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Market Outlook 2020: Tactical Opportunities
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Historically, most recoveries last approximately five to six years. Entering the 11th year of recovery since the financial crisis of 2008, we are faced with a statistical probability of nearing a market top. Investors who are concerned about an impending bear market cycle, or those simply seeking to diversify their portfolios in general, may wish to implement alternative investments that have the potential to enhance returns and reduce risk.

Figure 13 shows the rolling three-year performance of the Top 10 holdings of the S&P 500 versus the S&P 500 Index itself. When the line is moving up, the Top 10 are outperforming the overall index. Figure 13 shows massive outperformance of the Top 10 from 1995 to 1999 (the “Tech Boom”). From 2015 to now, we are again experiencing a similar concentration of performance from the Top 10 holdings of the S&P 500.

The top five U.S. companies comprise 18% of the S&P 500. That’s an unprecedented level, even at the height of the Tech Boom. What’s more, these same companies with the highest weights in the index also happen to have the highest returns and contribution to return of the S&P 500 over the last five years. The S&P 500’s return over the last five years was 73.07%, and 26.7% of that came from just the five largest companies in the index (Apple, Microsoft, Amazon, Google and Facebook). Figure 13a places that in stark visual relief. This was even more pronounced in 2019. With the S&P 500 up over 30% in 2019, and with this degree of concentration of performance in the market, it makes comparing other strategies difficult and assessing true risks deceiving.

Fig 13. Rolling 3-Year Performance of S&P 500’s Top 10 Holdings
vs. the S&P 500
Past performance is not indicative of future returns. Source: Bloomberg, calculated by Arrow.


 Fig 13a. Contribution to S&P 500’s Return over last 5 years
Past performance is not indicative of future returns. Source: Bloomberg, calculated by Arrow.

The S&P 500 is a capitalization-weighted index. This is why the largest technology companies have such a dramatic influence. Investors who buy products based on the S&P 500 may be unknowingly taking on more exposure to “Big Tech” than they realize. Equal weighting the components of the index results in diminishing the size bias.

Figure 14 illustrates the 10-year rolling difference between the total market index capitalization weighted versus same index equal weighted between 1980 to 2019. When the line is trending upward, Cap-Weighted is outperforming. When the line is trending downward, then Equal-Weighted is outperforming. Also note that when Equal-Weighted is outperforming, the environment is more conducive to active or alternative strategies like Tactical and Global Macro, Managed Futures and World Allocation.

No doubt, some alternative-oriented mutual funds and ETFs have suffered disappointing performance during the last decade, which is not surprising given the strong run in equities over that same time period. Investors should be cautioned against chasing performance and encouraged to view alternatives as a possible cushion against market downturns. Nevertheless, “liquid” alternatives have improved over the last decade. The line used to be drawn as either a bull (long-only) or bear (short-only) strategy. But some options in the space are now designed to weather bear markets, while also seeking competitive returns when equities are on the upswing. These types of alternative investments may be especially attractive options for investors seeking to hedge market downturns without sacrificing potential performance.

Fig 14. Market Concentration Ratio

Past performance is not indicative of future returns. See asset class proxy disclosure. Source: Morningstar and Barclay calculated by Arrow.

With the recent prolonged recovery bull market, the relative underperformance of alternatives is not surprising. Figure 15 highlights how insignificant allocation decisions were between stocks and bonds in the 10-year period ending October 2010. During this period, equities provided more risk and less return than bonds, mirroring what happened in the 1930s and the 1970s. If U.S. equity markets migrated into another weak market cycle like they did from November 2000 to October 2010, the implication of negative or flat returns for an equity and bond portfolio is far reaching. This is why those who influence asset allocation decisions may want to consider utilizing tactical and alternative strategies to help extend the efficient frontier.

Investors who seek further diversification typically allocate to international equities, growth and value equities, and equities of different capitalization ranges and sectors. Unfortunately, these efforts do not always combine assets that move independently of one another. When a bull market prevails, investors rarely complain. On the other hand, in a world of lower equity returns, advisors and planners turn to alternative assets such as real estate, global macro, commodities, long/short equities, managed futures and fixed income arbitrage (non-traditional bond). Why? Basically, because adding alternatives to a portfolio of traditional assets may potentially lower risk and increase returns. A clear understanding of how this happens requires studying alternative strategy returns and their correlation to the returns of stocks and bonds.

To realize the benefit of diversification, a portfolio’s underlying asset classes must behave differently in varying market conditions. Thinking about diversification requires investors to understand what negative correlation means and how a given investment instrument should be used when blending it into their portfolio. If an asset class goes up and down independently of traditional assets (equities or bonds), it means that there are times when they are doing the same thing as equities or bonds and times when they are doing the opposite. The biggest complaint on most alternative products is that they are not adding as much value during those downtrends for the targeted traditional asset and that they only add value when that traditional asset is going up. This is why investors need to look at the correlation of alternative vehicles under consideration. Look for investment strategies that are non-correlated to the asset that it will be replacing or complementing. Investors should also look at how the performance and risk of that strategy can deliver absolute returns to their portfolio.

Fig 15. Alternative vs. the Market — 10 Years as of 10/31/10

Past performance is not indicative of future returns. See asset class proxy disclosure. Source: Morningstar, calculated by Arrow.


Many investors seek absolute returns through a low volatility approach. However, there are now strategies available that embrace the volatility. In some cases, utilizing higher volatility strategies allows the investor to utilize less to add value.

Most alternative categories contain funds that pursue strategies divergent in one or more ways from conventional returns generated from traditional assets. Many products in these categories describe themselves as “absolute return” portfolios, which seek to avoid losses and produce returns uncorrelated with the overall bond market; they employ a variety of methods to achieve those aims. The environment in the coming year could be poised for adding alternatives, especially in the event of a short-term market correction or even a recession. When adding an alternative strategy to a traditional portfolio, long/short methods are specifically designed to work with the ups and downs of the market. But again, a key metric to consider is correlation—specifically, a low correlation to the asset class that is presenting the reason for concern. It doesn’t make sense to add something with a high correlation to stocks if the stock market is the cause for concern.

It’s easy to understand investors’ excitement over technology companies and the products and productivity these companies provide. Ultimately, the earnings and performance of big tech companies going forward must support the significant price advances of the last few years. As we look ahead, we recommend that investors get their exposure to the tech sector by other, more tech-centric approaches where holdings are selected and weightings are managed with more criteria than just capitalization size. Going forward, we believe “fundamentals” and the ability to shift when trends emerge or fail will matter. We recommend that investors consider tactical strategies that are nimble, managed futures strategies and global macro strategies.

Important Factors to Consider When Selecting Tactical or Alternatives:
  • Correlation: Look for investment strategies that are non-correlated to the asset that it will be replacing
       or complementing.
  • Absolute Returns: Consider how the alternatives may provide performance and manage risk in all
       market environments.
  • Complex: Provide access to sophisticated investments but in some cases, can provide higher risk and costs
       when compared to traditional investments.

  • Fig 16. Alternatives in Active vs. Passive Investing Environments
    Past performance is not indicative of future returns. See asset class proxy disclosure. Source: Morningstar and Barclay, calculated by Arrow.

    Asset Class Proxy Disclosure:
    Past performance does not guarantee future results. Categories display the returns of current funds in the Morningstar category during the time period shown, subject to survivorship and/or re-categorization. Index and strategy research returns assume reinvestment of dividends, but do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and are not available for direct investment. 

    Asset class proxies (in order as shown above by figure): Figure 13: S&P 500, Managed Futures (Barclay Top50), Global Macro (Barclay Global Macro), Morningstar Categories: Small Value, Mid-Cap-Value Figure 14: Agg Bond (BBgBarc U.S. Agg Bond), Equity (S&P 500), Morningstar Categories: Large Core Growth, Large Core Value, Mid Core Growth, Mid Core Value, Allocation--50% to 70% Equity, World Allocation; Figure 15: Bonds (BBgBarc U.S. Agg Bond), Equity(S&P 500), 6040 (60% Equity & 40% Bonds), Global Macro (AI Research: Global Macro DWGM Strategy), Long Short Equity (Barclay Equity Long/Short ) Commodity (AI Research: Extended Commodity AIEC strategy), Managed Futures(Barclay Top50), Multi-Alternative (Barclay Hedge Fund) Real Estate (FTSE NAREIT), Morningstar Category: Nontraditional Bond, Alternative Funds includes alternative mutual funds and private placements; Figure 16: U.S. Equity (S&P 500), Int’l Country Markets (average of 48 investable countries- Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong, India, Indonesia, Ireland, Israel, Italy, Japan, Korea, Malaysia, Mexico, Netherlands, New Zealand, Nigeria, Norway, Pakistan, Peru, Philippines, Poland, Portugal, Qatar, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, UAE, United Kingdom and Vietnam), Commodity (S&P GSCI), Real Estate (FTSE NAREIT), Managed Futures (Barclay BTop 50), Global Macro (Barclay Global Macro).