Global Macro: Communicating Tactical To Clients

Risk management is an overarching objective of tactical asset allocation strategies.  Whether you are employing our Global Macro strategy (available as an SMA, DWTFX, or DWAT), one of the Tactical Tilt Models, or another application of DALI, becoming great at communicating the merits of these strategies is an important part of your business.  Two images that I have found useful in this effort are shown below and I share them here with the idea that you also may wish to incorporate them into your communications with your clients.

The first image is taken from John Lewis’ white paper Tactical Asset Allocation Using Relative Strength.  In this white paper, John ran a portfolio test on a broad range of ETFs from a variety of asset classes: U.S. Equities (long and inverse), International Equities (long and inverse), Currencies, Commodities, Real Estate, and Fixed Income.  In the white paper, the portfolio test showed the results of implementing a disciplined relative strength strategy of ranking a universe of ETFs by relative strength and making buy and sell decisions based on relative strength rank.  This trend following approach to asset allocation had results that were very compelling (detailed in the white paper).  One chart from the white paper that I like to use when presenting tactical asset allocation is shown below.  The green line is the trailing 12 month beta of the tactical asset allocation model vs. the S&P 500 and the black line is the trailing 12 month beta of a 60/40 (60% S&P 500/40% Barclays Aggregate Bond Index) vs. the S&P 500.  Visually, it is very easy to see that the green line fluctuates within a much broader range than does the black line, illustrating the more dynamic nature of a tactical asset allocation strategy driven by relative strength.  In markets where equities are in favor, the portfolio will be tilted towards equities and will tend to be more volatile.  In markets where equities are doing poorly, it is likely that the portfolio will be tilted towards more defensive asset classes.

Ultimately, I believe that this is what clients are looking for form a tactical asset allocation strategy.  They want to dial up the risk in good markets and they want the ability to dial down the risk in bad markets.  I believe that relative strength is ideally suited for this task.

trailing 12 month beta

Source: Tactical Asset Allocation Using Relative Strength, John Lewis

This example is presented for illustrative purposes only, and does not represent a past or present recommendation.  Performance of the switching strategy is the result of back-testing.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision-making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. The performance numbers above are pure price returns, not inclusive of dividends, fees, or all transaction costs.  Investors cannot invest directly in an Index, like the S&P 500 Index (SPX), and index performance numbers do not include fees.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

Another chart that I often use in presentations on tactical asset allocation strategies is the chart below.  I came across this image on Twitter a couple years ago and immediately knew I would be making good use of it.  If you happen to lose some clients with terms like beta, standard deviation, drawdowns, etc, chances are good that you’ll be able to help them understand the concept with the following chart.  It would be nice if investing were similar to the “Your plan” portion of the image below.  Under that scenario, it is a smooth upward trajectory to your financial goals.  Clients often look at the long-term annualized return of a strategy and mistakenly think that they will be granted that return each and every year.  “Reality” doesn’t quite work that way.  There are bull markets, bear markets, periods of high volatility, periods of low volatility, geopolitical risks, market shocks and all kinds of other things that are part of investing.  The goal of tactical asset allocation is to help smooth out the ride for a client.  Will a tactical asset allocation strategy be able to completely smooth out the ride?  Clearly not.  No strategy can do that.  However, if tactical asset allocation is able to seek to mitigate some of the downside risk and also be able to adapt and participate in good markets then it will have achieved its goal of providing risk management to a client.

plan_reality

Source: Twitter @ThinkingIP

Of course, telling the story is part of what is required.  Delivering results is the other part of it.  As shown below, the Arrow DWA Tactical Fund (DWTFX) has outperformed 91% of its peers in the Morningstar Tacical Allocation category over the past 5 years, which I believe speaks to the efficacy of relative strength investing over time.

dwtfx

Source: Morningstar, 4/27/17

If you have questions about accessing tactical asset allocation strategies for your clients, please contact Andy Hyer at andyh@dorseymm.com or 626-535-0630.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. ETFs may result in the layering of fees as ETFs impose their own advisory and other fees. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov)  There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.  Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

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