The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 8/19/2013:
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Posted by: Andy Hyer
Every time I read an article about how active investing is hopeless, I shake my head. Most of the problem is investor behavior, not active investing. The data on this has been around for a while, but is ignored by indexing fans. Consider for example, this article in Wealth Management that discusses a 2011 study conducted by Morningstar and the Investment Company Institute. What they found doesn’t exactly square out with most of what you read. Here are some excerpts:
But studies by Morningstar and the Investment Company Institute (ICI) suggest that fund shareholders may not be so dumb after all. According to the latest data, investors gravitate to low-cost funds with strong track records. “People make reasonably intelligent choices when they pick active funds,” says John Rekenthaler, Morningstar’s vice president of research.
The academic approach produces a distorted picture, says Rekenthaler. “It doesn’t matter what percentage of funds trail the index,” says Rekenthaler. “What matters most is how the big funds do. That’s where most of the money is.”
In order to get a realistic picture of fund results, Rekenthaler calculated asset-weighted returns—the average return of each invested dollar. Under his system, large funds carry more weight than small ones. He also calculated average returns, which give equal weight to each fund. Altogether Morningstar looked at how 16 stock-fund categories performed during the ten years ending in 2010. In each category, the asset-weighted return was higher than the result that was achieved when each fund carried the same weight.
Consider the small-growth category. On an equal-weighted basis, active funds returned 2.89 percent annually and trailed the benchmark, which returned 3.78 percent. But the asset-weighted figure for small-growth funds exceeded the benchmark by 0.20 percentage points. Categories where active funds won by wide margins included world stock, small blend, and health. Active funds trailed in large blend and mid growth. The asset-weighted result topped the benchmark in half the categories. In most of the eight categories where the active funds lagged, they trailed by small margins. “There is still an argument for indexing, but the argument is not as strong when you look at this from an asset-weighted basis,” says Rekenthaler.
The numbers indicate that when they are choosing from among the many funds on the market, investors tend to pick the right ones.
Apparently investors aren’t so dumb when it comes to deciding which funds to buy. Most of the actively invested money in the mutual fund industry is in pretty good hands. Academic studies, which weight all funds equally regardless of assets, don’t give a very clear picture of what investors are actually doing.
Where, then, is the big problem with active investing? There isn’t one—the culprit is investor behavior. As the article points out:
But investors display remarkably bad timing for their purchases and sales. Studies by research firm Dalbar have shown that over the past two decades, fund investors have typically bought at market peaks and sold at troughs.
Active investing is alive and well. (I added the bold.) In fact, the recent trend toward factor investing, which is just a very systematic method for making active bets, reinforces the value of the approach.
The Morningstar/ICI research just underscores that much of the value of an advisor may lie in helping the client control their emotional impulse to sell when they are fearful and to buy when they feel confident. I think this is often overlooked. If your client has a decent active fund, you can probably help them more by combatting their destructive timing than you can by switching them to an index fund. After all, owning an index fund does not make the investor immune to emotions after a 20% drop in the stock market!
4 Comments | From the MM, Investor Behavior, Markets, Thought Process | Tagged: factor investing, investor behavior, systematic investment process | Permalink
Posted by: Mike Moody
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 (8/12/13 – 8/16/13) is as follows:
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Posted by: Andy Hyer
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/15/2013.
Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares
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Posted by: Andy Hyer
Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.
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Posted by: Andy Hyer
Yep, factor investing is somewhere between active and passive investing:
However, factor investing has taken off in recent years along with passive investing, though not nearly at the same torrid pace, as the shift away from actively managed equity funds continues.
“Passive and factor investing are joined at the hip,” said Samuel Lee, an analyst at Morningstar Inc.
“Passive is based on a lot of academic and finance theory that says it’s impossible to beat the market. Factor investing is an offshoot of that,” Mr. Lee said.
“Factor investors probably started off as Bogle-style buy-and-hold investors, then looked deeper into the research,” he said, referring to The Vanguard Group Inc. founder John Bogle.
The research shows that over time, overweighting companies with favorable prices, profitability, size or momentum can lead to better overall risk-adjusted returns. The key to that, though, is time.
Source: Investment News
Factor investing is passive in its systematic execution, transparency, and relatively low cost and active in its design to be built around return factors that have demonstrated the possibility of outperforming cap-weighted indexes over time.
HT: Abnormal Returns
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Posted by: Andy Hyer
Although many technicians consider volume in their analysis, we have chosen to focus solely on price. As pointed out by Business Insider, those waiting for higher volume to confirm this uptrend are still waiting:
Almost every day since the the bull market began in March 2009, some stock market pundit has complained about low trading volumes.
Some fear that low volume means sell-offs could turn sharp due to lack of liquidity.
However, Charles Schwab’s Liz Ann Sonders points us to this interesting counterintuitive chart from the Bespoke Investment Group.
“The chart breaks out performance the current bull market based on days when volume (using the SPY exchange-traded fund as a proxy) has been above and below its 50-day moving average,” explained Sonders.
“On a cumulative basis, the S&P would be up nearly 300% if you were only invested on the days when volume was below average,” she added. “That’s nearly double the return of the entire bull market! On the other hand, if you were only invested when volume was above average, you would actually be down 37%. Complain if you’d like, but gains are preferred over volume, no?”
“Market bears seem never to be short reasons for gloom; but valuation and volume shouldn’t be among them,” she said.
1 Comment | Markets | Permalink
Posted by: Andy Hyer
The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 8/12/2013:
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
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 (8/5/13 – 8/9/13) is as follows:
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Posted by: Andy Hyer
Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.
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.
Leave a Comment » | Investor Behavior, Markets, Sentiment | Permalink
Posted by: JP Lee
7/31/2013
The Arrow DWA Balanced Fund (DWAFX)
At the end of July, the fund had approximately 46% in U.S. Equities, 26% in Fixed Income, 16% in International Equities, and 11% in Alternatives. U.S. equities, our biggest overweight, had a very strong July after pulling back slightly in June. Among our best performing holdings were our positions in Healthcare and Small-Cap Value for the month of July. U.S. equities continue to be the dominant asset class from a relative strength perspective. Developed international equities continued their trend of outperforming Emerging Markets in July. European Central Bank President Mario Draghi sought to dispel doubts about the strength of the central bank’s recent guidance on interest rates by recently reaffirming its commitment to keep borrowing costs low for as long as Europe struggles to recover. The European equity markets responded favorably to those statements. We saw strong performance from our positions in Belgium and Germany in July. Reflecting the superior relative strength of Developed International Markets versus Emerging Markets, all five of our current international equity holdings are from Developed International Markets. After spiking higher in June on fears of Fed tapering of its quantitative easing program, interest rates were fairly stable in July. Our Fixed Income holdings remain near their lower constraint as this asset classes has been among the biggest laggards so far in 2013. Our Alternative holdings of real estate and a currency carry trade were fairly flat in July.
DWAFX gained 3.38% in July and is up 8.95% through 7/31/13.
We believe that a real strength of this strategy is its balance between remaining diversified, while also adapting to market leadership. When an asset class is weak its exposure will tend to be towards the lower end of the exposure constraints, and when an asset class is strong its exposure in the fund will trend toward the upper end of its exposure constraints. Relative strength provides an effective means of determining the appropriate weights of the strategy.
The Arrow DWA Tactical Fund (DWTFX)
At the end of July, the fund had approximately 90% in U.S. Equities and 9% in International Equities. The U.S. equity markets again broke out to a new all-time high in July. It has been more than 10 years since we have seen this kind of superior relative strength of U.S. equities compared to fixed income, international markets, real estate, and commodities. The nature of this strategy is to be flexible enough to adapt to new market environments and the market environment that we are seeing now has little in common with what we have seen for over a decade. For the year, small and mid-cap equities have had better relative strength than large caps and we have a number of small and mid-cap positions in the fund. We have seen fairly stable sector leadership this year with Healthcare, Consumer Discretionary, and Financials. According to Morningstar, this fund is currently outperforming 99% of its peers in the World Allocation category YTD. As trend followers, we benefit from environments with stable leadership and we are seeing that now.
DWTFX was up 5.03% in July and has gained 14.93% through 7/31/13.
This strategy is a go-anywhere strategy with very few constraints in terms of exposure to different asset classes. The strategy can invest in domestic equities, international equities, inverse equities, currencies, commodities, real estate, and fixed income. Market history clearly shows that asset classes go through secular bull and bear markets and we believe this strategy is ideally designed to capitalize on those trends. Additionally, we believe that this strategy can provide important risk diversification for a client’s overall portfolio.
1 Comment | Markets | Permalink
Posted by: Andy Hyer
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/8/2013.
Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.
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Posted by: Andy Hyer
The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 8/5/2013:
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
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 (7/29/13 – 8/2/13) is as follows:
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Posted by: Andy Hyer
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 8/1/2013.
Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
Our recent post Relative Strength Dividend Investing highlighted a couple of key ways that relative strength screens have the potential to improve the experience of dividend investors. A “land of agony” for dividend investors is those holdings that cut their dividends. As pointed out in the article, companies that cut their dividends overwhelmingly had negative relative strength.
Today, we see another example of that with Barrick Gold:
The world’s largest gold miner has now written off nearly $13-billion in 2013.
Because of the latest charge, Barrick lost $8.6-billion during the second quarter. Stripping out the one-time item, the company made $663-million, or 66 cents per share, down from $821-million, or 82 cents per share in the same period last year.
To conserve cash, Barrick has decided to slash its dividend to 5 cents per share each quarter , down from 20 cents previously. The cut will help the company save $600-million annually.
And just like that, Barrick Gold has slashed its dividend (which was 4.66%) by 75%. However, the technical case for Barrick Gold has been weak for some time.
Source: Yahoo! Finance, 8/1/12 - 7/31/13, Price return only
Dorsey Wright also ranks all stocks by their “technical attributes” on a scale of 0-5 (5 being the strongest). Four of the attributes are based on relative strength and one is based on trend. The technical attribute history of Barrick Gold (ABX) has also been weak for years:
Source: Dorsey Wright
As Josh Peters of Morningstar recently pointed out, “Investing—even when focused on dividends—is never just about the dividends. Total return, which reflects both income and capital appreciation, is the bottom line for any investment strategy.” Relative strength has the potential to be an effective defense against dividend cutters.
Dorsey Wright manages Relative Strength Dividend UITs for First Trust. Click here for more information.
Past performance is no guarantee of future returns. A list of all holdings for the trailing 12 months is available upon request.
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Posted by: Andy Hyer
Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.
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Posted by: Andy Hyer
Modern portfolio theory imagines that you can construct an optimal portfolio, especially if you can find investments that are uncorrelated. There’s a problem from the correlation standpoint, though. As James Picerno of The Capital Spectator points out, correlations are rising:
A new study from the Bank of International Settlements (BIS) raises doubts about the value of commodities as a tool for enhancing portfolio diversification. The paper’s smoking gun, so to speak, is that “the correlation between commodity and equity returns has substantially increased after the onset of the recent financial crisis.”
Correlations are a key factor in the design and management of asset allocation, but they’re not the only factor. And even if we can find assets and strategies with reliably low/negative correlations with, say, equities, that alone isn’t enough, as I discussed last week. You also need to consider other factors, starting with expected return. It may be tempting to focus on one pair of assets and consider how the trailing correlation stacks up today. But that’s hardly the last word on making intelligent decisions on how to build a diversified portfolio.
As more investors pile into commodities, REITs, hedge funds, and other formerly obscure corners, the historical diversification benefits will likely fade. Granted, the outlook for expected diversification benefits fluctuates through time, and so what looks unattractive today may look considerably more compelling tomorrow (and vice versa). But as a general proposition, it’s reasonable to assume that correlations generally will inch closer to 1.0. That doesn’t mean that diversifying across asset classes is destined to become worthless, but the expected payoff is likely to dim with the passage of time.
Mathematically, any two items that are not 100% correlated will reduce volatility when combined. But that doesn’t necessarily mean it’s a good addition to your portfolio—or that modern portfolio theory is a very good way to construct a portfolio. (We will set aside for now the MPT idea that volatility is necessarily a bad thing.) The article includes a nice graphic, reproduced below, that shows how highly correlated many asset classes are with the US market, especially if you keep in mind that these are 36-month rolling correlations. Many asset classes may not reduce portfolio volatility much at all.
Source: The Capital Spectator (click on image to enlarge)
As Mr. Picerno points out, optimal allocations are far more sensitive to returns than to correlations or volatility. So even if you find a wonderfully uncorrelated investment, if it has a lousy return it may not help the overall portfolio much. It would reduce volatility, but quite possibly at a big cost to overall returns. The biggest determinant of your returns, of course, is what assets you actually hold and when. The author puts this a slightly different way:
Your investment results also rely heavily on how and when you rebalance the mix.
Indeed they do. If you hold equities when they are doing well and switch to other assets when equities tail off, your returns will be quite different than an investor holding a static mix. And your returns will be way different than a scared investor that holds cash when stocks or other assets are doing well.
In other words, the return of your asset mix is what impacts your performance, not correlations or volatility. This seems obvious, but in the fog of equations about optimal portfolio construction, this simple fact is often overlooked. Since momentum (relative strength) is generally one of the best-performing and most reliable return factors, that’s what we use to drive our global tactical allocation process. The idea is to own asset classes as long as they are strong—and to replace them with a stronger asset class when they begin to weaken. In this context, diversification can be useful for reducing volatility, if you are comfortable with the potential reduction in return that it might entail. (We generally advocate diversifying by volatility, by asset class, and by strategy, although the specific portfolio mix might change with the preference of the individual investor.) If volatility is well-tolerated, maybe the only issue is trying to generate the strongest returns.
Portfolio construction can’t really be reduced to some “optimal” set of tradeoffs. It’s complicated because correlations change over time, and because investor preferences between return and volatility are in constant flux. There is nothing stable about the portfolio construction process because none of the variables can be definitively known; it’s always an educated approximation. Every investor gets to decide—on an ongoing basis—what is truly important: returns (real money you can spend) or volatility (potential emotional turmoil). I always figure I can afford Maalox with the extra returns, but you can easily see why portfolio management is overwhelming to so many individual investors. It can be torture.
Portfolio reality, with all of its messy approximations, bears little resemblance to the seeming exactitude of Modern Portfolio Theory.
2 Comments | Markets, Portfolio Theory | Tagged: diversification, factor investing, momentum, portfolio theory, relative strength, Tactical Asset Allocation, volatility | Permalink
Posted by: Mike Moody
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 7/30/13.
The 10-day moving average of this indicator is 89% and the one-day reading is 88%.
3 Comments | Markets | Permalink
Posted by: Andy Hyer
Advisor Perspectives recently carried an article by Michael Nairne of Tacita Capital about factor investing. The article discussed a number of aspects of factor investing, including factor performance and periods of factor underperformance (factor failure). The remarkable thing about relative strength (termed momentum in his article) is the nice combination of strong performance and relatively short periods of underperformance that it affords the investor seeking alpha.
Mr. Nairne discusses a variety of factors that have been shown to generate excess returns over time. He includes a chart showing their performance versus the broad market.
Source: Advisor Perspectives/Tacita Capital (click on image to enlarge)
Yep, the one at the top is momentum.
All factors, even very successful ones, underperform from time to time. In fact, the author points out that these periods of underperformance might even contribute to their factor returns.
No one can guarantee that the return premia originating from these dimensions of the market will persist in the future. But, the enduring nature of the underlying causes – cognitive biases hardwired into the human psyche, the impact of social influences and incremental risk – suggests that higher expected returns should be available from these factor-based strategies.
There is another reason to believe that these strategies offer the prospect of future return premia for patient, long-term investors. These premia are very volatile and can disappear or go negative for many years. The chart on the following page highlights the percentage of 36-month rolling periods where the factor-based portfolios – high quality, momentum, small cap, small cap value and value – underperformed the broad market.
To many investors, three years of under-performance is almost an eternity. Yet, these factor portfolios underperformed the broad market anywhere from almost 15% to over 50% of the 36-month periods from 1982 to 2012. If one were to include the higher transaction costs of the factor-based portfolios due to their higher turnover, the incidence of underperformance would be more frequent. One of the reasons that these premia will likely persist is that many investors are simply not patient enough to stay invested to earn them.
The bold is mine, but I think Mr. Nairne has a good point. Many investors seem to believe in magic and want their portfolio to significantly outperform—all the time.
That’s just not going to happen with any factor. Not surprisingly, though, momentum has tended to have shorter stretches of underperformance than many other factors, a consideration that might have been partially responsible for its good performance over time. Mr. Nairne’s excellent graphic on periods of factor failure is reproduced below.
Source: Advisor Perspectives/Tacita Capital (click on image to enlarge)
Once again, whether you choose to try to harvest returns from relative strength or from one of the other factors, patience is an underrated component of actually receiving those returns. The market can be a discouraging place, but in order to reap good factor performance you have to stay with it during the inevitable periods of factor failure.
5 Comments | Markets, Portfolio Theory, Relative Strength Research | Tagged: factor failure, factor investing, momentum, patience, relative strength | Permalink
Posted by: Mike Moody
The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 7/29/2013:
11 Comments | Markets | Permalink
Posted by: Andy Hyer
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 (7/22/13 – 7/26/13) is as follows:
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.
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.
Leave a Comment » | Investor Behavior, Markets, Sentiment | Permalink
Posted by: JP Lee
The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Performance updated through 7/25/2013.
Numbers shown are price returns only and are not inclusive of transaction costs. Source: iShares
Leave a Comment » | Markets | Permalink
Posted by: Andy Hyer
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