State of the Market With 200 Day Moving Average

May 14, 2015

One well-recognized method of assessing the overall direction of the market is comparing the S&P 500′s current price to its 200 day moving average.  If the S&P 500 is above its 200 day moving average, it suggests a lower risk environment for the broad market.  If the S&P 500 is below its 200 day moving average, it suggests a higher risk environment for the broad market.  As the adage goes, the trend is your friend.  Being prepared to play defense when in a higher risk environment has the potential to help mitigate severe declines for investors.  Consider the following charts of the S&P 500 and its 200 day moving average since 1950 and the second chart showing it since 2000.

sp lt State of the Market With 200 Day Moving Average

sp2 State of the Market With 200 Day Moving Average

Source: Yahoo! Finance.  *10/18/1950 – 5/12/2015.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  Investors cannot invest directly in an index.  Indexes have no fees.  

Since 1950, the S&P 500 has been above its 200 day moving average 70% of the time.  That means that 30% of the time it was below its 200 day moving average and there were some pretty hairy markets during those times.  Consider the range of trailing 12 month performance of the S&P 500 over this period of time:

12 month State of the Market With 200 Day Moving Average

Source: Yahoo! Finance.  10/18/1950 – 5/12/2015.  The performance above is based on pure price returns, not inclusive of dividends or all transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  Investors cannot invest directly in an index.  Indexes have no fees.  

During some 12 month periods, the S&P 500 had spectacular returns—even approaching and exceeding 60%.  However, there were also plenty of trips into negative territory, with a number of them falling 20+%.

What does this mean for your clients?  Well, it depends upon the client.  If a particular client’s time horizon is really long and their tolerance for draw downs is high, then a passive approach to investing may work just fine.  However, most clients would prefer to have the ability to play some defense, especially if they planning on tapping into their nest egg in the near future.

One of the nice features of the 5 Virtus funds that Dorsey Wright was recently hired to manage is that they all have the ability to play defense in a meaningful way.  Each of the funds implement defensive measures in a slightly different way, but the 200 day moving average is a key component in all 5 of the funds.

To learn more about each of the funds, please click here to access the fact sheets and accompanying How It Works sheets.

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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Tactical Diversification in Global Multi-Asset Portfolios

May 4, 2015

Dorsey Wright’s systematic macro approach to portfolio construction empowers momentum and relative strength versus forecasting and market timing. With tactical diversification and enhanced returns as the goal, advisor interest in these global strategies has surged. Join us for this webcast with on Tactical Diversification in Global Multi-Asset Portfolios.  Replay of this webcast is available here.

arrow Tactical Diversification in Global Multi Asset Portfolios

Sponsors of this webcast may contact registrants. This webcast is for financial professionals only.

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Market Timing vs. Global Tactical Allocation

March 17, 2015

The Irrelevant Investor takes a look back at rolling 6 and 10-year returns for the U.S. stock market:

6 Market Timing vs. Global Tactical Allocation

10 Market Timing vs. Global Tactical Allocation

Where Do Stocks Go From Here?

After six years of virtually uninterrupted gains, people are wondering where we go from here.

Stocks are up more than 200% over the last six years which is the best six-year run since the tech bubble. Looking at the chart, we see that we are well above the 85% historical average. Once stocks have achieved this level of success, returns going forward have declined.

There have been 54 prior periods where six year returns were greater than 200%. The average return over the next three years was 9% (median 20%) compared with an average historical three-year return of 38%. Furthermore, following these strong runs, we have seen negative three-year returns 35% of the time compared with the 17% negative three-year returns that we have seen historically. So, three-year returns following such a strong run have been one quarter of the average three-year return with negative returns occurring twice as often as we have seen historically.

While there might be reason to be cautious looking back over the last six years, when we take a step back the picture starts to change. Over the last ten years, stocks have gained 115% which is just 60% of the historical average ten-year return of 192%.

This type of observation can lead an investor to believe that a choice needs to be made.  Given the run that we have had over the past 6 years, should we preemptively reduce equity exposure?  Or, should we view the future through the lens of having a sub-par decade and therefore stay exposed to equities with the expectation that they may continue to rise from here?

The advantage of using a global tactical asset allocation strategy for a healthy portion of a client’s allocation is that they can let relative strength make this decision for them rather than engage in the fruitless game of forecasting.  The stress of trying to make the right call is taken off the table.  Relative strength may not (and, in fact, will not) always be right.  However, it does allow an investor to participate in long-term trends and when it is wrong, it will not stay wrong.

Market timing is very different than global tactical allocation.  The former relies heavily on the luck of getting calls right and entails a large risk of devastating investment results.  The latter is pragmatic and disciplined and, we believe, likely to result in favorable investment results over time.

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

HT: Abnormal Returns

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Market Timing with CAPE

March 5, 2015

How worried should you be when you hear someone say that the market is overvalued?

Wesley Gray at Alpha Architect takes a deep dive into the topic of timing the market using CAPE, Shiller’s Cyclically Adjusted PE ratio in a recent post.  His results should give pause to even he most strident market timing fundamentalist.  He also looked at market timing using simple trend following (trend following performed better!).  His methods are described below (study covered the period 1/1/1947 – 1/31/2015):

To create our “valuation-timing” indicator, every month we identify the 99 percentile valuations using rolling 5-, 10-, and 20-year look-back periods. Our trading rule is simple: if the current market valuation is greater or equal to the 99 percentile measure, we invest in the risk-free rate (short-term treasury bills), otherwise, we stay invested.

We compare the valuation-timing indicator to a monthly-assessed simple moving-average (MA) trading rule, and a buy-and-hold strategy. The buy-and-hold strategy is straightforward, and the MA indicator is simple: if the current market price is lower than the 12 month moving average, we invest in the risk-free rate (short-term treasury bills), otherwise, we stay invested.

Our conclusion is counterintuitive, but not entirely surprising:

Strategy Legend:
  • SP500 = S&P 500 Total Return Index
  • LTR = The Merrill Lynch 10-year U.S. Treasury Futures Total Return Index
  • Rolling 5 year 99perc CAPE= Timing signal uses the 99th percentile valuation metric using rolling 5 year look-back periods.
  • Rolling 10 year 99perc CAPE = Timing signal uses the 99th percentile valuation metric using rolling 10 year look-back periods.
  • Rolling 20 year 99perc CAPE= Timing signal uses the 99th percentile valuation metric using rolling 20 year look-back periods.
  • (1,12) MA= If last month’s price is above the past 12 month average, invest in the S&P 500; otherwise, buy U.S. Treasury Bills (RF).

alpha architect Market Timing with CAPE

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Conclusion

There is no evidence to support the use of “valuation-timing,” which performs similarly to buy-and-hold strategies (after costs it would we much worse). There is nothing magical about the 99th percentile. Trend-following, at least historically, seems to more effective.

Perhaps there are more convoluted, complex, and data-optimized ways in which we can leverage overall market valuations to help us time markets. We haven’t found any, but that doesn’t mean they don’t exist. Please share.

Pretty shocking results.  If you can’t even successfully identify overvalued markets when a market is in the 99th valuation percentile, then why even pay any attention to valuation measures at all?  If someone wants to be bearish, there is always some seemingly plausible reason and CAPE valuation measures are an often-cited reason.  However, Gray’s study is a solid takedown of the idea that CAPE can be effectively used as a way to get out of the market at the right time.  As pointed out in his study, a simple trend following method worked better.  Perhaps, an even more promising approach is a relative strength-driven Tactical Asset Allocation strategy as is detailed in this white paper by our own John Lewis.

I agree with a recent tweet by Cullen Roche:

FYI, no one knows how “expensive” the market really is or how “expensive” it really should be.

A reality that investors would do well to embrace.

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

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Global Macro: 2015 Market Outlook

February 18, 2015

The replay to the Global Macro 2015 Market Outlook webinar can be accessed by clicking here.  Andy Hyer of Dorsey Wright Money Management and Jake Griffith, President of Arrow Funds, present our Global Macro portfolio.  This strategy is now available as a separately managed account, UMA (Wells Fargo Masters and DMA platforms), mutual fund (Arrow DWA Tactical Fund, DWTFX), and as an ETF (Arrow DWA Tactical ETF, DWAT).  This strategy, now approaching 6 years since inception, continues to resonate with clients who are looking for flexible global asset allocation and who are looking to grow their money, but do so with an eye on risk management.

gm Global Macro: 2015 Market Outlook

The 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 and www.arrowshares.com for a prospectus.  Dorsey Wright is the signal provider for DWTFX and DWAT.  An investor should consider the Funds’ investment objective, risks, charges, and expenses carefully before investing. This and other information is contained in the Funds’ prospectus, which can be obtained by calling 1-877-Arrow-FD (877-277-6933). Please read the prospectus carefully before investing. Arrow Funds are distributed by Archer Distributors, LLC (member FINRA). ArrowShares are distributed by Northern Lights Distributors, LLC (member FINRA). Arrow Investment Advisors and Northern Lights Distributors are unaffiliated entities. This message is for the designated recipient only and may contain privileged, proprietary, or otherwise private information. If you have received it in error, please notify the sender immediately and delete the original. Any other use of the email by you is prohibited.   Dorsey Wright is the signal provider for the Arrow DWA Tactical Fund.

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Why Tactical Asset Allocation?

February 18, 2015

From Ben Carlson, comes one reason:

Japanese stocks Why Tactical Asset Allocation?

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DWAT in the News

February 17, 2015

From ETF Trends:

A growing number of exchange traded funds launched over the past year are using the ETF of ETFs approach, meaning these funds are comprised of other ETFs.

The Arrow DWA Tactical ETF (DWAT) is one such fund. The Arrow DWA Tactical ETF is Arrow’s first actively managed ETF and second ETF after the popular Arrow Dow Jones Global Yield ETF (GYLD) .

Importantly, DWAT’s ETF of ETF approach is working for investors. The ETF has slightly outpaced the S&P 500 this year and touched a new high last Friday. The actively managed DWAT, which has an annual expense ratio of 1.52%, “seeks to achieve its investment objective by implementing a proprietary Relative Strength (RS) Global Macro model managed by Dorsey Wright & Associates (DWA),” according to ArrowShares. DWAT came to market last October. [ArrowShares Adds a Second ETF]

The combination of active management and a methodology rooted in relative strength allows DWAT to build a diversified portfolio of well-known, and more importantly, strong performing ETFs. For example, the Health Care Select Sector SPDR (XLV) , the largest health care ETF, is currently DWAT’s largest holding at a weight of nearly 13.7%.

With a combined 19.7% weight to the iShares Cohen & Steers Realty Majors (ICF) and the SPDR Dow Jones REIT ETF (RWR) , DWAT offers ample leverage to a low interest rate environment. However, that does not imply DWAT is vulnerable to rising interest rates.

The Technology Select Sector SPDR (XLK) and the Financial Select Sector SPDR (XLF) have been two of the sturdier performers at the sector level as 10 -year Treasury yields have recently jumped. Additionally, XLF and XLK give DWAT a bit of a value tilt because financials and technology are two of the more attractively valued sectors relative to the S&P 500. [High Beta ETFs Time to Shine]

Conversely, DWAT does not hold richly valued consumer staples, energy or utilities sector ETFs. DWAT has another advantage that makes the ETF worth considering if equity markets retreat: The fund can also invest up to 30% in inverse U.S. equity exposure in the event of a prolonged market drawdown,” according to a statement issued by ArrowShares.

The Vanguard Mid-Cap Value ETF (VOE) and the Materials Select Sector SPDR (XLB) were DWAT holdings when the ETF first came to market, but DWAT has since parted ways with those funds.

Arrow DWA Tactical ETF

dwat1 DWAT in the News

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  See www.arrowshares.com for more information.  Dorsey Wright is the signal provider for DWAT.

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The Move to Tactical Fixed Income

February 10, 2015

The WSJ recently took notice of the growing demand for unconstrained bond strategies:

Unconstrained, or “nontraditional,” bond funds took in $79 billion in new money in 2013 and 2014, or more than twice as much as all other bond funds combined, according to Morningstar, the investment research firm.

It isn’t hard to see why. With the 10-year U.S. Treasury yielding less than 2%, barely better than inflation, trying to invest for income nowadays is like trying to find a good plate of prime rib at a vegan food convention. And if the Fed stays true to its word and raises interest rates sometime this year, the future could be even worse. A one-percentage-point rise in rates would cause a 5.5% fall in the price of funds that track the Barclays Aggregate, based on the “duration,” or interest-rate sensitivity, of the index.

With unconstrained bond funds, say portfolio managers, you can do better.

At Dorsey Wright, we believe that this category of unconstrained bond strategies will continue to become more important to investors in the years ahead. In March of 2013, we introduced our “Tactical Fixed Income” separately managed account and we have been very happy with the results since inception. Performance and holdings are shown below:

tfi performance The Move to Tactical Fixed Income

Performance 3/31/13 – 1/31/15

tfi hldgs The Move to Tactical Fixed Income

Holdings as of 2/10/15

For more information about this strategy, please see the FAQ’s below:

Why is there a need for Tactical Fixed Income?

Bond buyers face a dilemma. Yields are very, very low (and have recently been going even lower). If interest rates stay low this low, bondholders are facing minimal returns, all the while having those returns eaten away by inflation. If interest rates rise, bondholders are facing potentially significant capital losses. Both outcomes, obviously, are problematic. This situation demands a tactical solution that can manage through either outcome.

At Dorsey Wright, we have taken our time-tested relative strength tools and have applied them in a unique way to the fixed income markets. This solution is now available as a separately managed account. We think it will be welcome news for bond holders and prospective bond buyers who are grappling with the current bond market dilemma. Equally important, we think it will be a robust solution in the future across a broad range of possible interest rate environments.

What is the investment universe for the Tactical Fixed Income strategy?

The Tactical Fixed Income strategy can invest in short-term and long-term U.S. Treasurys, inflation-protected bonds, corporate, convertible, high yield, and international bonds. This is a broad universe of fixed income types that have varying yields and volatility characteristics.

How is the risk managed in the Tactical Fixed Income portfolio?

The Tactical Fixed Income model structures the portfolio in a way that balances risk and reward. Certain types of fixed income behave better in “risk-on” environments, while other fixed income categories are more defensive. Our model is built to ensure that the portfolio remains diversified. It’s very important to understand that this is designed as core fixed income exposure. We’re trying to generate good fixed income returns, without creating equity-like volatility.

Our model compares the relative strength of all of the ETFs in the investment universe. Those fixed income sectors exhibiting the strongest trends will be represented in the portfolio.

How does the strategy handle a rising rate environment?

Although the general trend of interest rates has been down over the past three decades, there have been periods where rates have generally risen. The period of mid-2003 to mid-2007 was generally a period of rising interest rates, while the period of mid-2007 to present has generally been a period of declining interest rates. Sectors like long term government bonds tend to perform much better in a declining interest rate environment while sectors like convertible bonds tend to perform much better during rising rate environments.

Our Tactical Fixed Income strategy is designed to be adaptive and seeks to add value in both environments.

Will the strategy invest in inverse bond ETFs?

We do not use inverse bond ETFs in the portfolio due to the cost of carrying the short positions, which includes the management fees of the ETFs as well as paying out the interest payments while you own these funds. However, a rising rate environment typically is accompanied by a strong economy. We do have ample ability to have exposure to sectors of the fixed income market, like high yield, international, and convertible bonds, that may perform well during these environments.

What is the turnover of the Tactical Fixed Income strategy?

Adapting to different fixed income environments is the nature of the Tactical Fixed Income strategy. We built the strategy to be robust across the spectrum of bond market environments. The model typically has about twenty swaps a year. Our model selects approximately six ETFs to be held in the portfolio and each position remains in the portfolio only as long as it retains strong relative strength. We have a disciplined relative strength process in place to replace any positions that weaken beyond an acceptable level.

To receive the fact sheet for this portfolio please e-mail andy@dorseywright.com or call 626-535-0630.

Net performance shown is total return net of management fees for all Dorsey, Wright & Associates accounts, managed for each complete quarter for each objective. The advisory fees are described in Part II of the adviser’s Form ADV. All returns since inception of actual Accounts are compared against the Barclays Aggregate Bond Index. 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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Arrow DWA Tactical Receives 4 Star Morningstar Rating

February 6, 2015

The Arrow DWA Tactical Fund A-Share Load Waived and Institutional Share are now both 4 Star Morningstar Rated Overall with a 5 Star Rating for 3 Years and 4 Star Rating for 5 Years.

dwtfx Arrow DWA Tactical Receives 4 Star Morningstar Rating

Source: Morningstar, 2/6/15

See www.arrowfunds.com for a prospectus.

An investor should consider the Funds’ investment objective, risks, charges, and expenses carefully before investing. This and other information is contained in the Funds’ prospectus, which can be obtained by calling 1-877-Arrow-FD (877-277-6933). Please read the prospectus carefully before investing. Arrow Funds are distributed by Archer Distributors, LLC (member FINRA). ArrowShares are distributed by Northern Lights Distributors, LLC (member FINRA). Arrow Investment Advisors and Northern Lights Distributors are unaffiliated entities. This message is for the designated recipient only and may contain privileged, proprietary, or otherwise private information. If you have received it in error, please notify the sender immediately and delete the original. Any other use of the email by you is prohibited.   Dorsey Wright is the signal provider for the Arrow DWA Tactical Fund.

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Global Macro: Relative Strength-Driven Asset Allocation

January 27, 2015

In an ideal world, retirement planning could be simplified into the old saying “It’s not timing the market that makes all the difference, it’s time in the market.”  That seems like such a prudent statement, doesn’t it?  After all, timing the market conjures up images of undisciplined and emotion-driven allocation shifts in and out of the market, hopelessly trying to capture all of the up, but none of the down.  Since nobody can time the market, why not just build a nicely diversified portfolio, rebalance once a year, and be done with it?  Won’t that lead to fairly steady results and ultimately reaching your retirement goals?  That is a nice theory, but I don’t believe that it holds up to reality.  The problem with the static allocation approach, I believe, is as follow:  It is not clear what the appropriate asset mix should be for a static allocation.  One might look at 50 years worth of data and conclude that the static allocation should be 40% U.S. Equity, 20% International Equity, 30% Fixed Income, and 10% Commodity exposure.  However, looking at 50 years worth of data is one thing.  Having an appreciation for just how much variability there can be, decade to decade, in asset class returns, volatilities, and correlations can be an entirely different thing.  If asset classes go through bull and bear markets, and they do, will investors have enough patience and tolerance for losses to stay the course?  Some will, and over the course of 30 to 50 years, I suspect that some percentage of extremely patient clients will do just fine.  However, most investors will make emotion-driven changes to their allocations.  They will swear off Fixed Income in 1982.  They will get bullish on Commodities in June 2008.  They will give up on U.S. equities in March 2009.  They will give up on European equities in 2011….and on and on.  The Dalbar numbers are what they are for this very reason.

Less quantitatively, the problem with the static allocation approach can be seen in the following picture.  One would like to believe that an investor could adhere to a static allocation / annual rebalance approach (“Your plan”) and steadily make progress towards your financial goals–kind of like a bank making monthly interest payments to your savings account.  However, actual markets (“Reality”) are very different.  Asset classes go out of favor for years, and even decades, at a time.  There can be spectacular stretches of capital gains and there can be  excruciatingly painful periods of market losses.

plan thinkingip1 Global Macro: Relative Strength Driven Asset Allocation

Source: @ThinkingIP

Thus, the need for a tactical approach to asset allocation.  Let me be clear, I in no way advocate an undisciplined approach to asset allocation—what many think of when they think of market timing.  Such an approach is very likely to perform substantially worse that the static approach to asset allocation over time.  However, our research shows that relative strength can be an effective method of building an adaptive approach to asset allocation.

See: Tactical Asset Allocation Using Relative Strength, by John Lewis, CMT

A relative strength-driven approach to asset allocation basically allows the investor the possibility of investing in multiple asset classes, but allows for great flexibility.  When asset classes are relatively strong, they will receive exposure in the strategy.  When they are relatively weak, they will receive little or no exposure.  The exposure ranges for our Global Macro portfolio, for example, are as follows.

exposure ranges Global Macro: Relative Strength Driven Asset Allocation

Global Macro is one of our most widely used approaches to asset allocation and it is available as a separately managed account, as a mutual fund, and an ETF:

  • Separately Managed Account and UMA: Available on the Masters and DMA platforms at Wells Fargo Advisors and some 20 other firms.  E-mail andy@dorseywright.com for a fact sheet.
  • Mutual Fund: Arrow DWA Tactical Fund (DWTFX).  See www.arrowfunds.com
  • ETF: Arrow DWA Tactical ETF (DWAT).  See www. arrowshares.com

This strategy was first launched as a separately managed account on March 31, 2009.  It was later adopted in the Arrow DWA Tactical Fund (DWTFX) in August 2009.  Through 1/26/15, the Arrow DWA Tactical Fund (DWTFX) is stacking up quite well against its peers in the Morningstar Tactical Allocation category:

dwtfx1 Global Macro: Relative Strength Driven Asset Allocation

Source: Morningstar

Over the past 5 years, it has outperformed 92% of its peers; 97% of its peers over the past 3 years, 91% of its peers over the last year, and 74% of its peers so far in 2015.

Asset allocation can be flexible without being erratic and undisciplined and we believe that relative strength is the right tool for the task.

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.  Dorsey Wright is the signal provider for the Arrow DWA Tactical Fund (DWTFX) and the Arrow DWA Tactical ETF (DWAT).  See www.arrowfunds.com for a prospectus.

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DWTFX vs. Tactical Allocation Peers

January 27, 2015

Through 1/26/15, the Arrow DWA Tactical Fund (DWTFX) is stacking up quite well against its peers in the Morningstar Tactical Allocation category:

dwtfx1 DWTFX vs. Tactical Allocation Peers

Source: Morningstar

Over the past 5 years, it has outperformed 92% of its peers; 97% of its peers over the past 3 years, 91% of its peers over the last year, and 74% of its peers so far in 2015.

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.  Dorsey Wright is the signal provider for the Arrow DWA Tactical Fund (DWTFX) and the Arrow DWA Tactical ETF (DWAT).  See www.arrowfunds.com for a prospectus.

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Dorsey Wright Separately Managed Accounts

January 26, 2015

Picture1 Dorsey Wright Separately Managed Accounts

Our Systematic Relative Strength portfolios are available as separately 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

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 Separately 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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Global Macro: In Case Your Time Horizon Is Not 45 Years

December 12, 2014

Cliff Asness recently posted an excellent review of Modern Portfolio Theory (MPT) that included some very interesting charts of the return and volatility of stocks, bond, and commodities from 1970-November 2014.  Over this 45-year period of time the efficient frontier of those three asset classes was as follows:

11 Global Macro: In Case Your Time Horizon Is Not 45 Years

Probably, what most would expect.  Stocks had higher returns than bonds and commodities, with more volatility than bonds, but less volatility than commodities.  Nothing too shocking in that picture.  However, the fun really starts when you look at the efficient frontier in 5-year increments:

2 Global Macro: In Case Your Time Horizon Is Not 45 Years

3 Global Macro: In Case Your Time Horizon Is Not 45 Years

4 Global Macro: In Case Your Time Horizon Is Not 45 Years

5 Global Macro: In Case Your Time Horizon Is Not 45 Years

6 Global Macro: In Case Your Time Horizon Is Not 45 Years

7 Global Macro: In Case Your Time Horizon Is Not 45 Years

8 Global Macro: In Case Your Time Horizon Is Not 45 Years

9 Global Macro: In Case Your Time Horizon Is Not 45 Years

10 Global Macro: In Case Your Time Horizon Is Not 45 Years

Pretty shocking, huh!  The long-term (45-year in this case) average returns and volatility of stocks, bonds, and commodities tell you very little about their return and volatility characteristics in any 5-year period.  Stay the course, focus on the long term, don’t sweat the small stuff, don’t make knee-jerk reactions…all those maxims aren’t going to work with your clients.  Those aren’t calming to a client, they are offensive!  Imagine saying that to a 65-year old investor who has just retired.  This investor sits down with you, their trusted financial advisor, and takes a look at their entire portfolio.  This is all they have.  This client is not planning on going back to work.  They have worked hard to amass this money and they need it to work for them for the next few decades of their life.  If their portfolio has a devastating 5 or 10 years this is not just an inconvenience for them, this will degrade their standard of living in a major way.

This is why we are big advocates of global tactical asset allocation.  Expand the investment universe to include not just U.S. Stocks, U.S. Bonds, and Commodities, but also Real Estate, International Equities, Currencies, and even Inverse Equities.  The table below shows just how flexible our Global Macro portfolio can be.  We believe that this type of flexibility is prudent given the significant variability on display in the above efficient frontiers.

exposure ranges Global Macro: In Case Your Time Horizon Is Not 45 Years

To learn more about this relative strength-driven approach to global asset allocation, click here for a fact sheet.  This portfolio is available on the Masters and DMA platforms at Wells Fargo Advisors and on SMA platforms at many other firms.  The strategy is also available as The Arrow DWA Tactical Fund (DWTFX and DWAT).

The 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 more information.  Click here for disclosures.

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July Arrow DWA Funds Review

August 8, 2014

7/31/2014

The Arrow DWA Balanced Fund (DWAFX)

At the end of July, the fund had approximately 40% in U.S. equities, 27% in Fixed Income, 22% in International equities, and 11% in Alternatives.

We had one change in July—replaced a position in Netherlands with Taiwan.  The addition of Taiwan is the first signs of Emerging markets starting to come back into the fund.  Developed international markets have been stronger than Emerging markets for quite some time, but that is showing some signs potentially changing.  For the month, our best performing holdings were Technology, Real Estate, and Healthcare, while much of our exposure to Europe was a drag.  If we continue to see weakness in our International equity holdings, this could be an area where we see more changes in the coming weeks.

DWAFX lost 2.46% in July, and is up 0.27% YTD through 7/31/14.

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 July Arrow DWA Funds Review

The Arrow DWA Tactical Fund (DWTFX)

At the end of July, the fund had approximately 89% in U.S. equities and 9% in Real Estate.

We had a couple of trades in July—sold two of our European equity positions and Agricultural Commodities and bought Large Cap Growth, a Dividend fund, and Real Estate.  The declining relative strength of U.S. Small Caps has been one of the key changes in the fund so far this year.  We came into 2014 with 30 percent exposure to U.S. Small Caps, but now have zero.  The purchases this month reflect the continued relative strength improvement of  U.S. Large Caps.  In July, our Healthcare position and a couple of our other Large Cap  positions held up relatively well, while some of our Mid Cap and European equity positions were a drag on the portfolio.

DWTFX lost 3.12% in July, and is down 0.68% YTD through 7/31/14.

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.

dwtfx July 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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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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