With each passing year, global financial markets offer more and more choices to investors. More choice can be good, if investors have a logical framework to analyze this broad universe of securities. The Arrow DWA Tactical ETF (DWAT), which is expected to begin trading on October 1, 2014, provides a logical framework for analyzing a broad universe of investment categories and investing in those asset classes that are in favor. This fund is designed to make available a strategy that many of you use within your business already, but within a structure that was not previously available.
This new Tactical ETF can invest in the following macro asset classes:
- U.S. Equities
- International Equities
- Inverse Equities
- Real Estate
- Fixed Income
Why We Believe This ETF is Timely
While we believe this ETF is built on an investment process that will stand the test of time, we also believe it is particularly timely for investor’s needs now. After the last decade, this generation of investors has a much greater appreciation for how much variability there can be in returns of different asset classes that commonly make up a diversified portfolio. Today’s investors first ask a prospective advisor about their plan for risk management. Only if that is answered satisfactorily will they move on to other questions. Yes, they want to earn good returns, but they want to do it in a way that gives them a process for dealing with bear markets. 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%, 8%, or 12% on their portfolio over the next several decades is going to dramatically change their standard of living.
How DWAT Manages Risk
All asset classes go through secular bull and bear markets. For example, Commodities as measured by the Goldman Sachs Commodity Index (GSCI) had an annualized return of 21% in the 1970s, but just over 3% in the 1990’s; U.S. equities as measured by the S&P 500 had an annualized return of 18% in the 1990s, but -1% in the 2000s. Bonds have also had wide fluctuations in returns from one decade to the next. Flexibility in an asset allocation strategy is key to keeping clients invested in the markets and working towards achieving their financial goals.
This ETF holds approximately 10 ETFs that demonstrate favorable relative strength characteristics. 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.
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. Our investment process can be summarized in the diagram below. First, we categorize a broad investment universe into asset class baskets so that we can identify which asset classes we want to own.
Then, we rank all the individual ETFs in our universe. That ranking determines what we buy and when we will sell a current holding. Holdings will only remain in the ETF as long as they remain sufficiently highly ranked in our model. In short, we let the winners run and we cut the losers out so that they can be replaced with stronger options.
Just How Flexible is the Strategy?
Exposure to the different asset classes can vary within the following bands:
Exposure may have minor fluctuations outside those bands based on market appreciation.
Currently, DWAT is heavily weighted towards US Equity, followed by Real Estate. Roughly, 91% of the fund is allocated to US Equity at this time with exposure to US sectors as well as size and style themes. The three largest holdings are currently US Sectors; Healthcare (XLV), Materials (XLB), and Technology (XLK). Outside of US Equity, Real Estate has a 8.5% position in the fund at this time, through the SPDR DJ Wilshire REIT (RWR).
Legacy of This Strategy:
While being able to access this strategy in an ETF wrapper is new, the strategy itself is not. High demand for this strategy is what has driven us to the point where we have made it available in a number of different investment vehicles. This strategy can now be employed in the following:
- Mutual Fund: Since August 2009, this strategy has been the underlying model used to manage The Arrow DWA Tactical Fund (DWTFX)
- Separately Managed Account: Under the name of Global Macro, this strategy is available on over 20 different platforms
- Unified Managed Account: Also under the name of Global Macro, this strategy is available on the Wells Fargo Masters and DMA platforms
- Exchange Traded Fund: Now, investors can easily access the Arrow DWA Tactical strategy in an ETF (DWAT).
Experience has demonstrated that this strategy resonates with investors. Investors want flexibility, risk management, and diversification. They want to make money, but they want to do it in a prudent way. This strategy is designed to be that solution.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.