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Suit of armour

Armour up against potential drawdowns, says ARMR


Last week saw Armor Index launch a defensive index and ETF (ARMR) designed to protect a portfolio of US equities against downside risk.

Last week saw Armor Index launch a defensive index and ETF (ARMR) designed to protect a portfolio of US equities against downside risk.

The index is the brainchild of ETF industry veteran Jim Colquitt, who spent close to 20 years with Invesco in a variety of senior positions, and is offered from the Exchange Traded Concepts’ stable.

ARMR is designed to provide investment returns that, before fees and expenses, correspond generally to the total return performance of the Armor US Equity Index. Rebalanced monthly, the index provides exposure to those sectors of the US economy that score the highest using Armor’s proprietary market performance indicator (MPI), which identifies the sectors best positioned to offer strong, long-term performance potential with lower expected downside risk.

Only the sectors that score well in the MPI are included each month, represented by using highly liquid sector ETFs. If no sector appears attractive based on the MPI’s results, the index can shift to a focus on US Treasuries.

“We are giving investors exposure to the US equity market but with downside protection built into the product,” Colquitt says.

“If you look at any sort of investment return profile, what becomes paramount over the long term, is to manage your drawdowns. Managing your drawdowns allows you to set yourself up for better results over the long-term because remember, if you lose 25 per cent of an asset, it takes a 33 per cent return to get back to even; even worse, if you were to lose 50 per cent of an asset, it takes a 100 per cent return to get back to even. If you can keep losses on the shorter end through time, you won’t have to make as much back over the long term which allows your portfolio more quickly.”

The key to achieving that, Colquitt says, is to make sensible, rules-based decisions. “Too many decisions are made that are driven by fear or greed. We use a rules-based, quant-driven process for creating the investments that underpin our success.”

Colquitt’s back testing of the MPI to 2002 gave him a set of returns from 2002 to 2019 which revealed a compounded annual growth rate of 8 per cent, against the S&P 500 which returned 6 per cent.

“It did so with lower volatility, a higher Sharpe ratio and the crowning achievement was that in 2008, when the S&P 500 lost 38.5 per cent, ARMR lost only 7.9 per cent,” Colquitt says.

“The hallmark of this product is that when the deepest drawdowns happen, the index is designed to not have a similar drawdown. In a hypothetical scenario, if you had put USD1 million into ARMR on 31st December 2007, and a similar amount into the S&P 500 on 31st December 2007, by the end of 2008, the S&P 500 would have lost 38.5 percent while ARMR would have lost 7.9 percent, but the even bigger point is to ask the question, ‘how long did it take for these investments to get back to their original USD1 million?’

“The answer is that it took the S&P 500 49 months – or a little over four years – to get back to USD1 million while it took ARMR only 11 months to get back to USD1 million.  In the investing world, time can be your greatest enemy or your best friend.  By reducing drawdowns, we give investors more time to grow their investment portfolios which in turn provides the opportunity to meet their investing goals.”

The MPI is run on a monthly basis, at the end of the month, across 11 US equity sectors and selects which ones should be used.

“If the MPI said all 11 sectors for that month we would invest across all 11 sectors – if it moved to nine, we would sell out of the two sectors not chosen and redeploy the capital to nine remaining sectors, Colquitt says.

The system is never over ridden: “That’s not part of the thesis. We don’t want to be making qualitative decisions that can be impacted by human emotion.”

Offering a defensive equity investment product into the US market seems counter intuitive given the continued economic expansion in the country but Colquitt argues that the history of the US shows that on average there has been a recession every seven years and the US is now on 10 years plus of good times.

“I have no idea when we will have a recession but we will have one at some point,” he says. “You could argue that we are in extra innings here.”

ARMR’s research shows that during a recession, the market, from peak to trough, has lost an average of over 30 per cent in the post-World War II era.

“This is a timely product as investors are looking for protection right now, a hedge against what could be coming in the next couple of years but with the added benefit of continuing to provide US equity exposure in the interim.”

Outside of recessions, there have also been a number of correction periods with losses of 10-20 per cent with a fair amount of regularity which Colquitt says ARMR will also protect against.

“This product is proven to give you downside protection so for me, given where we are in the current economic expansion, it makes a lot of sense to add this to your portfolio at this time.”

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