Unlucky Umberto

July 25, 2014

One reason to invest in our Global Macro portfolio: Decrease the chances that you are “Unlucky Umberto.”  Click here to read more (NYT).

A brief description of our Global Macro portfolio is as follows:

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

The idea of risk diversification is that by expanding the number of asset classes in the investment universe and by giving yourself the flexibility to overweight and underweight those asset classes based on relative strength an investor can seek to avoid extended periods of time with poor returns, especially in the later decades of an investor’s life.

E-mail andyh@dorseywright.com to request a brochure on our Global Macro portfolio.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is no guarantee of future returns.

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Dorsey Wright Managed Accounts

July 22, 2014

Picture1 Dorsey Wright Managed Accounts

Our Systematic Relative Strength portfolios are available as managed accounts at a large and growing number of firms.

  • Wells Fargo Advisors (Global Macro available on the Masters/DMA Platforms)
  • Morgan Stanley (IMS Platform)
  • TD Ameritrade Institutional
  • UBS Financial Services (Aggressive and Core are available on the MAC Platform)
  • RBC Wealth Management (MAP Platform)
  • Raymond James (Outside Manager Platform)
  • Stifel Nicolaus
  • Kovack Securities
  • Deutsche Bank
  • Charles Schwab Institutional (Marketplace Platform)
  • Sterne Agee
  • Scott & Stringfellow
  • Envestnet UMA
  • Placemark
  • Scottrade Institutional
  • Janney Montgomery Scott
  • Robert W. Baird
  • Prospera
  • Oppenheimer (Star Platform)
  • SunTrust
  • Lockwood

Different Portfolios for Different Objectives: Descriptions of our seven managed accounts strategies are shown below.  All managed accounts use relative strength as the primary investment selection factor.

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

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

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

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

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

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

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

Picture2 Dorsey Wright Managed Accounts

To receive fact sheets for any of the strategies above, please e-mail Andy Hyer at andy@dorseywright.com or call 626-535-0630.  Past performance is no guarantee of future returns.  An investor should carefully review our brochure and consult with their financial advisor before making any investments.

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June Arrow DWA Funds Review

July 9, 2014

6/30/2014

The Arrow DWA Balanced Fund (DWAFX)

At the end of June, the fund had approximately 40% in U.S. equities, 25% in Fixed Income, 23% in International equities, and 11% in Alternatives.

We had one change in June—sold a currency position and replaced it with real estate.   Our Alternatives sleeve now has exposure to MLPs and real estate, both areas with strong relative strength and attractive yields.  Our U.S. equity exposure performed well in June (this continues to be our biggest overweight), but our exposure to European equities did not fare as well for the month.  After struggling for a couple months, U.S. small caps also had a strong June and outperformed mid and large caps.  Although we have seen some shifts in leadership this year the major trends remain intact. We saw some underperformance in our strategies at the beginning of the second quarter, but after we made shifts in allocations, the portfolios recovered nicely.  While there are always unforeseen events that can derail the market, we are quite optimistic for the second half of the year.

DWAFX gained 1.21% in June, and is up 2.81% YTD through 6/30/14.

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 June Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of June, the fund had approximately 70% in U.S. equities, 19% in International equities, and 10% in Commodities.

We made one change to the fund in June—replaced a small cap value position with large cap value.  U.S. equity markets continued to climb in June.  Equities had some volatility early on in the second quarter (especially in the high relative strength areas we own), but volatility tapered off toward the end of the quarter.  Although we have seen some shifts in leadership this year the major trends remain intact.  This year has been remarkable in the sense that nearly all asset classes have posted strong returns.  Generally, there tends to be greater dispersion in asset class returns and it is quite possible that we will see that in the remainder of the year.  Bond prices have risen in the first half of the year, but rates are showing some signs of moving higher so this is one area where there may be some weakness ahead.

DWTFX gained 1.44% in June, and is up 2.52% YTD through 6/30/14.

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 June 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.  These relative strength strategies are NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.arrowfunds.com for a prospectus.

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Trend Toward Professionally Managed 401(k) Portfolios

July 2, 2014

From U.S. News comes some interesting insight for any who might have thought that all a 401(k) participant needs is an roster of index funds with no additional guidance:

Another positive trend noted by Vanguard is the increased use of professionally managed portfolios. At the end of 2013, 40 percent of participants enrolled in Vanguard plans had their entire balance invested in a single target-date fund, balanced fund or managed account advisory service. Vanguard projects that 58 percent of all plan participants and 80 percent of new plan participants will be fully invested in some form of a professionally managed portfolio by 2018.

If one thing is obvious from the sordid history of 401(k) plans, it’s that most participants are incapable of putting together a globally diversified portfolio in a suitable asset allocation on their own, using low management fee index funds. Of course, this assumes that low management fee index funds are even an option. Although they are available in Vanguard plans, these funds are more the exception than the rule in 401(k) plans “advised” by brokers and insurance companies. (my emphasis added)

We are happy to be working with Pat Church of Church Capital on what we believe will be part of the solution to this challenge.  Click here and here to learn more.

Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Cyclicality in Practice

June 30, 2014

This post from A Wealth of Common Sense makes a very compelling case for diversification.  It also happens to be a powerful argument for Tactical Asset Allocation.

1 Cyclicality in Practice

 

2 Cyclicality in Practice

Asset class returns are anything but stable.  Consequently, a trend following approach seeks to capitalize on these multi-year swings.  Click here to read a white paper by John Lewis which tests a relative strength-based approach to trend following on an asset class level.

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  This example is presented for illustrative purposes only and does not represent a past recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

HT: Abnormal Returns

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Two Sides of Risk Management

June 24, 2014

How did institutional investors handle their equity allocations in the aftermath of the financial crisis?  Just as a student of behavioral finance would have expected.  As reported by the WSJ:

The average college endowment had 16% of its investment portfolio in U.S. stocks as of the end of June 2013, the most recent academic year, according to a poll of 835 schools conducted by Commonfund, an organization that helps invest money for colleges. That is down from 23% in 2008 and 32% a decade ago. The 18% allocation to foreign stocks didn’t change in that period. Schools in the poll, which collectively manage nearly $450 billion, had 53% of their funds in alternative strategies, up from 33% in 2003.

The average allocation of corporate pension funds to stocks was 43% at the end of last year, down from 61% at the end of 2003, according to J.P. Morgan Chase & Co. The average public pension fund had 52% of its portfolio in stocks at the end of 2013, down from 61% at the end of 2003, J.P. Morgan said.

P1 BQ523 PENSIO G 20140623180315 Two Sides of Risk Management

After going through a traumatic event like the financial crisis, it is only natural to want to dial back the risk.  However, now that the S&P 500 Total Return Index has had an annualized returns of 18.39 percent over the past five years, ending 5/31/14, institutional investors are starting to realize just how costly their risk aversion has been.

Meanwhile, U.S. equity exposure in our Global Macro portfolio has been on the rise in recent years.  This global tactical asset allocation fund is driven by relative strength and as a result it dispassionately overweights those asset classes demonstrating the best performance.

Global Macro Two Sides of Risk Management

This Global Macro strategy is also used to manage The Arrow DWA Tactical Fund, which has outperformed 81 percent of its peers over the past 5 years—no doubt in large part because of its relatively high U.S. equity exposure.

morningstar Two Sides of Risk Management

Source: Morningstar, as of 6/24/14 

After experiencing two major bear markets in the last decade, investors big and small are demanding risk management.  However, it is important to remember that part of risk management is seeking to manage downside risk and part of it is seeking to capitalize in strong equity markets.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Click here for Appendix A.  This example is presented for illustrative purposes only and does not represent a past recommendation.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. 

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May Arrow DWA Funds Review

June 15, 2014

5/31/2014

The Arrow DWA Balanced Fund (DWAFX)

At the end of May, the fund had approximately 39% in U.S. equities, 26% in Fixed Income, 24% in International equities, and 11% in Alternatives.

We generally has positive returns in each of the different sleeves (U.S. equities, Fixed Income, International equities, and Alternatives) of the fund in May—something not always seen in a diversified balanced fund like DWAFX.  We had a number of trades in May: sold Large-Cap Growth, Small-Cap Growth, and Consumer Cyclicals and bought Mid-Cap Value, Small-Cap Value, and Basic Materials.  We also slightly reduced our U.S. Equity exposure and increased our Int’l Equity Exposure.  While there were relatively few trades in the fund in 2013, this year has brought a number of changes.

DWAFX gained 1.23% in May, and is up 1.57% YTD through 5/31/14.

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 May Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of May, the fund had approximately 70% in U.S. equities, 19% in International equities, and 10% in Commodities.

Our U.S. equity exposure was reduced from 90% to 70% in May and we added another position to European equities and a position to Commodities.  U.S. equities continue to be the dominant asset class from a relative strength perspective, but we have seen better performance from other asset classes as well this year.  Relative strength in general had a strong month in May after pulling back in March and part of April.

DWTFX gained 0.87% in May, and is up 1.07% YTD through 5/31/14.

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.

dwtfx1 May 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.  These relative strength strategies are NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.arrowfunds.com for a prospectus.

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The Case for Tactical Asset Allocation

June 4, 2014

One of the realities for a typical investor preparing for retirement is that they do not have an unlimited time for their investments to work out.  Take, for example, a 55 year old client with $1.5 million in investable assets.  Whether this investor earns a return of 4% or 8% on their portfolio over the next several decades is going to dramatically change their standard of living.  Yet, I think few clients have an appreciation for just how much variability there can be in returns to different asset classes that commonly make up a diversified portfolio.  For example, consider the variation in returns over the last couple of decades in U.S. stocks, commodities, bonds, and real estate as shown in the table below.

asset class 06.04.14 The Case for Tactical Asset Allocation

Source: Global Financial Markets and FactSet.  *Data through 5/28/14.  This example is presented for illustrative purposes only and does not represent a past recommendation.  The performance above is based on total returns, inclusive of dividends, but does not include all transaction costs.   Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. 

The column in green highlights the dispersion between the best and worst performing decade for that asset class.  There really is no such thing as stability in the financial markets!  Think about the implications that this might have on different approaches to building an asset allocation.  One approach to dealing with the amount of variability in asset class returns could be to simply equal weight exposure to a broad range of asset classes.  That may work out okay over time, but I think is susceptible the behavioral weaknesses of most investors, as pointed out in the quote below.

The problem with the person who thinks he’s a long-term investor and impervious to short-term gyrations is that the emotion of fear and pain will eventually make him sell badly. –Robert Wibbelsman

A tactical approach to asset allocation, driven by a relative strength, has a number of potential performance and client management advantages over many alternative approaches to asset allocation.  As shown in the images below, a trend following approach to asset allocation seeks to identify and overweight those asset classes that are in favor and to underweight those asset classes that are out of favor.

arrow trend following The Case for Tactical Asset Allocation

Source: Arrow Funds

One of the developments over the past decade that has made a tactical approach to asset allocation even more accessible to individual investors is the expansion of the ETF universe to include a broad range of asset classes like U.S. equities, international equities, currencies, commodities, real estate, and fixed income.

To learn more about our “Global Macro” approach to asset allocation, please click here.

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

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Maintaining Flexibility

May 23, 2014

Morgan Housel recently shared an excellent way to think about one of the biggest challenges facing investors—failure to think outside their own viewpoint:

Statistics genius Nate Silver spoke at a conference in Seattle a few weeks ago. He made a point that stuck with me. Radar technology was in its infancy in the early 1940s. To protect U.S. interests like the Pacific Fleet in Pearl Harbor, Navy planes circled the Hawaiian Islands, searching for threats. “You were just sending a couple of planes that would go around a circumference until they ran out of fuel and then head back to base,” Silver said.

Alas, the Japanese military knew exactly how large that circumference was, and in November, 1941, sent its aircraft carriers just beyond the range our reconnaissance planes could fly. On December 7th, it attacked.

“My point is that everyone has a viewpoint,” Silver said, and that viewpoint usually shows just a fraction of the whole picture. There are important events sitting outside your viewpoint that, if you knew about them, would totally change how you view the world.

There’s a similar problem with investors and history. Your view of history is heavily influenced by your own experiences. But just like the Navy, your own experiences are an incomplete view of the world, arbitrarily blocked by when and where you were born — the equivalent of reconnaissance planes with limited fuel range. There are important events sitting outside your viewpoint that, if you experienced them, would totally change how you view the world.

This has important implications for how to design an asset allocation.  If one looks at too narrow a slice of history when determining the exposure constraints for different asset classes an investor could easily optimize those constraints to fit just that last 20 or 30 years.  Depending on what 20 or 30 year period you look at you may wish you had more exposure to U.S. equities, International equities, Inverse Equities, Currencies, Commodities, Real Estate, or Fixed Income.  Since none of us have a crystal ball to know which asset classes will be most rewarding over the next 20-30 years, it makes sense to maintain flexibility.  This is precisely the reason that we have given ourselves so much flexibility in The Arrow DWA Tactical Fund (DWTFX), which we sub-advise.

The Arrow DWA Tactical Fund (DWTFX) invests in various asset classes and market segments exhibiting positive relative strength.  In essence, the model works by reallocating to various market segments in response to the changing patterns of returns available in the global markets.  The table below shows the Fund’s potential allocation ranges.

dwtfx Maintaining Flexibility

Source: Arrow Funds

Investors may greatly benefit by not painting themselves into a corner when it comes to asset allocation.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.arrowfunds.com for a prospectus for DWTFX.

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Systematic RS International Portfolio

May 22, 2014

International equities continue to rank just behind U.S. equities in Dorsey Wright’s Dynamic Asset Level Investing (DALI) tool, reflecting this asset class’s favorable relative strength.  DALI, one of the most widely used tools on Dorsey Wright’s research database, provides a clear way for investors to identify leadership from an asset class perspective.  While most investors are likely to have some portion of their overall asset allocation always exposed to International equities, those advisors who look to provide a tactical overlay may seek to overweight those asset classes with the best longer-term relative strength and to underweight those with the weakest relative strength.

dali 05.22.14 Systematic RS International Portfolio

Source: Dorsey Wright.  This example is presented for illustrative purposes only and does not represent a past recommendation.

One way that advisors may consider gaining exposure to International equities is through our Systematic RS International portfolio (available as a separately managed account).  We have been managing this strategy since March 31, 2006 and it is an area where we have been able to generate some meaningful outperformance over time.

Intl perf Systematic RS International Portfolio

Source: Dorsey Wright, March 31, 2006 – April 30, 2014.  The performance above is based on total returns, inclusive of dividends and transaction costs.  Investors cannot invest directly in an index.  Indexes have no fees. 

As shown above, this strategy has outperformed its benchmark by 4.19% annually on a net basis since its inception, over eight years ago.  A description of the strategy is found below:

The Dorsey Wright Systematic RS International strategy seeks to provide long-term capital appreciation through exposure to international equities, primarily using American Depository Receipts (ADRs).

The strategy holds approximately 30-40 equities that demonstrate, in our opinion, favorable relative strength characteristics.  The strategy is constructed pursuant to Dorsey Wright’s proprietary macroeconomic sector ranking and individual stock rotation methodology.

This strategy is uniquely positioned from an investment opportunity perspective because it is not limited by style (value or growth), investment capitalization (small, mid or large), or even classification of international market (emerging or developed).  Rather, the Systematic Relative Strength International strategy is allowed the flexibility to seek out strong trends wherever they may be found within our universe of International equities.

The allocation of this portfolio is currently tilted towards developed international markets, as shown below:

Intl alloc 05.22.141 Systematic RS International Portfolio

Source: Dorsey Wright

Relative strength works all over the world!  We certainly aren’t experts in analyzing the financials of foreign companies, but price is universal.  With a relative strength strategy, you can succeed in many different markets and asset classes without specialized knowledge of the fundamentals of each country.  Click here to see where this separately managed account is currently available.  E-mail andy@dorseywright.com or call 626-535-0630 to receive the brochure for this portfolio.

The performance represented in this brochure is based on monthly performance of the Systematic Relative Strength International Model.  Net performance shown is total return net of management fees for all Dorsey, Wright & Associates managed accounts, managed for each complete quarter for each objective, regardless of levels of fixed income and cash in each account.  The advisory fees are described in Part II of the adviser’s Form ADV.  The starting values on 3/31/2006 are assigned an arbitrary value of 100 and statement portfolios are revalued on a trade date basis on the last day of each quarter.  All returns since inception of actual Accounts are compared against the MSCI EAFE Total Return Index.  The MSCI EAFE Total Return Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the United States and Canada and is maintained by MSCI Barra.  A list of all holdings over the past 12 months is available upon request.  The performance information is based on data supplied by the Manager or from statistical services, reports, or other sources which the Manager believes are reliable.

There are risks inherent in international investments, which may make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities.

Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey, Wright & Associates.

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Adaptive Asset Allocation

May 14, 2014

Vitaliy Katsenelson in Institutional Investor doesn’t mince words when it comes to Modern Portfolio Theory (MPT):

Teachers will teach what is teachable; they’ll default to solving a mathematical equations (while stuffing it with arbitrary numbers for the most part), because that is what they know how to do.  They can learn MPT by reading their predecessors’ textbooks, and therefore that is what they’ll teach, too.  The beauty of MPT, at least from a teaching perspective, is that it turns investing into a math problem, with elegant equations that always spit out precise, albeit random numbers.

But please don’t tell anyone I said this, because as an investor I’d love for MPT to be taught starting in kindergarten.  It would make my job easier: I’d be competing against imbeciles who still believe the world is flat.  However, as a well-wishing person dispensing advice, I’d say, spend as little time as you can studying MPT.

Among the more dubious assumption in MPT are that correlations between assets are fixed and constant forever and that the volatility of an asset is known in advance and is also constant.  Yea, about that…  See below for a chart that is a couple years old, but the point should be pretty clear—correlations change!

rex2 Adaptive Asset Allocation

Source: Rex Macey, Investments & Wealth Monitor

The five-year correlation between domestic large stocks (Russell 1000) and the MSCI EAFE index varied but never exceeded 0.6 from the start of the dataset until the late 1990s.  Consultants used this data to argue for international diversification.  Who would have expected based on historical data that the correlation would rise to the 0.9 level matching the correlation of large U.S. stocks with small U.S. stocks?  I suspect those relying on international diversification were quite disappointed.

It has been estimated that there is some $7 trillion invested in accordance with the tenets of MPT, so this is far from being just an academic exercise.

So, what’s the alternative?  How about Tactical Asset Allocation for one.  Rather than relying on an approach to asset allocation that makes assumptions about how the future should look, why not embrace a tactical approach to asset allocation that is designed to adapt?  Correlations can change, variances can change, and returns can change and tactical asset allocation still has the potential to produce favorable returns over time.

Click here to read an FAQ on our Global Macro strategy, which provides a truly tactical alternative to MPT.

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Global Macro FAQ

May 14, 2014

Systematic RS Global Macro Strategy

Frequently Asked Questions

What is the investment objective of the strategy?  The strategy seeks to achieve meaningful risk diversification and investment returns.  The historical correlation of this strategy to every major asset class has been relatively low over time.  Our global macro strategy is uniquely positioned from an investment opportunity perspective because it is not limited to a specific market.

What asset classes are represented in the strategy?  The strategy is designed to invest in the following asset classes:  Domestic Equities (long & inverse), International Equities (long & inverse), Fixed Income, Real Estate, Currencies, and Commodities.  Exposure to each of these areas is achieved through ETFs.

How are the investments selected?  The strategy holds approximately ten ETFs that demonstrate powerful relative strength characteristics.  The strategy is constructed pursuant to Dorsey Wright’s proprietary basket ranking and rotation methodology.

How is this different from strategic asset-allocation?  We do not approach the asset allocation from a strategic standpoint. Instead, we implement a tactical approach. Our tactical overlay is designed to own the areas of the market exhibiting the greatest relative performance and avoid or use inverse funds for the weakest areas. You can expect the weightings to change over time!  When, for example, domestic equities are performing poorly our tactical process will avoid or use inverse funds in these areas or favor an area with better relative performance, like fixed income.  We make changes to the investment mix as markets and leadership change. The portfolio is designed to be quite responsive to emerging strength.

How do all these processes come together?  The investment strategy is 100% systematic. We have designed our processes to remove the portfolio managers’ emotions and biases, which are detrimental to superior long-term performance.

How is risk managed in the portfolio?  Our investment process is designed to systematically rotate the portfolio into the strongest asset classes and individual alternatives within those asset classes. If an asset class is performing poorly the tactical asset allocation overlay will avoid or use inverse funds in that area and buy an asset class with better relative strength.  There is a stop, based on the relative strength ranking, on each holding. The asset classes used in the portfolio are not typically highly correlated, so that our investment guidelines provide enough latitude to deliver solid returns in a variety of market conditions.

Will the portfolio ever go to cash?  Our investment universe includes ETFs that represent the shorter-term sector of the United States Treasury market.  So, yes, we can effectively allocate a portion of the account to cash if that is where the best relative strength is found.

What is the average annual turnover?  The portfolio is designed to rapidly adapt to changing market conditions.  As a result, there might be more realized gains and losses during periods when asset class leadership is changing, and fewer realized gains and losses when there is stable leadership.  The average annual turnover has been approximately 250% over time.  With 10 positions in the portfolio, that represents an average of 25 swaps per year.

What is an ETF? An exchange-traded fund is an investment vehicle traded on a stock exchange, much like a stock.  ETFs offer public investors an undivided interest in a pool of securities and other assets and thus are similar in many ways to traditional mutual funds.  An ETF holds assets such as stocks, bonds, currencies, commodities, or futures contracts on commodities and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day.  ETFs are attractive investments because of their low costs, tax efficiency, and stock-like features.

Will you be investing in all of the ETFs?  We have a rigorous process to determine what ETFs we will evaluate for our portfolios. There are many ETFs that are duplicative or not suitable for the investment strategy we are using in this portfolio, and we do not consider these for purchase in the fund. As new ETFs come to market we are committed to evaluating their investment merits and the effect they might have on our investment strategy. Any new ETFs will need to meet the same stringent criteria as existing ETFs for consideration in the portfolio.

For more information about this strategy, please e-mail andy@dorseywright.com.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any se­curity. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright & Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if neces­sary, seek professional advice.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Relative Strength is a measure of price momentum based on historical price activity.  Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC.  To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

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April Arrow DWA Funds Review

May 8, 2014

4/30/2014

The Arrow DWA Balanced Fund (DWAFX)

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

After a number of allocation changes in March, the fund had no changes in April.  One of the asset classes with the most changes in 2014 has been alternatives—commodities and real estate have been particularly strong after being quite weak in 2013.  Our position in MLP’s was our best performing holding in April.  We also generally had good performance from our European equity positions.  Interest rates fell in April, helping bonds also produce some positive gains.  The weakness in April came from our U.S. equity exposure—particularly our small cap exposure.  While 2013 tended to favor more concentrated asset allocation strategies, 2014 has been a year with more cross-currents and diversified asset allocation strategies, like this one, have been able to dampen much of the volatility.

DWAFX lost 0.20% in April, but is up 0.34% YTD through 4/30/14.

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 April Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

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

One of the dominant themes in 2013 was the outperformance of U.S. small cap stocks.  DWTFX had a lot of exposure to small caps last year and this was part of the reason that the fund performed well in 2013.  That trend continued through February of this year, but in March and April we have seen sharp underperformance of small caps.  While our buy and sell criteria for the fund are not based on short-term relative strength signals, small caps have dropped in our ranks and if this trend continues it is likely that we will see some changes to the fund in the coming weeks.  Our European equity exposure was a bright spot for the fund in April as it added to its gains for the year.  Asset classes like commodities and real estate continue to see improvement and, if it continues, may be areas where we add exposure in the coming weeks.

DWTFX lost 0.96% in April, but is up 0.19% YTD through 4/30/14.

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 April 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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Dorsey Wright Managed Accounts

May 2, 2014

Picture1 Dorsey Wright Managed Accounts

Our Systematic Relative Strength portfolios are available as managed accounts at a large and growing number of firms.

  • Wells Fargo Advisors (Global Macro available on the Masters/DMA Platforms)
  • Morgan Stanley (IMS Platform)
  • TD Ameritrade Institutional
  • UBS Financial Services (Aggressive and Core are available on the MAC Platform)
  • RBC Wealth Management (MAP Platform)
  • Raymond James (Outside Manager Platform)
  • Stifel Nicolaus
  • Kovack Securities
  • Deutsche Bank
  • Charles Schwab Institutional (Marketplace Platform)
  • Sterne Agee
  • Scott & Stringfellow
  • Envestnet UMA
  • Placemark
  • Scottrade Institutional
  • Janney Montgomery Scott
  • Robert W. Baird
  • Prospera
  • Oppenheimer (Star Platform)
  • SunTrust
  • Lockwood

Different Portfolios for Different Objectives: Descriptions of our seven managed accounts strategies are shown below.  All managed accounts use relative strength as the primary investment selection factor.

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

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

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

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

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

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

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

Picture2 Dorsey Wright Managed Accounts

To receive fact sheets for any of the strategies above, please e-mail Andy Hyer at andy@dorseywright.com or call 626-535-0630.  Past performance is no guarantee of future returns.  An investor should carefully review our brochure and consult with their financial advisor before making any investments.

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Lost Decades

April 24, 2014

How concerned should investors be about the possibility of have a 10-year stretch with negative equity returns? RPSeawright addresses this all-important question for retirees or near-retirees:

A Journal of Financial Perspectivespaper from last summer considers how unusual it really is for equity markets actually to “lose a decade.” As it turns out, lost decades of this sort are not the exceptional episodes that only very rarely interrupt normal steady economic growth and progress that so many seem to think.

In the paper, Brandeis economist Blake LeBaron finds that the likelihood of a lost decade — as assessed by the historical data for U.S. markets via a diversified portfolio — is actually around 7 percent (in other words, about 1 in 14). Adjusting for inflation (using real rather than nominal return data) makes the probability significantly higher (more like 12 percent, nearly 1 in 8). The chart below (from the paper) shows the calculated return (nominal in yellow, real in dashed) for ten-year periods over the past 200+ years, and shows six periods in which the real return dips into negative numbers.

lost decades Lost Decades

So a “lost decade” actually happens fairly frequently. As LeBaron summarizes:

The simple message here is that stock markets are volatile. Even in the long-run volatility is still important. These results emphasize that 10-year periods where an equity portfolio loses value in either real or nominal terms should be an event on which investors put some weight when making their investment decisions.

And that is why demand for global tactical asset allocation strategies remains high.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is no guarantee of future returns. Potential for profits is accompanied by possibility of loss.

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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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