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Past Is Not Prologue

August 20, 2020

The Danger of Overreliance on Past Relationships
In constructing their portfolios, investors, and their advisors, tend to look at strategies that have historically performed well in specific economic and market scenarios.

For example, when investors anticipate a period of market and/or economic stress they tend to turn to defensive strategies which generally have a dual objective: 1) to provide investors with overall equity exposure while, at the same time, 2) limiting the losses that investors may experience during times of market and economic stress.

These strategies may target factors, such as dividend yield or value, or sectors, such as consumer staples or utilities, that have historically performed well during market downturns. Conversely, they may turn to cyclical sectors, such as consumer discretionary and materials, or factors such as growth when they expect a strong economy.

However, market participants have noted that during the Covid19-related market downturn and subsequent rebound, what has traditionally been considered defensive (and vice-versa) did not necessarily follow the script.

These altered relationships may require investors to rethink how they pursue equity strategies in general. We believe that the Armor US Equity Index ETF (ARMR) may provide investors with an attractive means of achieving the dual goal of gaining equity exposure in both good and bad times.

As a Matter of Factor
Beta is a measure of a stock’s volatility relative to the overall market. A stock with a beta of 1 is expected to move in line with the market. A beta above (below) 1 indicates that the stock’s return is expected to exceed (trail) the overall market’s return.

An article in Wealth Professional[1] noted that the beta of traditional investment factors have changed significantly during the current Covid-crisis. For example, factors typically associated with growth, such as momentum and forward earnings, which historically have had a beta of around 1, have exhibited a beta in the 0.50-0.70 range this year. Conversely, defensive factors such as value and dividend income, which historically have had a beta below 1, have exhibited a beta well above 1.

Changing Definition of Defensive Another article in Institutional Investor[2] also noted that traditional defensive stocks have not performed as expected during the Covid-crisis.

In particular, the Institutional Investor article pointed to low volatility strategies which historically have tended to perform well when the market is declining. The article noted that low volatility held up well during the market decline experienced during the dot.com bust[3] as they generally avoided technology stocks which were imploding.

However, during the financial crisis of 2008 and the current Covid-crisis, broad swaths of the economy and stock market have been affected, and low volatility strategies have not performed as expected.

The article noted that exposure to a new factor – social distancing – may have provided defensive exposure. For example, food service industry companies, such as those which service restaurants, are typically defensive in nature. However, with much of the country shut down due to social distancing requirements, these types of stocks performed poorly.

The article also noted that massive intervention by global central banks may also have changed the calculus deciding market winners and losers.

Is Tech the New Defensive?
Companies that have lots of cash on their balances sheets and offer essential services may be the new defensive, according to a Forbes[4] article. By that definition, technology stocks may be the new defensive for this market environment.

The article noted that many technology stocks have a significant amount of cash on their balance sheets. In addition, they offer services that have facilitated work-from-home, food delivery, and entertainment (such as streaming gaming).

In fact, the article noted, even if the economy does poorly, the large weighting of technology stocks in mainstream equity indices may propel the stock market higher, or at least buffer large losses.

What Does This Mean for Investors?
Markets advance and decline for various reasons. Picking the winners and losers may become more complicated than looking at what has historically worked well during similar market scenarios.

Where May Investors Find a Potentially More Effective Equity Strategy?

The Armor US Equity Index ETF (ARMR)
The Armor US Equity Index ETF (ARMR) seeks to provide investment returns that, before fees and expenses, correspond generally to the total return performance of the Armor US Equity Index. The index is designed to provide exposure to the sectors of the US equity market that the fund’s index provider believes are most likely to generate positive returns while managing downside risk and experiencing lower volatility relative to the US equity market.

By using sector momentum as the basis for portfolio construction, the index which underlies the ARMR ETF may more effectively capture the factors and segments of the equity market that investors deem to have the characteristics to perform well in the current environment.

[1] Almazora, Leo, Are Growth Stocks Taking a Defensive Turn, Wealth Professional, 7/21/20
[2] Segal, Julie, ‘Low Vol’ in Name, Big Losses in Practice, Institutional Investor, 7/7/20
[3] The 2000 – 2002 period
[4] Light, Larry, Why Tech Stocks Are Now the New Defensive Plays, 7/19/20

Carefully consider the Fund’s investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Fund’s prospectus and Summary Prospectus, which may be obtained by visiting https://armoretfs.com/documents. Read the prospectus and Summary Prospectus carefully before investing.

Foreside Fund Services, LLC, distributor.

Investing involves risk, including possible loss of principal. The Fund’s return may not match or achieve a high degree of correlation with the return of the Index. To the extent the Fund’s investments are concentrated in or have significant exposure to a particular issuer, industry or group of industries, or asset class, the Fund may be more vulnerable to adverse events affecting such issuer, industry or group of industries, or asset class than if the Fund’s investments were more broadly diversified. Issuer-specific events, including changes in the financial condition of an issuer, can have a negative impact on the value of the Fund.

A new or smaller fund is subject to the risk that its performance may not represent how the fund is expected to or may perform in the long term. In addition, new funds have limited operating histories for investors to evaluate and new and smaller funds may not attract sufficient assets to achieve investment and trading efficiencies.

Shares are bought and sold at market price (closing price) not net asset value (NAV) and are not individually redeemed from the Fund. Market price returns are based on the midpoint of the bid/ask spread at 4:00pm Eastern Time (when NAV is normally determined) and do not represent the return you would receive if you traded at other times.