“There’s no such thing as a perfect investment strategy,” says Roy Gray, a financial planner with Dallas-based Munn & Morris Financial Advisors, “and asset allocation is no different.”
What is working for Gray and his firm is a strategy called relative strength. At its most basic, relative strength is a ratio of stock or index price to market average or other indices, a momentum investing technique that Gray considers a tool to determine and detect which asset classes are the strongest performers.
One of the major weaknesses of asset allocation is that it tends to lag behind the better performing asset classes in a bull market. “Using relative strength to overweight those strong asset classes may allow you to boost the performance of your asset allocation without taking on substantial risk because you’re only carving out a small piece,” Gray notes. “Relative strength tends to do well in bull markets and it “may also help your allocation reduce losses in a bear market as the more conservative asset classes gain relative strength and become overweighted.”
“Our relative strength research focuses first on macro asset classes to help us identify which asset class we want to overweight. We compare U.S. versus International, versus commodities and fixed income, for example. We then focus on the asset classes that exhibit the most strength and target the leading sectors in that asset class for investment,” Gray says.
“To reduce the effects of being wrong, we carve out only a portion of the client’s portfolio, depending on how aggressive the client is. For our more aggressive clients, we may carve out up to 30%, for our moderate risk profiles, we may carve out only 15%. And we don’t do it at all for our conservative clients because it does introduce the potential for additional volatility and risk.”
But, Gray points out, a relative strength technique doesn’t always work and therefore should only augment your core strategy. “There are periods when it works well and periods when it doesn’t, so you need to have a strategy that’s appropriate,” he says. “Our research suggests that the periods of outperformance have more than made up for the periods of weakness.”