In these posts, we take our monthly fund factsheet commentary and extend on it with some thoughts and charts. Passive Allocator’s portfolio allocation depends purely on Momentum calculated in a quantitative/mechanical way, however prices always move due to some underlying cause. No one really knows the cause but it’s fun to guess!

The global equity market’s ‘sleepwalk’ is over. Short and medium term upward momentum is broken, along with volatility rising and sustaining at higher levels. Especially equity vols are now firmly in the high teens with occasional pops above 20%. These are signals for us to lighten risk exposures as per our Passive Allocator re-balancing strategy. Equity ETF asset flows have had their worst negative month in 5 years – we admittedly are a tiny part of that outflow. Risk control has always taken precedence over return chasing for Passive Allocator, thus towards the end of May we lightened majority of our equity ETFs and went heavily in to medium term US treasury ETFs. Over the past few months we had increased equity allocations, though still remained much lesser than our 60/40 benchmark. This is probably why we gave up 1.19% in May vs. our benchmark’s decline of 3.3%. We are now once again positioned like the end of 2018 – super defensive, with an overweight to fixed income. Interestingly enough, fixed income is also part of our asset universe in terms of return generation; it’s not just a safety play. We also follow fixed income momentum and volatility signals to enter or exit positions. US treasuries have developed strong upside momentum over May, thus we are quite comfortable holding overweights in that particular asset class. The economic/fundamental reason behind all of this is quite obvious: Trade wars are heating up and Brexit is going more (and more) into uncharted territory.

Passive Allocator Strategy Momentum & Volatility score table for May 2019

Some interesting liquidity based narratives in May: popular Equity ETFs like SPY, QQQ, EEM have seen major collective outflows. However, these do not have any significant bearing on future returns, at least not anything major.

Major outflows seen in equity ETFs in May 2019. Source: Bloomberg Analytics

The usual “fear gauge” – VIX index – has started strutting its stuff. Previous few corrections have seen this go to 30+, so no harm in being on the safe side and letting high volatility regimes play out.

VIX index RHS. SPX Index LHS. Source: Bloomberg Analytics

Fixed Income, epecially US treasuries has been the best performer this year, and if one were to trust pure price momentum patterns – it looks like things are just getting started. Momentum traders have a patient view of the world, including us. We’re holding overweights in medium term US treasuries, something that still yields above 2.00%. We’re getting paid to wait.

US 10 Year Treasury bond futures, with 1 month and 3 month rate of change indicators

Happy Investing,
PA Fund Team