Dorsey Wright Separately Managed Accounts

June 15, 2016

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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 (Opportunity Platform)
  • Kovack Securities (Growth and Global Macro approved on the UMA Platform)
  • Charles Schwab Institutional (Marketplace Platform)
  • Envestnet UMA (Growth, Aggressive, Core, Balanced, International, and Global Macro approved)
  • Fidelity Institutional

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).

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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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Relative Strength Spread

June 15, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 6/14/2016:

spread

The 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 not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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A Momentum Based Core Equity Strategy (Part 4)

June 14, 2016

To read Part 1 click here

To read Part 2 click here

To read Part 3 click here

The Core Equity strategy uses the three factor strategies discusses in Part 3.  In order to keep things as simple and non-optimized as possible I just included each model at a 1/3 weight of the total portfolio.  However, by using three different models you can adjust the weightings of each one to suit the end investor’s needs.  For example, if you needed less volatility you can just increase the weight of that model in the combined portfolio.

The Core Equity strategy is rebalanced monthly just like the individual factor models are.  Since a stock can be included in more than one of the factor models, the final model isn’t necessarily 300 stocks with equal weights.  Some stocks will have larger weights than others because they are in multiple models.  That is the only weighting difference though – there is no market capitalization or factor adjustment made to the stock weightings.

CE

In order to judge the fourth factor, size, I modified the final portfolio construction process to account for market cap.  Each stock’s market cap along with how many of the three factor models it was in was taken into account.  A mega cap stock in only one of the factor models might have a higher weight than a smaller cap stock in multiple models in this scenario.  Generally speaking, market capitalization weighting is sub-optimal for investment returns (not for capacity) and that is one big reason why Smart Beta has taken off.  We see the same thing here when we adjust for market cap.

CE2

The returns for the final Core Equity strategy add significant value over the broad market while keeping the volatility (standard deviation) close to that of the benchmark (below for a cap weight version of the Core Equity strategy).  More importantly, it helps smooth out the ride of the individual factor models.  In 1999, for example, Low Volatility was a large underperformer, but momentum was strong enough to carry the overall portfolio to strong returns.  Just two years later in 2001, the roles were reversed and it was Low Volatility and Value picking up the slack for the poor momentum returns.  You can see similar things happening in years like 2006, 2007, and 2011.  I think this point is vastly underrated because investors tend to abandon strategies at exactly the wrong times – after they have underperformed and are due for a rebound.  Combining all three factor strategies into one large Core Equity portfolio helps mask the underperformance of specific factor models and helps investors stay with underperforming strategies.

There are probably an infinite number of ways you can construct a core equity strategy using different factors.  Here, I have looked at just one that was designed to be extremely simple, non-optimized, and robust going forward.  I used some custom models to create the underlying factor models, but they shouldn’t be so dramatically different from existing ETF’s or mutual funds that something similar couldn’t be done on a smaller scale.  I’m sure there are better ways to construct the factor models and put them together in the final Core Equity strategy.  If you have any ideas about how that can be done I would love to hear them!

 

The returns used within this article are the result of a back-test using indexes that are not available for direct investment.  Returns do include dividends, but do not include transaction costs.  Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of the discussed strategy during a specific period.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight.  Dorsey, Wright & Associates believes the data used in the testing to be from credible, reliable sources, however; Dorsey, Wright & Associates, LLC (collectively with its affiliates and parent company, “DWA”) makes no representation or warranties of any kind as to the accuracy of such data. Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  

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Core/Satellite International Equity Exposure

June 14, 2016

The technical picture of the U.S. Dollar Spot Index (DX/Y) continues to show signs of weakness.  Over the past year, we have seen a series of lower lows, a trendline break in March of this year, and then a reversal to a column of O’s this month, as shown in the chart below.

dxy II

The strength or weakness of the U.S. Dollar has far-reaching effects on a variety of asset classes.  However, for investors in international equities, this U.S. Dollar weakness can actually be a welcomed development as international securities can help protect investors from a falling dollar.  All other things equal, if the currencies of the foreign markets you are invested in (i.e. Euro) strengthen while the dollar continues to fall, these investments will be worth more when converted back into dollars. What a great way to hedge the greenback.

Among the most popular ways that investors tend to get that international equity exposure is through the $60 billion iShares MSCI EAFE ETF (EFA), which provides investors with broad exposure to companies across Europe, Australia, Asia, and the Far East.  However, this ETF–like many other international equity ETFs–is weighted by capitalization.  That may be fine if the large and mega caps are generating strong returns.  However, it can be a challenge if there are better returns in small or mid cap companies.

For a variety of reasons, many advisors like to keep a core position in a capitalization-weighted ETF, like EFA.  However, see the efficient frontier below to get a sense of the potential benefits of adding an actively managed “satellite” strategy to core EFA exposure.

intl efficient frontier

Source: Dorsey Wright and Yahoo! Finance.  Period 3/31/06 – 5/31/16.  Returns include dividends.

The efficient frontier above shows the risk and return profile of different combinations of the iShares MSCI EAFE ETF (EFA) and our Systematic Relative Strength International portfolio.  As shown above, the Systematic Relative Strength International portfolio has had much higher returns over time, albeit with slightly higher standard deviation.  Deciding how to get international equity exposure doesn’t have to be a binary decision between these two strategies.  An investor may choose to make a satellite allocation to Systematic RS International.  Note that from the efficient frontier above, a 50/50 allocation between EFA and Systematic RS International had returns that were several percent higher with standard deviation that was only about 1 percent higher than EFA alone over this period of time.

Some quick facts on our Systematic RS International portfolio:

  • Inception: 3/31/2005
  • Invests in 30-40 ADRs from both emerging and developed international markets
  • Available on a variety of SMA and UMA platforms.  For example, it is available at Stifel, UBS, RBC, Envestnet, Schwab, TD Ameritrade, Fidelity, and more.

Performance is shown below:

intl performance

intl performance II

Period 3/31/05 – 5/31/16.

A core/satellite approach to international equity exposure is a popular way to construct an allocation and we believe that our Systematic RS International portfolio can be an effective way to get that satellite exposure.

For additional information about Systematic RS International, please contact Andy Hyer at 626-535-0630 or andyh@dorseymm.com.

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, commissions, and expenses 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 2A 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 NASDAQ Global ex US Index.  The NASDAQ Global ex US Index Total Return Index is a stock market index that is designed to measure the equity market performance of global markets outside of the United States and is maintained by Nasdaq.  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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A Momentum Based Core Equity Strategy (Part 3)

June 13, 2016

To read Part 1 click here

To read Part 2 click here

I am using three different factor strategies (Momentum, Low Volatility, and Value) to form a Core Equity strategy.  A fourth factor, Size, will also be considered in the portfolio construction process (equal weighted instead of cap weighted).

All three of the factor strategies are constructed in a similar way.  The universe is the top 1000 market cap stocks traded in the U.S.  All of these stocks should have plenty of liquidity and should eliminate a lot of the issues that occur when you are dealing with small or micro-cap stocks.  All three strategies are rebalanced at the end of each month and have 100 stocks.  The strategies are run separately so in theory a stock could appear in all three strategies (I will account for this in the final model).  In addition, all three strategies use a Point and Figure momentum overlay that was discussed in part 2.  One of the goals was to make the three factor strategies as similar as possible in terms of portfolio construction to avoid as much optimization and curve fitting as possible.  All three of the factor strategies use very simple metrics and I believe they should be robust going forward.  There will certainly be times of underperformance (sometimes dramatic underperformance) from each of the strategies, but over time they have all shown to work very well.

The momentum strategy uses a simple, well-known momentum measure with a Point and Figure relative strength overlay.  Each month stocks are ranked by their trailing 250 day performance skipping the most recent 20 days (or one month).  This is a pretty standard definition for momentum.  The Point and Figure overlay actually does help returns over time, but not anywhere near what it does for the Value and Low Volatility models.  However, I wanted to include the Point and Figure overlay to keep the momentum model similar in portfolio construction to the other two.  Momentum provides really good returns, but is really volatile.  Momentum also has the distinction of being the least correlated with the other factors so they really help smooth out the volatility of a stand-alone momentum strategy.

Mom

The Value strategy uses a composite of four value ratios to rank the stocks in the universe: Price/Sales, Price/Book, Price/Free Cash Flow, and Price/Earnings.  Again, we use a Point and Figure relative strength overlay to improve the returns and filter out some of the value traps.  The universe is the same as the momentum model as are the rebalance dates and weightings.

ValMom

The Low Volatility strategy uses the standard deviation of daily returns over the trailing year to rank stocks in the universe.  The Point and Figure overlay is also used to keep everything consistent, and the other portfolio construction parameters remain the same.

LVMom

All three models perform very well versus the broad market (S&P 500 Total Return).  They do have their bumps along the way in terms of when they outperform and underperform, but often one strategy’s underperformance is offset by outperformance in another.

FactorRet

 

The returns used within this article are the result of a back-test using indexes that are not available for direct investment.  Returns do include dividends, but do not include transaction costs.  Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of the discussed strategy during a specific period.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight.  Dorsey, Wright & Associates believes the data used in the testing to be from credible, reliable sources, however; Dorsey, Wright & Associates, LLC (collectively with its affiliates and parent company, “DWA”) makes no representation or warranties of any kind as to the accuracy of such data. Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  

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A Momentum Based Core Equity Strategy (Part 2)

June 10, 2016

To read Part 1 click here

The first post in this series laid out the background for a Core Equity strategy.  The goal is to use different factor strategies to create a more efficient portfolio than what you would get from traditional cap weighting.

The Value and Low Volatility strategies actually have a momentum component to them.  As I mentioned in the background post, we work with momentum all the time so it is easy for me to incorporate that with other factors to try and improve returns.  I realize this will lower some of the correlation benefits, but I think the potential return trade-off is worth it.

The graph below shows two versions of a Value model.  The Pure Value model selects the 100 cheapest stocks based on a composite indicator of Price/Sales, Price/Book, Price/Free Cash Flow, and Price/Earnings.  The Pure Value model below rebalances the portfolio quarterly with the 100 cheapest stocks out of a universe of the top 1000 market cap names.  The ValMom model uses the same value composite ranking system, but requires the stocks to be on a Point and Figure Buy Signal plus be in a Column of X’s.  For those of you not familiar with Point and Figure relative strength, this simply means the stock has been outperforming the broad market on an intermediate and long-term basis.

Val

You can see adding the momentum overlay to the value strategy is beneficial to returns.  Essentially, this helps filter a lot of the value traps.  More experienced Value investors have other methods to accomplish this goal, but adding the momentum overlay is something that works very well for what we do.

I did the same thing with the Low Volatility model.  This model picked 100 stocks with the lowest trailing one year daily standard deviation from a universe of 1000 top market cap names.  The portfolio was rebalanced quarterly.  Adding a momentum overlay helps ensure you have a portfolio of stocks that isn’t volatile, but has also demonstrated the ability to outperform the broad market over time.  Again, this will cut in to some of the correlation benefits of the factor strategies, but I think the return tradeoff is worth it.

LowVol

Adding the momentum overlay doesn’t improve returns as much as the Value example above, but it definitely does help.

The next post will detail the actual models I used for the factor strategies inside of the Core Equity model, but what has been discussed above is the basis for why I’m doing a couple of things differently than other models you might see and why the final model will have more of a momentum tilt.

 

The returns used within this article are the result of a back-test using indexes that are not available for direct investment.  Returns do include dividends, but do not include transaction costs.  Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of the discussed strategy during a specific period.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight.  Dorsey, Wright & Associates believes the data used in the testing to be from credible, reliable sources, however; Dorsey, Wright & Associates, LLC (collectively with its affiliates and parent company, “DWA”) makes no representation or warranties of any kind as to the accuracy of such data. Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  

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A Momentum Based Core Equity Strategy (Part 1)

June 9, 2016

Smart Beta strategies have become increasingly popular over the last few years.  These factor based strategies rank groups of stocks or certain characteristics that have proven to provide long-term outperformance over broad market benchmarks.  The strategies tend to be extremely disciplined in their stock selection processes, which has been one of the biggest knocks on active management over the years.

One of the best ways to use the idea of Smart Beta or Factor Investing is to combine them to form a core equity portfolio.  Individually, the factor portfolios often have greater volatility than the overall market.  But many of the factors have excess returns that are negatively correlated so you can combine individual factors together to lower the volatility of the portfolio.  The lower volatility can come with a nice benefit: the factor portfolios have the potential to generate better returns than the overall market.

I was working on another project that involved putting some factor data together so I decided to combine the portfolios into a Core Equity portfolio to see how it looked.  I’ll have a few posts on the blog that run through the steps and the data I used to create the factor strategies as well as the combined strategy.  Since I have developed a lot of momentum strategies over the years you will notice that most of what is going in to this model has a momentum bias.  I’m sure there are some other ways to go about this, but I have worked with the momentum factor for so long it is really easy for me to incorporate it into other factor based strategies.  I thought it would be a useful exercise to run through this process on the blog because we generally get some interesting feedback and suggestions on how to improve the processes.

There are quite a few factors out there, but we will really focus on a manageable number of four: Momentum, Low Volatility, Value, and Size.  I took care of the Size factor in the portfolio construction process.  All of the strategies are equally weighted, which gives them a small cap tilt over time.  I will revisit the effect of the equal weighting tilt at the end when I look at the combined portfolio.  It is easy to estimate the size effect by running a cap weight and an equal weight version of the same portfolio.

The other three factors really form the backbone of the core equity strategy.  In the next post I will discuss how those strategies where constructed and the historical performance of each factor portfolio.

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High RS Diffusion Index

June 8, 2016

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 6/7/16.

diffusion

The 10-day moving average of this indicator is 81% and the one-day reading is 90%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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Ode to Smart Beta

June 7, 2016

Nir Kaissar at Bloomberg recently published a nice summary of the historical returns of a number of Smart Beta factors, including Value, Size, Quality, Momentum, and Low Volatility:

In the brave new world of next generation, active investment management, smart beta is all the rage. Smart beta relies on five major strategies — or “factors” — to fine tune market returns:

Value – buying cheap companies

Size – buying small companies

Quality – buying highly profitable and stable companies

Momentum – buying the trend

Low Volatility – buying defensive companies

Investments built around each of those factors have historically beaten the market, as the following chart shows:

smart beta returns

blend

A couple of observations:

  • The market is efficient?  Really?  I don’t think so.  Excess returns are available if investors focus on the right factors.
  • These factors move in and out of favor so nobody should expect each factor to outperform all the time.  In fact, Kaissar highlighted the benefits of mixing these factors in order to smooth out the ride.
  • It’s hard to miss the fact that Momentum had the highest returns of any of the factors listed in this study.  Yes, Momentum had the highest volatility, but it also had the highest Sharpe ratio.

Smart Beta is far more than just a catchy marketing phrase.  It is a much more effective way to seek excess returns than traditional active management.

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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Relative Strength Spread

June 7, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 6/6/2016:

spread

The 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 not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

June 6, 2016

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/31/16 – 6/3/16) is as follows:

ranks

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Sector Performance

June 3, 2016

The table below shows performance of US sectors over the trailing 12, 6, and 1 month(s).  Performance updated through 6/2/16.

sector

The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  Source: iShares

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Factor Investing: The Benefits of Combining Momentum & Value

June 2, 2016

After our previous write up regarding the idea of combining momentum and low volatility into a portfolio, we had a few requests asking about the concept of combining momentum and value. As long time Dorsey Wright readers know, while we absolutely believe momentum can work as a stand-along strategy in a portfolio, combining momentum with a value based strategy does have certain advantages.   As is the case with low volatility, a value based approach can also typically be thought of as a reversion to the mean type of trade as market participants seek value in underperforming stocks or asset classes.   Obviously, a momentum based approach is focused on finding stocks that have outperformed their peers over a certain period (ex. 12 month trailing), hoping those strong trends continues to maintain leadership in the market.

Here is a brief summary of each strategy side by side.   Note we are using total return for the RPV (Pure Value) and SPX (Benchmark).  As shown below, PDP (Momentum) outperforms both RPV and SPX over the allotted time frame in this study, but not without slightly higher volatility.   We can also see a number of years in which momentum and value have substantially different performance numbers.   Let’s take this a step further and dive into some of the details on the correlation of excess returns between the two strategies.

PDP

As we pointed out in our previous post, the correlation of excess returns between low volatility and momentum came in at roughly -.70.  Given what we mentioned about the underlying theme of momentum investing (trend following) while compared to value investing (mean reversion), it’s logical to think a similar type of figure would exist between these two strategies as well.   The table below shows a comparison of annual returns using the time period 1998 and 2015 in which the correlation of excess returns between value and momentum comes out to be -.50.  A few of the outlier years to take note of which contain major differences in performance are 1998 – 2002, 2007, 2009, and finally 2015.  The main concept again being not only does having the ability to rotate or combine these two factor based strategies help improve performance; it also helps in reducing volatility. (click on below graphic to enlarge)

PDPVSRPV CORR

PDP inception date: March 1, 2007, RPV inception date: March 3, 2006 – data prior to inception is based on a back-test of the underlying indexes. Please see the disclosures for important information regarding back-testing.  PDP returns do not include dividends.  Returns do not include all potential transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss. 

Let’s take this a step further to answer the one question that is usually on most market participants minds.   “How do I implement these products into a portfolio for my clients?”   The number of possibilities is endless but to keep things simple we set up a “static allocation” model that rotates through a number of different portfolio’s starting with a 90% PDP/10% RPV and all the way to 10% RPV/90% PDP during our time period stated above.   This gives a very detailed description of how each one of these portfolios would have performed on a cumulative, annual, and risk –adjusted (volatility) basis.   However, what if we could improve on these returns and be more flexible in our allocations.   We know that often times combing some sort of trend following proxy (typically a moving average) in addition to a stand-alone momentum strategy can often times help improve these numbers.    This will be part of our final discussion. (click on below graphic to enlarge)

pdprpvhistorcials

Over time, it’s typically been the case that a momentum/trend following based strategy (assuming a long only portfolio) tends to perform better while the SPX is above its 200 day moving average.   On the flip side, a choppy market with a lack of sustained leadership (which can favor a value based strategy) is more likely to presents itself when the SPX is below its 200 day MA.  This is not always the case but over the years research has shown that the 200 day moving average is often considered a reliable proxy for a risk on/risk off environment.  The below table compares a model we have created using a 200 day moving average as a risk proxy to determine whether or not we will invest in a momentum (PDP) or value (RPV).   We thought it would be interesting to take these allocations to the extreme, relying on a 100% momentum based strategy when the SPX is above its 200 day MA, while flipping to Value when the SPX is below its 200 day moving average.   Our momentum/trend following model which incorporated the 200 day risk proxy averaged just over 10% annual return, while minimizing volatility to just 21%.   Comparing these towards using PDP or RPV as stand-alone vehicles as was in table 1, we can see the benefits when it comes to having access to both products. (click on below graphic to enlarge)

200ma NEW

PDP inception date: March 1, 2007, RPV inception date: March 3, 2006 – data prior to inception is based on a back-test of the underlying indexes. Performance of the switching strategy is the result of back-testing.  Back-tested performance results have certain limitations.  Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision-making process if the advisor were actually managing client money.  Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. PDP returns do not include dividends.  Returns do not include all potential transaction costs.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss. 

As this paper shows, there are a number of ways to combine both momentum and value into a portfolio.   For those investors willing to accept slightly higher volatility to achieve higher returns, a portfolio with a larger allocation towards momentum certainly is favorable.   The same can be true for those investors looking to low annualized volatility who might not be as concerned about achieving a certain level of excess return.   Finally, we showed adding a trend following proxy (the 200 day moving average) can help aide in substantial performance over the benchmark (SPX), and also help achieve better risk management when using a momentum or value based strategy as a stand-alone vehicle.

Performance data for the model is the result of hypothetical back-testing.  Performance data for RPV prior to 03/01/06 and PDP prior to 3/01/2007 is the result of backtested underlying index data.  Investors cannot invest directly in an index, like the SPX.  Indexes have no fees.  Total return figures are used in RPV and SPX calculations.  Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of the strategy during a specific period.  Back-tested performance results have certain limitations. Back-testing performance differs from actual performance because it is achieved through retroactive application of an investment methodology designed with the benefit of hindsight. Model performance data as well as back-tested performance do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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High RS Diffusion Index

June 2, 2016

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 6/1/16.

diffusion

The 10-day moving average of this indicator is 68% and the one-day reading is 84%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

June 1, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 5/31/16:

spread

The 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 not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Weekly RS Recap

May 31, 2016

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/23/16-5/27/16) is as follows:

ranks

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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High RS Diffusion Index

May 25, 2016

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 5/24/16.

diffusion

The 10-day moving average of this indicator is 66% and the one-day reading is 69%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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The Minority That Matter

May 23, 2016

Eric Crittenden has recently updated his research on the distribution of stock returns over time—research that underscores the rationale for trend following strategies.  His study now covers the period 1989-2015.  See below for further explanation:

Longboard’s original research proves that over the long term, a small minority of stocks drive returns for the overall market.

If you’ve heard of the Pareto Principle before, this might not surprise you.

What does this mean for investors? It may be more efficient to navigate this reality by getting defensive, and strategically avoiding the majority in this equation: the underperforming investments.

Be aware of disproportionate rewards

Here’s a closer look at our research on this competition gap in action in the U.S. stock market.

Under-Over-performers-1024x643

We analyzed 14,455 active stocks between 1989 and 2015, identifying the best performing stocks on both an annualized return and total return basis.

Looking at total returns of individual stocks, 1,120 stocks (7.7% of all active stocks) outperformed the S&P 500 Index by at least 500% during their lifetimes. Likewise, 976 stocks (6.8% of all active stocks) lagged the S&P 500 by at least 500%. The remaining 12,404 stocks performed above, at or below the same level as the S&P 500.

The principle of the competition gap remains true in practice: The minority accumulates a disproportionate amount of the total rewards, creating a “fat tail” distribution of extreme outperformers and underperformers with a large gap between the two.

Focus on the minority

What’s more, the left tail in the stock market’s competition gap (or distribution) is significant. 3,431 stocks (23.7% of all) dramatically underperformed the S&P 500 by 200% or more during their lifetimes.

AttributionCollectiveReturn-1024x613

So, let’s say an investor’s portfolio missed the 20% most profitable stocks between 1989 and 2015. Instead, he invested in only the other 80%. His total gain would have been 0%.

Once again, the principle holds true: Over the long term, the more efficient approach is to strategically avoid the many underperformers.

Seek alternative long-term returns
To get more benefits from alternative allocations, investors can seek long-term trend following strategies that proactively trim investments that don’t perform over time. These more defensive strategies are better positioned to avoid sustained downtrends — and a diversified portfolio with fewer strategies trapped in sustained downtrends can recover more quickly.

What’s more, some of the same strategies that can deliver this downside protection can add further diversification, potentially delivering results that are uncorrelated to the market and to other alternatives.

If ever there was a need to highlight the need for relative strength analysis, this is it!  It is no small thing to have a discipline for weeding out underperforming stocks from the portfolio and Dorsey Wright is uniquely positioned to help you with this task.  Subscribers of our research can use our technical attribute ratings and our matrix tools to weed out weak stocks.  Users of our investment products can access strategies that have defined sell disciplines in place.  The sell discipline will differ by strategy, but it is there for each of them.

Sitting on losing positions with the belief that they will eventually turn around is a fool’s errand.  But isn’t patience the key to long-term investment success?  Yes and no.  Patience in a well-designed investment strategy is one thing.  Patience in losing positions is another thing entirely.  Individual stocks are under no obligation to provide a profitable experience for their investors.  Stocks don’t know when or at what price you bought them.  As the research above demonstrates, many–in fact most–stocks are losers relative to a broad market benchmark.  It is up to you to successfully navigate the very fat-tailed distribution of stock returns.  Relative strength can help.

Click here for disclosures.  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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Weekly RS Recap

May 23, 2016

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/16/16 – 5/20/16) is as follows:

ranks

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

May 17, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 5/16/16:

ranks

The 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 not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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The Role of Cash in Systematic RS Growth

May 16, 2016

A fully-invested equity strategy or an equity strategy that has the ability to raise cash—which is better?  Which is better will depend on the time frame and the risk tolerance of the individual client, but I would suggest that there may be a place for both in a client’s asset allocation.  A fully-invested equity strategy will likely be more volatile, have deeper drawdowns, but may also perform better in certain time periods than a strategy that has the ability to raise cash.  A strategy that has the ability to raise cash can offer clients greater staying power because of knowledge that risk management is a key objective of the strategy.  In our family of Systematic RS portfolios, we have some fully invested portfolios and some that raise cash.

The chart below is based on Dorsey Wright’s opinion of the likely relationship between volatility and return relationships between each of the different strategies over a long period of time.  Actual results may differ from these expectations.  Greater volatility may result in greater gains and greater losses.

expected return_risk

Our Systematic RS Growth portfolio is a portfolio that has the ability to hold up to 50% cash if necessary.  See below for some frequently asked questions about how this ability to hold cash works:

Question: How do you determine when to raise cash in the portfolio?

Answer: We employ a trend following equity guideline that keeps the portfolio fully-invested when equity markets are trending higher.  However, when broad equity markets move into a declining trend, the guideline will start increasing the amount of cash to be held in the portfolio.  The further that the market moves from its highs, the more cash will be called for in the portfolio.  However, there is one twist to this process.  We raise cash in the portfolio if two things happen: 1) the model calls for increasing the cash position and 2) one or more of our current holdings has deteriorated sufficiently from a trend and relative strength perspective to be sold.  Basically, if a stock moves out of the top half of our ranks, moves below 3 technical attributes, or moves into a negative trend on a PnF chart, the stock will be sold.  See below for the historical cash allocation in the Growth portfolio:

cash_growth

Source: Dorsey Wright.  As of 4/30/16.  Estimate based on monthly cash values of a sample Growth portfolio.

Question: How do you determine when to reinvest the cash?

Answer: The trend following equity guideline will call for reinvesting the cash when the broad market moves off its lows.  The further it moves from its lows, the less cash will be called for in the portfolio until the point when the account is once again fully invested.

Question: How has this portfolio performed over time?

Answer: Since inception of 12/31/2006 through 4/30/2016, the Systematic RS portfolio has outperformed the S&P 500 Total Return Index 7.89% to 6.36% net of all fees.

mountain_growth

detailed perf_growth

As of 4/30/2016. Net performance shown is total return net of management fees, commissions, and expenses 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 2A of the adviser’s Form ADV.  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.  

Question: How can I access the Systematic RS Growth portfolio for my clients?

Answer: The Systematic RS Growth portfolio is available on the Envestnet UMA platform, Kovack UMA platform, Stifel Opportunity Platform, RBC MAP platform, UBS MAC platform, and for RIAs at Schwab, Fidelity, and TD Ameritrade.  If you would like to see it added to a SMA or UMA platform at your firm, please have your managed accounts department contact Andy Hyer at 626-535-0630 or andyh@dorseymm.com

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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Weekly RS Recap

May 16, 2016

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and quartile and then compared to the universe return.  Those at the top of the ranks are those stocks which have the best intermediate-term relative strength.  Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (5/9/16 – 5/13/16) is as follows:

ranks

This example is presented for illustrative purposes only and does not represent a past or present recommendation.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  The performance above is based on pure price returns, not inclusive of dividends, fees, or other expenses.  Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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Letting Winners Run: Using ADRs to Deliver Your Active International Exposure

May 12, 2016

Check out John Lewis’ article in Iris.com today on our Systematic RS International portfolio (click here).

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High RS Diffusion Index

May 11, 2016

The chart below measures the percentage of high relative strength stocks (top quartile of our ranks) that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 5/10/16.

diffusion

The 10-day moving average of this indicator is 73% and the one-day reading is 82%.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Investors cannot invest directly in an index.  Indexes have no fees.  Past performance is no guarantee of future returns.  Potential for profits is accompanied by possibility of loss.

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Relative Strength Spread

May 10, 2016

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 5/9/16:

spread

The 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 not indicative of future results.  Potential for profits is accompanied by possibility of loss.

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