Two follow-up items from last week's articles. One quick, one not so much.

First, many have been wondering about the brokerage availability of the new SMI Bond Fund (SMIUX). Fidelity wins the prize, as the fund is up and trading on their platform already. It's the only one of the major brokers to currently have it available, but the others should be close behind. As Introducing The SMI Bond Fund (SMIUX) and The 50/40/10 Fund (SMIRX) mentioned, some brokers are influenced by requests from account holders (Schwab has told SMI readers this when they've called to inquire about SMIUX). So if you want it available at your broker, give them a quick call and ask for it.

Second, I wanted to spend some time unpacking a question Rob asked after the monthly Dynamic Asset Allocation announcement came out last week. I've had other similar questions, so this seems like a good time to dig in and explore the topic. Rob wrote:

"This year there have been 3 or 4 days where DAA has taken a big hit when interest rates have increased and has significantly blunted my returns. As this is described as a defensive strategy I am curious how this type of strategy will do in a low interest rate environment that has more chance for interest rate increases than decreases. Also, it seems the majority of back testing was done when we had higher interest rates (you actually could make money with cash) and the bond market was in a 30 year bull market. Just curious on your thoughts here."

Rob could have been asking about days like today, when five of the six DAA categories are down for the day. Only gold is slightly higher. And recently we've had days when everything has been down. Last Thursday, when we were trying to figure out the May recommendations, was like that for much of the day, before things finally got bad enough in stocks that long-term bonds started floating higher.

It's pretty unusual to see most/all of these asset classes move together in unison, as they were specifically chosen for DAA because they normally don't. They're supposed to show low correlation — i.e., they tend to act respond differently to various market and economic conditions. The whole point of DAA is to always have something (and hopefully multiple somethings) in our portfolio that is benefitting from the current condition, whether that's inflation/deflation, recession/expansion, strong dollar/weak dollar, etc.

For example, the typical historical reaction when stocks get smacked around a bit is for investors to run to the safety of long-term Treasury bonds. So bonds often act as an offset to poor stock returns, especially during short-term panics. I still think that this relationship will hold if fear really takes over in the stock market — we saw a little of this last Thursday, as bonds traded lower most of the day until the stock market's losses accelerated, at which point bond prices started rising back up. But on a day to day basis, bonds have been under pressure lately and their prices have been falling as their yields rise. That dynamic is causing more days when bond prices are drifting lower alongside mildly lower stock prices. Real Estate, which is influenced both by the stock market (VNQ owns real estate investment trusts, which are a form of stock) and the bond market (interest rates clearly matter to real estate investments) have tended to bounce along with this general current as well.

So does DAA still offer adequate defensive properties in the current low interest rate environment? We think it does. In the short-term, long-term Tresuries should still benefit from any significant stock market sell-offs, as the flight to safety mentality takes hold. And over the longer-term, if bond yields do move higher, cash will become a more attractive alternative—more than just a place to avoid losses. Gold tends to shine when fear rises and other assets fall. There's more defensive capability built into DAA than just bonds, though bonds definitely do help us play good defense at times.

Let's address the issue of our back-testing taking place during a period of steadily falling interest rates. That's actually only partly true. SMI only released the results of DAA backtesting from 1982 forward because some of the categories weren't easily duplicated prior to that point and we didn't have a great way to connect some of the data series we used. (The real estate category, in particular, was pretty different than what we now use in DAA, so we didn't want to include earlier years as if they were the same as what we are doing now in the live strategy.) In other cases, unusual circumstances (like gold being fixed until the early 1970s and then suddenly allowed to float freely) seemed unlikely to repeat, so we didn't want to make too much of certain "one-off" occasions. But internally, we back-tested back to the early 1970s and were pleased with what we saw out of DAA even in the rising interest rate environment of the 1973-1982 period. That was a period when the S&P 500 didn't do well and interest rates were rising, yet DAA managed just fine.

There's no getting around the fact that most of our recent history has occurred against a backdrop of falling interest rates. It was the realization that bonds couldn't be counted on to protect investor portfolios from loss that drove us into the research that resulted in DAA. So in that sense, DAA was specifically created to function in a rising-rate environment. We'd love to have more years with those conditions to test with, but we're confident enough from what we do have that it will be up to the job.


You should carefully consider the investment objectives, potential risks, management fees, and charges and expenses of the SMI Funds before investing. The prospectus contains this and other information about the Funds, and should be read carefully before investing. You may obtain a current copy of the Funds' prospectus by calling 877-SMI-FUND or downloading one from the SMI Funds website.

The Sound Mind Investing Funds are distributed by Unified Financial Securities, 2960 N. Meridian St., Suite 300, Indianapolis, Indiana 46208-4715 (Member FINRA).