March Arrow DWA Funds Review

April 8, 2014

3/31/14

The Arrow DWA Balanced Fund (DWAFX)

At the end of March, the fund had approximately 45% in U.S. Equities, 25% in Fixed Income, 18% in International Equities, and 12% in Alternatives.

We had a number of changes to this fund over the last month.  In our Style sleeve, we replaced Mid-Cap Value and Small-Cap Value with Large-Cap Growth and Small-Cap Growth.  In our Sector sleeve, we sold Financials and bought Technology.  Finally, in our International sleeve, we sold Japan and bought Spain.  From an overall asset allocation perspective, we slightly reduced our U.S. equity exposure and increased our International equity exposure.  Much of the U.S. equity leadership in the first two months of the year pulled back in March.  For example, positions like Healthcare and Small-Cap Growth which were among the leaders in January and February were among the laggards in March.  However, International equity leadership was more stable in March.

DWAFX lost 1.01% in March, but is up 0.55% YTD through 3/31/14.

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.

dwafx 04.08.14 March Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of March, the fund had approximately 90% in U.S. equities and 9% in International equities.

There were no changes in holdings to this fund in March.  Leadership generally took a breather and underperformed in March, yet longer-term relative strength continues to favor U.S. equities.  One area to keep an eye on is Commodities.  This asset class has been a laggard for the last couple of years, but is showing some strong signs of life.  A number of commodity ETFs are rising in our relative strength ranks, and if that continues, may find their way to into the fund.

DWTFX lost 0.57% in March, but is up 1.16% YTD through 3/31/14.  This fund has outperformed 97% of its peers in the Morningstar Tactical Allocation category over the past year.

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.

DWTFX 04.08.14 March Arrow DWA Funds Review

A list of all holdings for the trailing 12 months is available upon request.  Past performance is no guarantee of future returns.  See www.arrowfunds.com for a prospectus.

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DWA Collective Investment Trusts for 401k Plans

March 21, 2014

Managed ETF solutions are in their initial phase in entering the retirement plan industry to provide much needed alternatives to current products such as target date funds. The Church Capital ETF Global Growth and Church Capital ETF Global Balanced has hired Dorsey Wright & Associates as sub-advisor for these relative strength driven ETF asset allocation funds. They are currently available on the following platforms:

Fidelity
CPI
Frontier Trust
Schwab
TD Ameritrade
Wilmington Trust
MidAtlantic
Mass Mutual
ING
Greatwest
Paychex
Reliance Trust
MG Trust Company

Collective Investment Funds

CIF’s are specific to retirement plans only and registered under the banking regulations enforced by the office of Comptroller of Currency, which is part of the U.S. Treasury. CIF’s are issued cusip numbers and trade over the NSCC. CIF’s are created and administered by trust companies. The Church Capital funds use Altatrust, Denver, CO as their trust company. CIF’s are a natural fit for ETF money managers such as Dorsey Wright because they allow for unique strategy flexibility and inexpensive to create and manage.

These funds are portable to any 401k platform and Altatrust continues to complete new agreements with various 401k providers. In addition to making relative strength strategies available to any 401k plan, Church Capital and Altatrust provide a side benefit to plan sponsors of these plans by signing off as 3(38) fiduciaries for the management of these funds.

Church Capital ETF Global Growth, Global Balanced (QDIA)

By providing two different ETF asset allocation funds, the majority of 401k participant risk profiles can be met. Each fund retains a static asset class allocation, but provides the dynamic relative strength rotation management of ETF’s within the asset class allocation.

Click CC_Brochure2 to view the Church Capital brochure for more information.

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February Arrow DWA Funds Review

March 6, 2014

2/28/2014

The Arrow DWA Balanced Fund (DWAFX)

At the end of February, the fund had approximately 47% in U.S. Equities, 25% in Fixed Income, 17% in International Equities, and 10% in Alternatives.

DWAFX gained 3.49% in February and is up 1.57% YTD through 2/28/14.

As trend followers, it is no surprise that we tend to benefit when trends continue.  While not all of the trends in place in 2013 have continued in 2014, many of them have.  For example, Healthcare was one of the best performing sectors last year and is again leading the way in 2014.  Small and Mid-Cap U.S. stocks outperformed Large Caps last year and are again leading the way in this year.  European equities have also generally performed well with Belgium and Switzerland among our best performing holdings so far this year.  Emerging market equities have also continued their weakness from 2013 into this year and are not currently represented in the fund.  However, there have been signs of some potential changes in asset class performance as well.  Commodities had a dreadful 2013, but have shown some real signs of strength in 2014.  While this asset class is not currently represented in the fund, many commodities are starting to rise in our relative strength ranks.  Fixed income also had a poor 2013, but has actually performed reasonably well so far this year.

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.

dwafx 03.06.14 February Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of February, the fund had approximately 90% in U.S. equities and 9% in International equities.

DWTFX gained 5.22% in February and is up 1.75% YTD through 2/28/14.

Turnover in this fund over the past year has been well below its historical average—another indication that trend following is performing well.  Through 3/4/14, DWTFX is outperforming 78 percent of its peers in the Morningstar Tactical Asset Allocation category and is outperforming 96 percent of its peers over the past 12 months.  Among our best performing holdings so far in 2014 are Healthcare, Small-Cap Growth, and Small-Cap Value.  50% of our current holdings are either Small or Mid Cap U.S. stocks, reflecting their continued strength compared to Large Caps.

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.

dwtfx 03.06.14 February Arrow DWA Funds Review

A list of all holdings for the trailing 12 months is available upon request.  Past performance is no guarantee of future returns.  See www.arrowfunds.com for a prospectus.

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Predicting the Next Decade’s Bond Returns

March 5, 2014

Before investors automatically default to a standard 60/40 balanced fund (60% U.S. equity / 40% U.S. fixed income) because it has worked just fine over the past 30 years, the WSJ suggests that they think twice about the returns that bonds may deliver going forward.

Want to bet on what bonds will return over the next decade? You might want to wager on today’s yield—or about 2.7% in the case of the 10-year Treasury note.

It is impossible to know what bonds will return over a short period such as the next 12 months. If interest rates shoot up, for instance, an investor could lose money as the resale value of today’s bonds plummets.

But if you are going to hold bonds for a longer period, the current yield gives you a decent indication of what you might earn over time, says John C. Bogle, founder and former chairman of Vanguard Group. Since 1926, he notes, the entry yield on the 10-year Treasury explains 92% of the annualized return an investor would have earned over the subsequent decade had he or she held the bond to maturity and reinvested the coupon payments at prevailing rates.

Similarly, the entry yield on the Barclays U.S. Aggregate Bond index (of investment-grade U.S. bonds) explains 90% of its 10-year returns for the years 1976 to 2012, says Tony Crescenzi, a portfolio manager and strategist at Pacific Investment Management Co.

By contrast, one figure that doesn’t predict bond returns—and which can lead investors astray—is the past return of a bond index or bond fund.

The article includes the following chart which shows the historic relationship between current yields and annualized bond returns over the next 10 years.

wsj Predicting the Next Decades Bond Returns

Instead of taking a buy-and-hold approach towards bonds going forward, investors may want to consider using them in the context of a tactical asset allocation strategy.  I suspect that during various periods over the next decade there will be times when investors will be glad they have the ability to rotate into bonds to help provide some income and also buffer volatility.  However, as the article suggests, a buy-and-hold approach to bonds from these low yields may leave many bond investors disappointed over the next decade.

It is likely that one of the reasons that the Arrow DWA Tactical Fund (DWTFX) has been able to outperform 97% of its peers in the Morningstar Tactical Asset Allocation category over the past year is because of its ability to rotate out of bonds while many of its peers have been hampered by their bond exposure:

dwtfx morningstar Predicting the Next Decades Bond Returns

Relative strength provides, what we believe, is an ideal tool for determining when it is time to own (or overweight) bonds and when it is time to look elsewhere.

Past performance is no guarantee of future returns.  See www.arrowfunds.com for a prospectus.  A list of all holdings for the trailing 12 months is available upon request.

HT: Abnormal Returns

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January Arrow DWA Funds Update

February 10, 2014

01/31/2014

The Arrow DWA Balanced Fund (DWAFX)

At the end of January, the fund had approximately 46% in U.S. Equities, 26% in Fixed Income, 16% in International Equities, and 11% in Alternatives.

DWAFX fell 1.85% in January, after gaining 15.77% in 2013.

After a remarkable year for equities in 2013, stocks pulled back in January.  Fixed Income prices moved higher, helping to buffer the overall returns of the fund for the month.  Interest rates moved sharply higher in the spring and summer of 2013, during initial announcements of Fed tapering of its quantitative easing program, but rates had chopped sideways for the last couple months.   January was not exactly a case of what performed best in 2013, performed worst in January.  Rather, Healthcare, which was one of last year’s biggest winners continued to gain relative strength and actually generated positive returns for the month.  Small and mid-caps also generally continued their favorable performance compared to large caps.  The biggest losses for the month came from our international equity exposure, including Japan, Netherlands, and Germany.

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.

dwafx January Arrow DWA Funds Update

The Arrow DWA Tactical Fund (DWTFX)

At the end of January, the fund had approximately 90% in U.S. equities and 9% in International equities.

DWTFX fell 3.30% in January, after gaining 26.19% in 2013.

There were no changes in holdings in the fund in January.  Healthcare and Small-Cap Growth held up relatively well, while Consumer Discretionary and European Equities were among our worst performers for the month.  Many of the longer-term relative strength trends remain firmly in place, even will the pull back over the last couple of weeks: U.S. equities continue to have strong relative strength, Emerging Markets and Commodities continue to be particularly weak, and Fixed Income and Currencies are not strong enough to warrant exposure at this point.

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.

dwtfx January Arrow DWA Funds Update

A list of all holdings for the trailing 12 months is available upon request.  Past performance is no guarantee of future returns.  See www.arrowfunds.com for a prospectus.

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Optimal Allocation Between Stocks and Bonds

January 27, 2014

Daniel Morillo of BlackRock looks to see if the 60/40 allocation is the optimal mix of bonds and equities over time:

Since my last post on the merits of using equities to balance the risk of rising rates, I’ve been asked well, what is the right mix of equities and fixed income? Almost everyone’s top-of-mind answer is, of course, 60/40. It’s a portfolio that holds 60% equities and 40% bonds, and it’s widely used as a benchmark for numerous multi-asset or “balanced” allocation products. Financial professionals tend to use it as a reference point during portfolio allocation discussions with clients, and it’s widely quoted in the media.

So, does 60/40 hold up? I decided to sift through the numbers to see. What I found is that while, in general, a 60/40 portfolio may be a reasonable bet for long term investors, it might not always be the way to go for investors who hold strong convictions.

To come to this conclusion, I took equity and government bond returns from the DMS database[1], which includes annual return data for 19 countries since 1900. For each possible 10-year period in each country, I constructed the allocation that, over that particular 10-year period, would have delivered the best ratio of excess return to risk, aka the allocation with the best or “optimal” Sharpe ratio.

Figure 1 shows the average optimal bond allocation for each country, averaged across countries. Guess what? The overall average across countries and time is about 43% bonds (so, the remaining 57% would be in equities) — eerily close to the 60/40 rule.

Figure 1 Optimal Allocation Between Stocks and Bonds

(click on the image to enlarge)

So the answer is that,  yes, since 1900 the optimal mix of equities and bonds is approximately 60/40.

However, note the variability in the optimal allocation to bonds in the chart above.  In some 10-year periods it was best to have 90% allocation to bonds and in other 10-year periods it was best to have 0% allocation to bonds!  While some may look at this study and conclude that there is no need to be tactical, I look at this study and come to the exact opposite conclusion.  Relative strength offers an effective tool for making macro asset allocation decisions, as explored in this white paper by John Lewis.

HT: Abnormal Returns

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Improving Sector Rotation With Momentum Indexes

January 21, 2014

Sector has been a popular investment strategy for many years.  The proliferation of sector based exchange traded funds has made it quick and easy to implement sector bets, but has also added a level of complexity to the process.  There are now many different flavors of ETF’s for each macro sector ranging from simple capitalization weightings to semi-active quantitative models to construct the sector index.  The vast array of choices in each sector allows investors to potentially add additional performance over time versus a simple capitalization based model.

Dorsey, Wright has a suite of sector indexes based on our Technical Leaders Momentum factor.  These indexes are designed to give exposure to the securities with the best momentum characteristics in each of the 9 broad macro sectors (Telecomm is split between Technology and Utilities depending on the industry group).  Long time readers of our blog should be aware of all of the research that demonstrates how effective the momentum factor has been over time providing returns above a broad market benchmark.  Using indexes constructed with the momentum factor have the potential to add incremental returns above a simple capitalization weighted sector rotation strategy just like they do on the individual stock side.

The sector SPDRs are the most popular sector suite of exchange traded products.  When investors make sector bets using this suite of products they are making a distinct sector bet and also making a bet on large capitalization stocks since the sector SPDRs are capitalization weighted.  There are times when large cap stocks outperform, but there are also times when the strength might be in small cap, value, momentum, or some other factor.  By not considering other weighting methodologies investors are potentially leaving money on the table.

We constructed several very simple sector rotation models to determine how returns might be enhanced by implementing a sector rotation strategy with indexes based on momentum.  The base models were created with either 3 or 5 holdings from the sector SPDR universe.  Each month a trailing 3 or 6 month return was calculated (based on the model specification) and the top n holdings were included in equal weights in the portfolio.  Each month the portfolio was rebalanced with the top 3 or 5 sector SPDRs based on the trailing return.  This is an extremely simple way to implement a momentum based sector rotation strategy, but one that proves to be surprisingly effective.

The second group of portfolios expanded the universe of securities we considered to implement the strategy.  All of the momentum rankings were still based on the trailing returns of the sector SPDRs, but we made one small change in what was purchased.  If, for example, the model selected Healthcare as one of the holdings we would buy either the sector SPDR or our Healthcare Momentum Index.  The way we determined which version of the sector to buy was simple: whichever of the two had the best trailing return (the window was the same as the ranking window) was included in the portfolio for the month.  In a market where momentum stocks were performing poorly the model would gravitate to the cap weighted SPDRs, but when momentum was performing well the model would tend to buy momentum based sectors.  Making that one small change allowed us to determine how important implementing the sector bet actually was.

Capture zps07daf1e3 Improving Sector Rotation With Momentum Indexes

 (Click Image To Enlarge)

The table above shows the results of the tests.  Trials were run using either 3 or 6 month look back windows to rank the sectors and also with either 3 or 5 holdings.  In each case, allowing the model to buy a sector composed of high momentum securities was materially better than its cap weighted counterpart.  Standard deviation also increased, but the returns justified the increased volatility as the risk adjusted return increased in each case.

This is one simple case illustrating how implementing your sector bests with different sector construction philosophies can be additive to investment returns.  The momentum factor is one of the premier investment anomalies out there, and using a basket of high momentum stocks in a specific sector has shown to increase returns in the testing we have done.

The performance numbers are not inclusive of any commissions or trading costs .  The Momentum Indexes are hypothetical prior to 3/28/2013 and do not reflect any fees or expenses.  Past performance is no guarantee of future returns.  Potential for profit is accompanied by potential for loss.  The models described above are for illustrative purposes only and should not be taken as a recommendation to buy or sell any security or strategy mentioned above.  Click here for additional disclosures.

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Is Sector Rotation a Crowded Trade?

January 16, 2014

As sector ETFs have proliferated, more and more investors have been attracted to sector rotation and tactical asset allocation strategies using ETFs, whether self-managed or implemented by an advisor.  Mark Hulbert commented on sector rotation strategies in a recent article on Marketwatch that highlighted newsletters using Fidelity sector funds.  All of the newsletters had good returns, but there was one surprising twist:

…you might think that these advisers each recommended more or less the same basket of funds. But you would be wrong. In fact, more often than not, each of these advisers has tended to recommend funds that are not recommended by any other of the top five sector strategies.

That’s amazing, since there are only 44 actively managed Fidelity sector funds and these advisers’ model portfolios hold an average of between five and 10 funds each.

This suggests that there is more than one way of playing the sector rotation game, which is good news. If there were only one profitable sector strategy, it would quickly become so overused as to stop working.

This is even true among those advisers who recommend sectors based on their relative strength or momentum. Because there are so many ways of defining these characteristics, two different sector momentum strategies will often end up recommending two different Fidelity sector funds.

Another way of appreciating the divergent recommendations of these top performing advisers is this: Of the 44 actively managed sector funds that Fidelity currently offers, no fewer than 22 are recommended by at least one of these top five advisers. That’s one of every two, on average, which hardly seems very selective on the advisers’ part.

Amazing, isn’t it?  It just shows that there are many ways to skin a cat.

Even with a very limited menu of Fidelity sector funds, there was surprisingly little overlap.  Imagine how little overlap there would be within the ETF universe, which is much, much larger!  In short, you can safely pursue a sector rotation strategy (and, by extension, tactical asset allocation) with little concern that everyone else will be plowing into the same ETFs.

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Price Persistence At the Asset Class Level

January 9, 2014

Leuthold’s January Green Book includes a simple, yet compelling study about applying momentum at the asset class level:

While even academics now acknowledge the existence of a “price persistence” effect at the stock and industry group level, it is less well known that the phenomenon exists at the broad asset class level.  We’ve examined a few simple approaches in which allocation decisions are based purely on the prior year’s total return performance of seven asset classes: Large Caps, Small Caps, Foreign Stocks, REITs, Commodities, Gold and U.S. Treasury Bonds.  Contrarians might be surprised to learn that a turnaround strategy of buying last year’s laggards (the #5, #6 and #7 performers), has been a consistently poor approach for the last 40 years.  Meanwhile, a naive, momentum-surfing strategy of buying last year’s #1 or #2 performer (or both) has soundly beaten the S&P 500 since 1973.  (We suspect these results are especially humbling to those who spend the rest of the year building and monitoring elaborate tools that track valuations, the economic cycle, investor sentiment, etc.)

Leuthold Table 1 Price Persistence At the Asset Class Level

(printed with permission from Leuthold)

Bottom line: momentum also works well at the asset class level.  Click here for a white paper written by John Lewis that also confirms that momentum can be successfully applied to a group of asset classes.

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December Arrow DWA Funds Review

January 8, 2014

12/31/2013

The Arrow DWA Balanced Fund (DWAFX)

At the end of December, the fund had approximately 46% in U.S. Equities, 25% in Fixed Income, 17% in International Equities, and 12% in Alternatives.

DWAFX rose 1.39% in December, and finished 2013 up 15.53%.

The fund produced positive returns in 10 out of 12 months in 2013, a year characterized by relatively low volatility.  Asset class leadership remained fairly steady throughout the year with domestic equities remaining the asset class with the best relative strength and is the area where we continue to have the most exposure.  However, we are seeing some relative strength improvement in the international equity sleeve.  Germany and the Netherlands were among our best performing holdings in December and the overall exposure of the fund to international equities has increased in recent months.

Interest rates rose in December and our position in the iShares Barclays 7-10 year Treasury Bond ETF was among our worst performers.  Our other fixed income position is the Vanguard Short-Term Bond ETF and that position was flat for the month.  Our fixed income exposure is at the lower end of its exposure constraint.

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.

dwafx hldgs December Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of December, the fund had approximately 90% in U.S. equities and 9% in International equities.

DWTFX was up 2.38% in December, and finished 2013 up 25.83%.

All of our holdings produced gains in December, led by our Industrial sector position, U.S. Mid Caps, and our European equity position.  According to Morningstar, DWTFX outperformed 95% of its peers in the Tactical Allocation category in 2013.  Although, this fund also has the flexibility to invest in asset classes like commodities and fixed income, those areas remain weak from a relative strength perspective.

Although the financial media spend much of 2013 hyperventilating about the fiscal cliff, the sequester, a partial government shutdown, a debt ceiling debate, tapering, and Obamacare, the equity markets largely seemed unfazed and marched higher throughout the year.  Relative strength did an excellent job of keeping us on the right side of that trend.

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.

dwtfx hldgs December Arrow DWA Funds Review

A list of all holdings for the trailing 12 months is available upon request.  See www.arrowfunds.com for more information.

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60/40 Portfolio Subjected To Historical Data

December 30, 2013

Conventional wisdom says you don’t need anything more complicated than a 60/40 portfolio.  From the WSJ:

Investment advisers and managers usually recommend some variant of 60% stocks and 40% bonds (with fewer stocks and more bonds as you get older). The portfolio should be rebalanced at least once a year—selling some of what has done well to buy more of what has done poorly, restoring the target proportions.

The theory is that when stocks do badly bonds will do well, and vice versa. But the theory is flawed.

Historically, this portfolio has only succeeded when stocks, or bonds, or both, have been reasonably valued or cheap. In the past, if you had invested in this portfolio when stocks and bonds were both overvalued, it proved a very poor deal.

Using data on stock and bond returns from New York University’s Stern School of Business and inflation data from the Labor Department, I looked at how such a portfolio performed in the past when measured in real, inflation-adjusted dollars.

It lost a third of its value from 1928 to 1932, and it lost value over two longer periods as well, from 1936 to 1947 and from 1968 to 1982—even before deducting taxes and costs. In reality, most investors would have done very badly indeed.

Another theory that doesn’t hold up when subjected to real data.

So what are your alternatives?  How about expanding the investment universe to include domestic equities, international equities, inverse equities, currencies, commodities, real estate, and fixed income.  John Lewis conducted a rigorous test of this type of Tactical Asset Allocation strategy in this 2012 white paper.  Of particular interest in light of this WSJ article, note the performance of the Tactical Asset Allocation strategy compared to a 60/40 portfolio over time.

From John Lewis’ white paper:

factor summary1 60/40 Portfolio Subjected To Historical Data

Table 2 shows a summary of returns using different lookback periods for various relative strength ranking factors.  Once again, the robust nature of relative strength is shown by the ability of multiple random trials to outperform using a variety of factors.  Some of the intermediate-term factors work better than others, but they all exhibit a significant ability to outperform over time.  At very short lookback periods, such as 1 month, the performance is not as good as at longer periods.  Relative strength models are not designed to catch every small wiggle, and investors need to allow positions to ebb and flow over time.  It is also clear from Table 2 that as you begin to lengthen your lookback period, returns begin to degrade.  While a long-term buy and hold approach to a relative strength strategy is necessary, the investments within the strategy are best rotated on an intermediate-term time horizon.

We have employed this type of tactical approach to portfolio management in The Arrow DWA Tactical Fund (DWTFX) and our Global Macro separately managed account.  DWTFX is +25.70% YTD through 12/27/13 and has outperformed 95 percent of its peers in 2013.

dwtfx1 60/40 Portfolio Subjected To Historical Data

Source: Morningstar

Investors may benefit from looking beyond just domestic equities and domestic fixed income when deciding what strategies they want to employ to get them through the next couple of decades.

Past performance is no guarantee of future returns.  

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November Arrow DWA Funds Update

December 6, 2013

11/30/2013

The Arrow DWA Balanced Fund (DWAFX)

At the end of November, the fund had approximately 47% in U.S. Equities, 25% in Fixed Income, 17% in International Equities, and 11% in Alternatives.

U.S. equities pushed to another all-time high in November and remain the dominant asset class from a relative strength perspective.  U.S. equities continue to be our biggest weighting in the fund.  All three of our sector positions (Consumer Services, Health Care, and Financials) outperformed the broad market in November.  We also continued to see strong performance in our style positions (Mid-Cap Value and Small-Cap Value).  Developed International Markets continued their outperformance versus Emerging Markets in November and all five of our international positions are from developed markets.

Our fixed income holdings were essentially flat in November and this asset class remains near the lower end of its exposure constraint.  Our exposure to Alternatives (MLPs and Currencies) was also relatively flat for the month.  Other Alternatives like precious metals (which we do not currently own) had steep losses for the month and remain among the weakest asset classes.

Stable leadership has been a theme in 2013 and relative strength has capitalized.

DWAFX rose 1.48% in November, and is up 14.18% through 11/30/13.

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.

dwafx 12.06.13 November Arrow DWA Funds Update

The Arrow DWA Tactical Fund (DWTFX)

At the end of November, the fund had approximately 90% in U.S. equities and 9% in International equities.

According to Morningstar, this fund is outperforming 95% of its peers YTD.  One of the dominant themes in the market in 2013 has been small and mid-cap stocks outperforming large caps.  Approximately half of the holdings of the fund are in either small or mid-caps as a result of their strong relative strength.  We also had strong performance from our sector positions in November (Healthcare, Industrials, and Consumer Services), all of which outpaced the broad market for the month.

Our one position in international stocks is focused on Eurozone stocks.  The position was up in November, but largely lagged U.S. equities.

Part of risk management is being able to capitalize in strong equity markets and this fund has certainly done that this year.

DWTFX was up 2.97% in November, and has gained 23.26% through 11/30/13.

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.

DWTFX 12.06.13 November Arrow DWA Funds Update

A list of all holdings for the trailing 12 months is available upon request.

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A Tactical Approach to Portfolio Management

December 5, 2013

Click below to hear Tom Dorsey explain “A Tactical Approach to Portfolio Management.”  This webinar includes an introduction to The Arrow DWA Balanced Fund (DWAFX), The Arrow DWA Tactical Fund (DWTFX), and an implementation idea that combines these two funds with our four PowerShares DWA Momentum ETFs.  (Financial Professional only)

DWA Arrow1 A Tactical Approach to Portfolio Management

See www.arrowfunds.com and www.powershares.com for more information.

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A Reminder About Real Return

November 20, 2013

The main thing that should matter to a long-term investor is real return.  Real return is return after inflation is factored in.  When your real return is positive, you are actually increasing your purchasing power— and purchasing goods and services is the point of having a medium of exchange (money) in the first place.

A recent article in The New York Times serves as a useful reminder about real return.

The Dow Jones industrial average broke through 16,000 on Monday for the first time on record — well, at least in nominal terms. If you adjust for inflation, technically the highest level was on Jan. 14, 2000.

Adjusting for price changes, the Dow’s high today was still about 1.3 percent below its close on Jan. 14, 2000 (and about 1.6 percent below its intraday high from that date).

There’s a handy graphic as well, of the Dow Jones Industrial Average adjusted for inflation.

DJIAinflationadjusted zps196c90a6 A Reminder About Real Return

Source: New York Times/Bloomberg

(click on image to enlarge)

This chart, I think, is a good reminder that buy-and-hold (known in our office as “sit-and-take-it”) is not always a good idea.  In most market environments there are asset classes that are providing real return, but that asset class is not always the broad stock market.  There is value in tactical asset allocation, market segmentation, strategy diversification, and other ways to expose yourself to assets that are appreciating fast enough to augment your purchasing power.

I’ve read a number of pieces recently that contend that “risk-adjusted” returns are the most important investment outcome.  Really?  This would be awesome if I could buy a risk-adjusted basket of groceries at my local supermarket, but strangely, they seem to prefer the actual dollars.  Your client could have wonderful risk-adjusted returns rolling Treasury bills, but would then also get to have a lovely risk-adjusted retirement in a mud hut.  If those dollars are growing more slowly than inflation, you’re just moving in reverse.

Real returns are where it’s at.

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Your Plan vs. Reality

November 12, 2013

Great pic from @ThinkingIP:

plan thinkingip1 Your Plan vs. Reality

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September Arrow DWA Funds Review

October 15, 2013

9/30/2013

The Arrow DWA Balanced Fund (DWAFX)

At the end of August, the fund had approximately 46% in U.S. Equities, 26% in Fixed Income, 17% in International Equities, and 11% in Alternatives.  Our best performing holdings in September were international equities.  The Eurozone economy continues to recover.  While unemployment is still excruciatingly high in many parts of Europe, there are signs of growth, and the borrowing costs for many of the countries who were most at risk just a few years ago have declined.  The U.S. equity markets also added to their gains for the year.  Our small and mid-cap exposure performed especially well in September.  U.S. equities continue to be our biggest overweight.  Our fixed income exposure remains near the lower end of its constraints, yet bond prices did rise in September as interest rates declined.  The Federal Reserve continues its quantitative easing program of buying $85 billion worth of bonds each month.  Although, there was speculation that the Fed would begin to taper its monetary stimulus, that appears to now be on hold.

We did make one change to the holdings in September.  We removed our position in real estate and added a position in a bearish dollar fund. Real-estate investment trusts posted negative returns in the third quarter and continue to trail the broader stock market.  Although interest rates pulled back in September, the overall trend of interest rates remains higher.  REITs, which pay little or no corporate income tax and usually pay steep dividends, are sensitive to rising interest rates because they depend on borrowed money to expand their business.  The U.S. dollar has declined relative to many other currencies since the middle of the year, perhaps partly as a result of the continued aggressive monetary policy.

DWAFX rose 3.68% in September, and is up 9.51% through 9/30/13.

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.

dwafx 10.15.13 September Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of September, the fund had approximately 90% in U.S. Equities and 9% in International equities.  This largely unconstrained tactical asset allocation strategy tends to perform best when there are stable trends and 2013 has provided plenty of such trends.  Sectors like Consumer Cyclical and Healthcare came into the year strong and have remained strong.  Our international equity holdings, benefiting in part from weak dollar, generated our strongest gains in September.  Our U.S. small and mid-cap exposure also performed well, outpacing large-caps.  There are no shortages of headline risks, such as Syria or the government shutdown, but the U.S. equity markets continue their impressive performance.

Although this strategy has the ability to invest in many different asset classes, including commodities, real estate, currencies, and fixed income, the fund has been focused on equities this year as that is where the dominant relative strength has been.  Commodities, particularly precious metals, have been weak for the last couple of years.  Real estate, which generated strong gains for most of the last several years, appears to have run out of steam for the time being.  Fixed income has generally produced modest gains over the last couple of years, but most sectors of fixed income are negative this year as the trend in interest rates has generally been higher.

DWTFX was up 4.42% in September, and has gained 15.54% through 9/30/13.

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.

dwtfx 10.15.13 September Arrow DWA Funds Review

 

See www.arrowfunds.com for more information.

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From the Archives: Market Anxiety Disorder

September 24, 2013

A recent article in the Personal Finance section of the Wall Street Journal had a prescription for anxious investors that Andy has been talking about for more than a year: consider asset allocation funds.  Our Global Macro separate account has been very popular, partly because it allows investors to get into the market in a way that can be conservative when needed, but one that doesn’t lock investors into a product that can only be conservative.

The stock market’s powerful rally over the past year has gone a long way toward reducing the losses that many mutual-fund investors suffered in late 2007 and 2008.

But the rebound—with the Standard & Poor’s 500-stock index up 74% from its March 9, 2009, low—has done nothing for one group of investors: those who bailed out of stocks and have remained on the sidelines. Some of these investors have poured large sums into bond funds, even though those holdings may take a beating whenever interest rates rise from today’s unusually low levels, possibly later this year. Some forecasters, meanwhile, believe that stocks may finish 2010 up as much as 10%.

So, for investors who want to step back into stocks but are still anxious, here’s a modest suggestion: You don’t have to take your stock exposure straight up. You can dilute it by buying an allocation fund that spreads its assets across many market sectors, from stocks and bonds to money-market instruments and convertible securities.

While the WSJ article is a good general introduction to the idea, I think there are a few caveats that should be mentioned.

There’s still a big difference between a strategic asset allocation fund and a tactical asset allocation fund.

Many [asset allocation funds] keep their exposures within set ranges, while others may vary their mix widely.

Your fund selection will probably depend a lot on the individual client.  A strategic asset allocation fund will more often have a tight range or even a fixed or target allocation for stocks or bonds.  This can often target the volatility successfully–but can hurt returns if the asset classes themselves are out of favor.  Tactical funds will more often have broader ranges or be unconstrained in terms of allocations.  This additional flexibility can lead to higher returns, but it could be accompanied by higher volatility.

One thing the article does not mention at all, unfortunately, is that you also have a choice between a purely domestic asset allocation fund or a global asset allocation fund.  A typical domestic asset allocation fund will provide anxious investors with a way to ease into the market, but will ignore many of the opportunities in international markets or in alternative assets like real estate, currencies, and commodities.  With a variety of possible scenarios for the domestic economy, it might make sense to cast your net a little wider.  Still, the article’s main point is valid: an asset allocation fund, especially a global asset allocation fund, is often a good way to deal with a client’s Market Anxiety Disorder and get them back into the game.

—-this article originally appeared 4/7/2010.  Investors still don’t like this rally, even though we are a long way down the road from 2010!  An asset allocation fund might still be a possible solution.

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On the Riskiness of a 60/40 Portfolio

September 23, 2013

The Capital Spectator weighs in on the riskiness of the traditional 60/40 portfolio:

It’s important to recognize that the US 60/40 strategy is a relatively risky allocation mix—one that’s paid off handsomely of late, but one that comes with higher risk vs. GMI or its equivalent.

The issue, of course, is that the US 60/40 strategy is cherry picking from the menu of global asset classes. The fact that this US-centric portfolio has delivered handsome gains will be mistakenly interpreted by some that more of the same is fate. Maybe, but maybe not. If we could muster a high degree of confidence about which asset classes would win or lose, we wouldn’t need to diversify globally. But in a world where uncertainty and surprise are forever harassing the best laid strategies of mice and men, the reality is somewhat different.

Good argument for employing a globally diversified portfolio.

HT: Abnormal Returns

 

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DWTFX Leading the Pack in 2013

September 20, 2013

Our partners at Arrow Funds have been making the case for some time now that we are generally in a favorable environment for tactical asset allocation (See Relative Strength Environments and Relative Strength Turns).  Stable asset class leadership and widening dispersion in performance between the different asset classes have helped the Arrow DWA Tactical Fund rise to the front of the pack in 2013.

dwtfx DWTFX Leading the Pack in 2013

Source: Dorsey Wright, YTD through 9/19/13

morn dwtfx DWTFX Leading the Pack in 2013

Source: Morningstar

Although this fund has wide flexibility to invest in a number of different asset classes, including domestic equities, inverse equities, international equities, currencies, commodities, real estate, and fixed income, this year the allocation has been dominated by equities.

 

dwtfx hdgs DWTFX Leading the Pack in 2013

 

Source: Arrow Funds

Past performance is no guarantee of future returns.  See www.arrowfunds.com for more information.

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Hope for the Great Rotation?

September 13, 2013

Numerous market observers over the past few years have wondered about the timing of ”the great rotation,” wherein investors would begin to rotate some of their massive bond holdings into the equity market.  When would the great rotation happen, or would it happen at all?

There has been a big return differential in stocks and bonds—much in favor of stocks—since the market bottom in 2009, but that did not convince investors to leave the bond market.  Stocks were doing great, but bonds were still going up.

stockbonddifferential zpsd9687824 Hope for the Great Rotation?

Stock-Bond Return Differential since 2009 Bottom

(click on image to enlarge)

It’s only been quite recently that bond total returns have actually been negative.  Maybe that will be the straw that breaks the camel’s back.

stockbonddifferential2 zpsde0e1aa4 Hope for the Great Rotation?

Stock-Bond Return Differential: Short-term View

(click on image to enlarge)

Dr. Ed Yardeni, an economist both respected and practical (which makes him very rare indeed!), suggests that we may possibly be seeing the beginnings of the great rotation.  He writes:

Over the past 13 weeks through the week of August 28, the Investment Company Institute estimates that bond funds had net cash outflows totaling $438 billion at an annual rate. Over the same period, equity funds had net cash inflows of $92 billion at an annual rate. I wouldn’t describe that as a “Great Rotation” just yet, but it could be the start of a big swing by retail investors into equities.

He accompanied his note with a couple of graphics that are interesting.

bondflow zps45dcaf66 Hope for the Great Rotation?

Source: Dr. Ed’s Blog (click on image to enlarge)

equityflow zpsf9bce516 Hope for the Great Rotation?

Source: Dr. Ed’s Blog (click on image to enlarge)

Things could certainly go the other way—all we really have right now are green shoots—but the implications of a great rotation could be significant.

One big reason for that is the difference in relative size of the stock and bond markets.  I looked at current SIFMA data on bonds outstanding and found it was about $38.6 trillion.  Total market capitalization for the Wilshire 5000, a super-broad stock index, is about $19.9 trillion right now.  Stocks are only about 34% of the capital markets.  The total US bond market is almost twice as large!  Even money that migrates from the margin of the bond market has the potential to move the stock market quite a bit.  (Global capital markets are even more lopsided, with the bond market estimated to be about 3 times larger than the equity market.)

I don’t know if we will see the great rotation going forward, but if the markets get even a whiff that we will, it could be pretty fun.

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Buy and Hold

September 9, 2013

John Rekenthaler at Morningstar launched into a spirited defense of buy and hold investing over the weekend.  His argument is essentially that since markets have bounced back since 2009, buy and hold is alive and well, and any arguments to the contrary are flawed.  Here’s an excerpt:

There never was any logic behind the “buy-and-hold is dead” argument. Might it have lucked into being useful? Not a chance. Coming off the 2008 downturn, the U.S. stock market has roared to perhaps its best four and a half years in history. It has shone in absolute terms, posting a cumulative gain of 125% since spring 2009. It has been fabulous in real terms, with inflation being almost nonexistent during that time period. It’s been terrific in relative terms, crushing bonds, cash, alternatives, and commodities, and by a more modest amount, beating most international-stock markets as well. This is The Golden Age. We have lived The Golden Age, all the while thinking it was lead.

Critics will respond that mine is a bull-market argument. That’s backward. “Buy-and-hold is dead” is the strategy that owes its existence to market results. It only appears after huge bear markets, and it only looks good after such markets. It is the oddity, while buy-and-hold is the norm.

Generally, I think Morningstar is right about a lot of things—and Rekenthaler is even right about some of the points he makes in this article.  But in broad brush, buy and hold has a lot of problems, and always has.

Here’s where Rekenthaler is indisputably correct:

  • “Buy and hold is dead” arguments always pop up in bear markets.  (By the way, that says nothing about the accuracy of the argument.)  It’s just the time that anti buy-and-holders can pitch their arguments when someone might listen.  In the same fashion, buy and hold arguments are typically made after a big recovery or in the midst of a bull market—also when people are most likely to listen.  Everyone has an axe to grind.
  • Buy and hold has looked good in the past, compared to forecasters.  As he points out in the article, it is entirely possible to get the economic forecast correct and get the stock market part completely wrong.
  • The 2008 market crash gave the S&P 500 its largest calendar year loss in 77 years.  No doubt.

The truth about buy and hold, I think, is considerably more nuanced.  Here are some things to consider.

  • The argument for buy and hold rests on hindsight bias.  Historical returns in the US markets have been among the strongest in history over very long time periods.  That’s why US investors think buy and hold works.  If buy and hold truly works, what about Germany, Argentina, or Japan at various time periods?  The Nikkei peaked in 1989.  Almost 25 years later, the market is still down significantly.  Is the argument, then, that only the US is special?  Is Mr. Rekenthaler willing to guarantee that US returns will always be positive over some time frame?  I didn’t think so.  If not, then buy and hold is not a slam dunk either.
  • Individual investors have time frames.  We only live so long.  A buy and hold retiree in 1929 or 1974 might be dead before they got their money back.  Same for a Japanese retiree in 1989.  Plenty of other equity markets around the world, due to wars or political crises, have gone to zero.  Zero.  That makes buy and hold a difficult proposition—it’s a little tough mathematically to bounce back from zero.  (In fact, the US and the UK are the only two markets that haven’t gone to zero at some point in the last 200 years.)  And plenty of individual stocks go to zero.  Does buy and hold really make sense with stocks?
  • Rejecting buy and hold does not have the logical consequence of missing returns in the market since 2009.  For example, a trend follower would be happily long the stock market as it rose to new highs.
  • Individual investors, maddeningly, have very individual tolerances for volatility in their portfolios.  Some investors panic too often, some too late, and a very few not at all.  How that works out is completely path dependent—in other words, the quality of our decision all depends on what happens subsequently in the market.  And no one knows what the market will do going forward.  You don’t know the consequences of your decision until some later date.
  • In our lifetimes, Japan.  It’s funny how buy and hold proponents either never mention Japan or try to explain it away.  “We are not Japan.”  Easy to say, but just exactly how is human nature different because there is an ocean in between?  Just how is it that we are superior?  (Because in 1989, if you go back that far, there was much hand-wringing and discussions of how the Japanese economy was superior!)

Every strategy, including buy and hold, has risks and opportunity costs.  Every transaction is a risk, as well as an implicit bet on what will happen in the future.  The outcome of that bet is not known until later.  Every transaction, you make your bet and you take your chances.  You can’t just assume buy and hold is going to work forever, nor can you assume it will stop working.  Arguments about any strategy being correct because it worked over x timeframe is just a good example of hindsight bias.  Buy and hold doesn’t promise good returns, just market returns.  Going forward, you just don’t know—nobody knows.  Yes, ambiguity is uncomfortable, but that’s the way it is.

That’s the true state of knowledge in financial markets: no one knows what will happen going forward, whether they pretend to know or not. 

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Finance Theory vs. Portfolio Reality

August 30, 2013

Index Universe carried an interview with Tad Rivelle, the chief investment officer at Trust Company of the West, that touched on the difference between finance theory and the reality in the markets.  Mr. Rivelle is mainly a bond guy and the interview mostly discussed interest rates and so on, but it contained this gem:

IU.com: We’re hearing projections of 3.5 percent rates by next year, 4.5 percent by 2015. What happens if the bond market decides to rush there at once rather than to gradually get to those levels? Could it derail the economic recovery?

Rivelle: Yes. In fact, that’s precisely what we saw when we had that taper tantrum back in May and June. It was catalyzed by Bernanke’s statement to the effect that the Fed was carefully considering an initiation of a taper late this year, and the bond market sold off horrifically in a very short period of time. It was a generalized deleveraging. I think it frightened the Fed, and consequently they walked those comments back.

The conflict here is that the Fed tends to approach things from a model-driven academic perspective—what’s supposed to happen in theory versus the realities of the marketplace. When people are looking to front-run one another to offload risk before the next guy does, these models basically go out the window.

How the bond market will respond is absolutely unknown, but it’s more typical for the bond market to move very rapidly, to gallop to what it believes is the next point of equilibrium and not to sell off gradually. I’ve never seen that happen.

I put the fun part in bold—in a real market, academic models go out the window and human behavior takes over.  Mr. Rivelle points out that markets trade on perception, and often make adjustments abruptly when perceptions change.

To me, this is the real strength of tactical asset allocation driven by relative strength.  As perceptions change, different securities or asset classes come to the forefront and others fade away.  As relative strength investors, we don’t have to predict what these changes might be.  We simply have to adapt our portfolio as the changes occur.  Relative strength adapts to changes in human behavior, not some elusive equilibrium proposed by academics.

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June Arrow DWA Funds Review

July 3, 2013

6/30/2013

The Arrow DWA Balanced Fund (DWAFX)

At the end of June, the fund had approximately 46% in U.S. Equities, 26% in Fixed Income, 16% in International Equities, and 12% in Alternatives.  The U.S. equity markets pulled back in for the first couple weeks of June as the market continues to digest the likelihood of the eventual “tapering” of the Federal Reserve’s quantitative easing program which has served to hold interest rates down.  However, the equity markets showed signs of stabilizing towards the end of the month.  Most of our U.S. equity holdings held up relatively well in June, with some areas (Consumer Cyclicals) actually showing a small gain for the month.  Small and mid-caps, which we own, also held up relatively well and continued to show positive relative strength compared to large caps for the year.  U.S. equities continue to be an overweight in the fund.  International equities pulled back even more sharply than U.S. equities in June.  Developed international markets have been performing better than emerging markets this year and now all five of our current international equity positions are in developed markets (Mexico was replaced with Japan in June).  Japanese equities pulled back sharply in May, but were actually positive in June and remain among the strongest international equity markets for the year.  We had relatively weak performance in our alternatives (real estate and the currency carry trade).  Our exposure to alternatives remains near its lower constraint of 10% of the fund.  Interest rates made a pretty strong move higher in June and most sectors of fixed income declined.  About half of our fixed income exposure is in short-term U.S. Treasurys and held up relatively well.

DWAFX lost 2.06% in June, but remains up 5.39% through 6/30/13.

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.

dwafx 07.03.13 June Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of June, the fund had approximately 90% in U.S. Equities and 9% in International Equities.  Historically, it has been pretty rare to have this much exposure to U.S. equities in this strategy.  The fact that U.S. equities have had the best relative strength compared to other asset classes is certainly a different picture that we saw for most of the last decade.  It has become “normal” to say that the U.S. equity markets are in a structural bear market, but with the breakout to new highs this year it is quite possible that we may have transitioned to more of a structural bull market.  Of course, one never knows how long any trend will persist and our methodology is designed to adapt regardless of how the future ultimately plays out.  There was a pullback in the equity markets in the first couple weeks of June.  Our U.S. equity holdings held up relatively well with Consumer Cyclicals actually showing a small gain for the month and a number of our other positions, including small and mid-caps, holding up better than large caps.  We did remove a position to international real estate in June and it was replaced with more U.S. equity exposure.  The rise in interest rates has not helped the performance of real estate and fixed income.  Although this fund also has the ability to invest in commodities, we currently have no exposure to this asset class due to its weakness.  Japanese equities pulled back sharply in May, but were actually positive in June and remain among the strongest international equity markets for the year.

DWTFX was down 0.67% in June and has gained 10.16% through 6/30/13.

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.

dwtfx 07.03.13 June Arrow DWA Funds Review

 

See www.arrowfunds.com for more information.

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(Really) Long-Term Perspective on Interest Rates

June 20, 2013

With interest rates surging in recent days, I think it is interesting to stand back and look at a chart of the 10-Year Treasury Yield from a broader historical perspective.  Via Business Insider:

image001 23 (Really) Long Term Perspective on Interest Rates

Source: Global Financial Data (click to enlarge)

Business Insider’s take:

So if you believe in the power of mean reversion, then it’s not unreasonable to expect yields to head back up toward 4%.

Although investors have grown accustomed to interest rates primarily moving in one direction (down) over the past 30+ years, history shows a number of periods of extended rising rate environments.  Needless to say, it is quite possible that there will be opportunities to add value over a passive approach to fixed income exposure by being tactical in years ahead.  In the context of multi-asset class portfolios, that may mean underweighting fixed income altogether.  For allocations within fixed income, it may mean being more discriminating when determining what sectors of fixed income to own.  I suspect that relative strength may prove to be very valuable in the years ahead as it relates to fixed income exposure.

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Endowment-Style Investing

June 17, 2013

Institutional Investor interviews Eric Upin to discuss global-endowment style investing.

How do institutions approach global multiasset-class investing?

It’s all about asset allocation, manager selection and risk management.  Global multiasset-class investing is a team sport, whether you’re an endowment, sovereign wealth fund or foundation.  When you’re investing around the world, trying to bring professionals together to make judgments such as whether you should be overweight or underweight Europe, real estate or other asset classes, the more smart people you can bring into the tent who do what you do — and who can help provide opinions and spark ideas — the better.

As a quantitative manager, this description of how to ultimately determine an asset allocation is completely foreign.  Maybe it works great for some, but the idea of trying to get an edge on the market by seeking out “smart people” who can help provide opinions and spark ideas seems problematic.  We have no aversion to smart people, however we do have a strong preference for removing the role of judgement calls in the investment process.  For us, the asset allocation decision goes something like this.  We determine an investment universe that is comprised of a broad range of asset classes.  We determine the model constraints (i.e. how much we can overweight or underweight a given asset class), and then apply our relative strength methodology to ranking the different asset classes and each of the individual components of the investment universe.  Then, our weights to different asset classes and exact holdings are determined by a systematic relative strength model.  Likewise, sell decisions are also based on this relative strength ranking process.

Those interested in seeing just how effective this quantitative approach to asset allocation can be over time, can read Tactical Asset Allocation Using Relative Strength by John Lewis.  This approach is also working well this year, as discussed in DWTFX Tops Peers.

Past performance is no guarantee of future results.  Please click here and here for disclosures.

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