Arrow Capital’s overall investment approach is designed to create consistent returns over time with low volatility while navigating market fluctuations that come from any number of economic, sectoral, geo-political or secular factors. Our process delivers results using both a top-down and a bottom-up actively managed approach.
The basic premise of our philosophy is that without an understanding of where we are in the business cycle and where we are headed you cannot be a successful investor. By successful we mean the ability to earn absolute returns while at the same time mitigating risk (volatility and drawdowns) over the business cycle. The reason why we prefer this definition over “buy and hold” or value / growth or bottom up or 60/40 asset allocation etc. is that investors (in most instances) are not capable of handling market volatility or drawdowns psychologically. Everybody says they invest for the “long term” but rarely do they act that way. In our process, we attempt to get in front of the volatility and either avoid it materially or, in the case of alternatives, benefit from it. Manage the business cycle correctly and you significantly increase your odds of managing the asset allocation of your portfolio correctly over the market cycle.
Our top-down macro framework utilizes two main variables – rate of change of real GDP and the rate of change of headline inflation or CPI. Our forecasts for real GDP and headline inflation are updated on a daily basis to project which asset classes and sectors will outperform through the economic cycle. That is combined with a bottom-up style agnostic process to determine the individual securities that offer the best potential for alpha while minimizing volatility. Our uncommon expertise and experience allows us to optimize both the top-down and bottom-up processes.
At the heart of the process is a cyclical economic model whose key variables (or inputs) are headline inflation (CPI) and real economic growth (real GDP). The rate of change of these two variables are at the heart of the model (or roadmap). Intuitively it makes perfect sense. The change in economic growth is directly correlated to the change in corporate profits, while the change in headline CPI and inflation is directly correlated to changes in interest rates – these rates are also the proxy for valuing / discounting company cash flows, bond interest payments etc. Our edge comes in our forecasting because it is the transition from one economic regime to another that creates the real alpha associated with our process.
In addition, we also consider the impact of changes in policy. These changes can be fiscal such as government spending; or monetary such as central bank policies. Finally, we consider secular changes and their impact on the economy including demographics and productivity.
Below is an example of the cyclical model where we forecast changes in real GDP and headline inflation today and for the next nine months going forward. Please interact with the graphic by rolling over each cycle to see how we actively manage and adapt to market cycles to ensure low volatility and consistent returns.
Actively Managing the Cycle
Footnote: Based on rate of change GDP and inflation. For illustrative purposes only.
Our bottom-up selection process takes into account many factors, including valuation, competitive advantages of the underlying business, track record of the management team, and strategic direction. Much like our top-down process, we focus on the rate of change. We use the above criteria to find companies that will experience meaningful changes in the rate of growth in revenues, earnings, and free cash flow.