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Newsletter - February 2018


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What's Hot…and Not

How different investments have done over the past 12 months, 6 months, and 1 month. As of 2/16/18:

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Past performance is not indicative of future results.

Never before has it been easier for investors to invest in the strongest trends wherever they might be found in the world. Relative strength offers a disciplined framework for allocating among those trends. Markets are global and your portfolio should be too.

See disclosures in Appendix A, which includes the ETFs and Indexes used for this performance table.

Performance numbers include dividends but do 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.

High RS Asset Class

High RS stocks, as an asset class, often move independently of broad indexes. As of 2/16/18.

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See disclosures in Appendix A.

Fund Flows

Total estimated inflows to long-term mutual funds and net exchange traded fund (ETF) issuance collected by The Investment Company Institute .

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See disclosures in Appendix A.

Sector and Capitalization Performance

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Past performance is not indicative of future results.

See disclosures in Appendix A.

High RS Diffusion Index

As of 2/16/18:

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The one day reading of this index fell to 16% on 2/8/18, but has since rebounded. The 10-day moving average is 42% and the one-day reading is 63%.

See disclosures in Appendix A.

Relative Strength Spread

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 2/16/18:

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Since April of 2017, the RS Spread has generally been rising, reflecting the outperformance of RS leaders vs. RS laggards.

See disclosures in Appendix A.

What Do Superior Manager Look Like?

Dr. Craig Callahan, Founder and President of ICON, weighs in on this question ( Advisor Perspectives, 2/2/18 ):

Research in behavioral finance over the last two decades suggests that superior managers do exist. We see how superior managers behave, we know what they look like, and we believe we know how to find them.

In 2002, University of Maryland professor Russ Wermers found that constraining managers to boxes defined by price/earnings ratio and market capitalization costs about 300 basis points a year in performance. In other words, a manager pursuing a rigid investment strategy should not refrain from purchasing his or her best ideas when those best ideas do not fit in one style box.1 Cremers & Petajisto reported that higher Active Share is associated with higher returns, with Active Share being the percent of the portfolio that is different from the portfolio's benchmark index.2 Yakov Amihud and Ruslan Goyenko at NYU found the same results but came at it from a different direction by measuring a fund's correlation with an index.3 Low correlation proved to be associated with superior performance. Finally, R.B. Cohen, at Harvard, reported that the typical fund manager had superior stock selection abilities and could even rank their best ideas, but held too many stocks. 'Productive' best ideas dropped off at about 40 stocks.4 Worded differently, Cohen's findings suggest you don't want a manager's 65th or 75th "best" idea.

ICON has been involved in additional research that has categorized managers into ten very different investment strategies, where a strategy is defined by how a manager goes about selecting stocks. Before categorizing a manager by strategy, we first determine what elements a manager uses to select stocks. Some managers may use P/E, economic forecasting, profitability ratios, etc. Our research supports the conclusion that the fewer elements used by the manager, the better his or her performance.5 This finding suggests superior managers are focused. In the course of our research, we learned what stocks each manager was holding in pursuit of his or her strategy. A manager holding stocks typical of other managers pursuing his or her same strategy is also associated with superior performance.6

Putting all of this research together, we believe we know how superior managers behave. They are not constrained to boxes. They are willing to have a portfolio that looks different from an index, resulting in low correlation. They are focused, evaluating and considering only a few elements. They hold concentrated portfolios of just their best ideas, usually 40 stocks.

At the opposite end of the spectrum, there are active managers who aren't focused, who hold too many stocks, are constrained by some limitation like a style box and who, perhaps inadvertently, hug an index. These managers and their funds are included in studies of average mutual fund performance and usually drag down overall performance of the mutual fund industry, much to the delight and benefit of those promoting passive investing.7

So much has been written about passive investing these days that advisers and their clients may overlook the body of research that champions active management. Superior managers do exist. We believe we know how they behave and what they look like. Therefore, we believe we can identify them.

Based on the above views, you might come to the following checklist when looking for superior active management:

  • Not constrained to a style box
  • High Active Share
  • Low Correlation to the Benchmark
  • Holds 40 stocks or less
  • Fewer inputs rather than more

With the sharp rise in popularity in indexing over the past decade I think many may have overlooked the fact that superior managers do exist. The problem is that if you expect to find superior managers by looking at the things that many voices in the industry espouse, like style purity, low tracking error to the benchmark, high R-Squared, multi-factor models then, according to Dr. Callahan, you may be looking in the wrong place.

I suspect that the investment management industry will increasing look like a barbell where there will be ample choices for cheap, passive exposure on one side and then there will also be opportunity to find good active management on the other side. What will probably continue to be on the way out is closet indexing.

We believe that the future is bright for active management, but investors will need to know what to look for.

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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. Investors cannot invest directly in an index. Indexes have no fees.

Media Center

Powershares DWA Momentum ETFs

Arrow DWA Funds and ETFs

First Trust DWA UITs and ETFs

AdvisorShares

ALPS

Elkhorn Investments

Virtus Investment Partners

Dorsey Wright SMAs and UMAs

Dorsey Wright White Papers

Other Relative Strength Sources

  • Brush, John S. "Eight Relative Strength Models Compared." Journal of Portfolio Management (1986).
  • Berger, Israel, Moskowitz. "The Case for Momentum Investing." AQR Capital Management. 2009.
  • Jegadeesh and Titman. "Returns to Buying Winners and Selling Losers." Journal of Finance (1993).
  • O'Shaughnessy, James P. What Works on Wall Street. McGraw Hill, 1997.

Appendix A

The information contained herein has been prepared without regard to any particular investor's investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources believed to be reliable ("information providers"). However, such information has not been verified by Dorsey, Wright & Associates, LLC (DWA) or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein. DWA and the information provider accept no liability to the recipient whatsoever whether in contract, in tort, for negligence, or otherwise for any direct, indirect, consequential, or special loss of any kind arising out of the use of this document or its contents or of the recipient relying on any such recommendation or information (except insofar as any statutory liability cannot be excluded). Any statements nonfactual in nature constitute only current opinions, which are subject to change without notice. Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This document does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. You should consider this strategy's investment objectives, risks, charges and expenses before investing. The examples and information presented do not take into consideration commissions, tax implications, or other transaction costs. Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund ("ETF") prior to investing. Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC. ETF's may result in the layering of fees as ETF's impose their own advisory and other fees. To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

The returns shown in the Sector and Capitalization Snapshot are price returns only.

1PowerShares DB Gold, 2MSCI Emerging Markets Index, 3DJ U.S. Real Estate Index, 4S&P Europe 350 Index, 5Green Haven Continuous Commodity Index, 6iBoxx High Yield Corporate Bond Fund, 7JP Morgan Emerging Markets Bond Fund, 8PowerShares DB US Dollar Index, 9iBoxx Investment Grade Corporate Bond Fund, 10PowerShares DB Oil, 11Barclays 20+ Year Treasury Bond, 12S&P 500 Index, 13PowerShares QQQ, 14Dow Jones Industrial Average

"High RS Index" is a proprietary Dorsey, Wright Index composed of stocks that meet a high level of relative strength. The volatility of this index may be different than any product managed by Dorsey, Wright. The "High RS Index" does not represent the results of actual trading. Clients may have investment results different than the results portrayed in this index. Performance for both the High RS Index and S&P 500 is price returns only.

What's Hot...and Not Disclosures

The performance above is based on total returns, but does not include transaction costs. 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.

High RS Asset Class Disclosures

The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. 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.

Fund Flows Disclosures

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

High RS Diffusion Index Disclosures

The index above is based on pure price returns, not inclusive of dividends or all transaction costs. 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.

Relative Strength Spread Disclosures

The index above is based on pure price returns, not inclusive of dividends or all transaction costs. 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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





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