Systematic Relative Strength

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 (11/30/15 - 12/4/15) is as follows:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

Interesting exchange in this paper on momentum by Man. The response by Nick Barberis, professor of Finance at Yale, is of particular interest given that conventional wisdom is that momentum stocks are often “overvalued.” According to his response, that momentum stocks are often rising for the very reason that they are “cheap.”

AHL/MSS: Do momentum investors do harm because they do not follow fundamental information?

Doug Greenig: If there are too many momentum investors relative to fundamental investors, capital allocations might get out of whack.

Cam Harvey: Policy makers might choose fundamental traders over momentum traders as value trading moves prices to where they should be, whereas momentum might move them away. Prices moving away from fundamental values could have a social cost. At the same time, momentum traders are good for providing liquidity.

Sandy Rattray: Value investing feels right. It’s a good thing to be doing. Finding cheap stocks is seen as a valuable skill. A value investor is seen to stand on higher moral ground than momentum investors.

Nick Barberis: But value and momentum may be more similar than they appear. According to under-reaction theories of momentum – for example, the slow diffusion of information theory – a stock that has been trending up is also a cheap stock: not all information about it has been absorbed into the price.

HT: Jerry Parker

All 7 of our Systematic RS portfolios outperformed their benchmarks in November. In a year where the broad equity market has been relatively flat, our equity portfolios have excelled by finding pockets of strength. Detailed performance is shown below:

A brief overview of each of these separately managed account strategies is shown below:

Different Portfolios for Different Objectives

Aggressive: This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation. It invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio.

Core: This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation. This portfolio invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio. This strategy tends to have lower turnover and higher tax efficiency than our Aggressive strategy.

Growth: This Mid and Large Cap U.S. equity strategy seeks to achieve long-term capital appreciation with some degree of risk mitigation. This portfolio invests in securities that demonstrate powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio. This portfolio also has an equity exposure overlay that, when activated, allows the account to hold up to 50% cash if necessary.

International: This All-Cap International equity strategy seeks to achieve long-term capital appreciation through a portfolio of international companies in both developed and emerging markets. This portfolio invests in those securities with powerful relative strength characteristics and requires that the securities maintain strong relative strength in order to remain in the portfolio. Exposure to international markets is achieved through American Depository Receipts (ADRs).

Global Macro: This global tactical asset allocation strategy seeks to achieve meaningful risk diversification and investment returns. The strategy invests across multiple asset classes: Domestic Equities (long & inverse), International Equities (long & inverse), Fixed Income, Real Estate, Currencies, and Commodities. Exposure to each of these areas is achieved through exchange-traded funds (ETFs).

Balanced: This strategy includes equities from our Core strategy (see above) and high-quality U.S. fixed income in approximately a 60% equity / 40% fixed income mix. This strategy seeks to provide long-term capital appreciation and income with moderate volatility.

Tactical Fixed Income: This strategy seeks to provide current income and strong risk-adjusted fixed income returns. The strategy invests across multiple sectors of the fixed income market: U.S. government bonds, investment grade corporate bonds, high yield bonds, Treasury inflation protected securities (TIPS), convertible bonds, and international bonds. Exposure to each of these areas is achieved through exchange-traded funds (ETFs).

To receive the brochure for these portfolios, please e-mail [email protected] or call 626-535-0630.

Total account performance shown is total return net of management fees for all Dorsey, Wright & Associates managed accounts, managed for each complete quarter for each objective, regardless of levels of fixed income and cash in each account. Information is from sources believed to be reliable, but no guarantee is made to its accuracy. This should not be considered a solicitation to buy or sell any security. Past performance should not be considered indicative of future results.

The S&P 500 is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the U.S. stock market, as defined by Standard & Poor’s. The Barclays Aggregate Bond Index is a broad base index, maintained by Barclays Capital, and is used to represent investment grade bonds being traded in the United States. The 60/40 benchmark is 60% S&P 500 Total Return Index and 40% Barclays Aggregate Bond Index. The MSCI EAFE Total Return Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the United States and Canada and is maintained by MSCI Barra. The Dow Jones Moderate Portfolio Index is a global asset allocation benchmark. 60% of the benchmark is represented equally with nine Dow Jones equity indexes. 40% of the benchmark is represented with five Barclays Capital fixed income indexes.

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.

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 11/30/15:

I’m really hoping this decides to break higher!

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile 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 (11/23/15 - 11/27/15) is as follows:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 11/24/15.

The 10-day moving average of this indicator is 78% and the one-day reading is 82%.

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

It is so easy to get caught up in the day to day outperformance or underperformance of our relative strength strategies. What do they currently own? Which positions are closest to being sold? What will replace them? All relevant questions for sure, but I find it helpful to take a couple steps back every now and again and look at a long-term look view of relative strength strategies. The RS Spread, shown below, offers a 25 year look at how the relative strength leaders have fared compared to the relative strength laggards.

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards.

Source: Dorsey Wright, 5/23/90 - 11/20/15. Price return only, not inclusive of dividends or transaction costs.

Some observations:

• Over time, you’ve been much better off owning RS leaders as opposed the RS laggards
• The RS Spread doesn’t always go up. In fact, there have been a number of periods (often after major recessions and during the first 12 months of new bull markets) where RS laggards have actually had better performance. Those are often the environments where momentum investors are glad they also own some value strategies in their allocation.
• From late 2009 through the middle of 2014, the RS Spread chopped sideways. This was a period where most all stocks were going up, but the RS leaders weren’t necessarily doing any better than the RS laggards.
• For the last year and a half or so, RS leaders have been dominating the RS laggards.

What does this suggest about the future? Could the meaningful outperformance of the RS leaders over the last year an a half or so constitute some type of breakout in light of the previous extended period of similar performance between the RS leaders and laggards? I am inclined to think so. Hopefully, this provides some food for thought for those advisors having discussions with clients about putting new money to work.

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. This analysis speaks only in generalities and may or may not be directly applicable to any particular investment strategy.

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile 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 (11/16/15 - 11/20/15) is as follows:

Big week for most all RS decides. One real exception was the bottom decile of the RS ranks (largely Energy stocks).

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

One of the realities of trend following is that you never know which trades are going to work out. In the case of our Systematic RS International portfolio, a stock has to meet certain relative strength-based criteria for us to add it to the portfolio. Specifically, we take a universe of ADR’s from both developed and emerging markets and rank them by their relative strength. Our purchases are made from the top quartile of our ranks and we sell the stocks once they fall out of the top half of our ranks. In other words, we buy stocks that have demonstrated favorable relative strength and then hold them for as long as they remain strong.

We have been employing this process in our Systematic RS International account since its inception on March 31, 2006. The result of 9 plus years worth of relative strength-driven trading is shown below:

Performance is price return only, not inclusive of dividends or transaction costs. 3/31/06-11/12/15

There are a couple things that stand out to me from the scatter chart above which shows the number of days a trade was held and its accompanying return.

• More than half of the trades (55%) were held for less than one year. These are the stocks that had strong momentum when we bought them, but they did not sustain it and were often sold at a loss.
• As we have seen with many of our other relative strength strategies, it is a much smaller number of trades that were held for multiple years. Our longest holding was held for just over five years.
• The trade where we made the most money was up over 600% and was held for over 2 years.

It is probably startling for some to see just how many trades don’t work out! Big multi-year winners are not a common phenomenon. This underscores just how important it is cut out the losers from the portfolio and move on. While looking at the profile of all the trading activity may not be a thing of beauty, the net results of this trend following approach has been something we are very proud of.

Results since inception are shown below:

As of 10/31/15

Since inception, the Systematic RS International portfolio has outperformed the MSCI EAFE by 6.17% annually on a net basis.

Among the firms where this SMA portfolio is available:

• Raymond James
• Stifel Nicolaus
• TD Ameritrade
• Charles Schwab

Please contact andy@dorseywright or call 626-535-0630 to receive a fact sheet or to find out about availability at your firm.

Click here for important disclosures. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Performance shown in the scatter chart are based on the day that the security was added and removed from our model. Actual trading of accounts may have happened a day after and may have resulted in a different gain/loss.

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 11/11/15:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile 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 (11/2/15 - 11/6/15) is as follows:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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 (10/26/15 - 10/30/15) is as follows:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

On March 1, 2007, we partnered with PowerShares to bring to market the first momentum ETF, The PowerShares DWA Momentum ETF (PDP). This ETF is based on our Technical Leaders Index which is designed to rank a universe of about 1,000 U.S. mid and large cap stocks, using our PnF relative strength methodology, and identify the top decile (top 100 stocks) in our rankings. This index is reconstituted on a quarterly basis.

PDP now has $1.9 billion in assets and has outperformed the S&P YTD, over the last 1, 3, and 5 years, and inception to date (ITD).

Source: Bloomberg, as of 10/29/15. Returns are inclusive of dividends, but do not include all transaction costs.

If someone simply bought PDP on 3/1/2007 and held the ETF to today, they may not be aware of all the changes in the Technical Leaders Index over time. The table below summarizes all the index changes that have happened behind the scenes.

Source: Dorsey Wright, as of 9/30/15. Returns are not inclusive of dividends or all transaction costs.

Some observations:

• 83% of all index trades were held for less than 4 quarters. In other words, these were the strong momentum stocks that we bought that did not sustain their momentum and were quickly removed from the index. The highlighted column shows the return of our index holdings relative to the S&P 500 during the period of time that we held them. Stocks held for only 1 or 2 quarters underperformed the S&P 500 on average.
• 17% of all index trades were held for longer than 4 quarters. These were the holdings that, on average, outperformed the S&P 500. You’ll notice that the longer the stocks were held in the index the better they tended to perform relative to the S&P 500.

This type of return profile is probably not surprising to those familiar with trend following. After all, the essence of the strategy is to cut your losers and let your winners run. We’ve all read the statistics about the percentage of active managers that fail to beat an index. Here is a smart beta alternative to active management that has demonstrated the ability to add value over time.

The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

What a month so far for the equity markets – through last night, the S&P 500 is up 8.87% and the MSCI EAFE is up 7.66% in October*. We have seen a particularly strong snap-back in our Systematic RS International portfolio. See below for the MTD performance of our current holdings**:

Historical performance (through September 2015) of our Systematic RS International portfolio is shown below:

In light of the recent strong performance of this strategy, I would suggest that now might be a good time to consider an allocation for your clients. Please e-mail [email protected] for a fact sheet and click here disclosures about this portfolio.

*9/30/15 – 10/28/15 Price return only, not inclusive of dividends or transaction costs, EFA is used for MSCI EAFE. **Not all current holdings were owned for the entire month, some may be been added during the month. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 10/27/15.

This index has rebounded sharply after hitting a single-day low of 8% on 8/25/15. The 10-day moving average of this indicator is 75% and the one-day reading is 77%.

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.