We have a market filter that moves the portfolio from a fully invested mode to a sell and don’t replace mode. We don’t automatically sell positions when the market filter turns negative. There are a lot of times when the market filter has a negative reading and out holdings continue to perform just fine. In that case we won’t sell anything. If we do need to sell something we wait until it breaks trend or drops to our sell level. So the cash tends to build slowly as the market drops. It is designed to be like an insurance policy. We would rather not use the insurance, but it is comforting for investors in the Growth strategy to know it is there. We use the same market filter to get back in to the market. If we raise cash and the market reverses we just go through our disciplined buy process and bring the portfolio back to a fully invested stance. This actually happens more often than the portfolio getting to very high cash levels. In strongly trending up markets raising cash tends to hurt performance, but it works very well to protect capital in bear markets.
Q: While the rules of these models might not change over the years, the investment universe can. How has the investment universe for the Global Macro portfolio changed over time?
A: The Global Macro strategy is a little different because it invests exclusively in ETF’s that represent different asset classes. It is a tactical asset allocation strategy that can go anywhere we can efficiently find exposure. We have a predefined investment universe that covers everything from domestic equities, to fixed income, to commodities, to international investments. There are all ranked unemotionally by our momentum ranking process and we are constantly driving the strategy to where the strength is. Over the years, the ETF landscape has expanded a great deal. As new products come to market they are evaluated and if there is a hole in our current lineup we will consider adding new ETF’s to broaden our opportunity set. In a go anywhere strategy like Global Macro, the more varied exposures we can add to the universe the better.
Q: The International portfolios has been among the best performing strategies in this family of accounts. From a portfolio construction perspective, how do you think our approach differs from the competition?
A: The SRS International strategy has a few unique features. First, it is comprised entirely of ADR’s and foreign equities listed on US exchanges. That means we can get exposure to foreign equities without having to buy the shares on local exchanges, do currency conversions, etc… It makes it an ideal way to get international exposure through a retail SMA. We also don’t have minimums or maximums on our developed versus emerging markets exposure. This has served us well over the last ten years as different markets have come in and out of favor. Our job is to buy the best momentum securities from the ADR universe so we don’t constrain ourselves to countries or regions. Wherever the strength is is where the portfolio will be overweighted. Since the process is very disciplined we are very comfortable that when markets change our models will pick that up and we can change the portfolio accordingly.
Q: A passive approach to fixed income has worked pretty well for the last 35 years, arguably until recent years. Why do you think there will be a need for Tactical Fixed Income in the years to come?
A: Tactical Fixed Income is one of our newer strategies, and it has also performed very well since inception. Our process is very much a risk on, risk off approach to fixed income markets. If rates begin to rise significantly we are able to rapidly rotate into defensive positions and preserve gains made during better times. Since we use ETF’s in this strategy it is very easy for us to move quickly between different areas of the bond market. We believe having an allocation to a tactical fixed income strategy will be a great way to diversify your bond holdings in a different interest rate environment.
Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright & Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if necessary, seek professional advice. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.