Savvy ETF investors just aren’t willing to sit tight or ride out the bumps any more.
A sharp uptick in volatility, global unrest and rate uncertainty has revived memories of the stock market busts of the early 2000s. Neither financial advisors nor the clients they serve relish the idea of getting burned again with an unwavering buy-and-hold approach.
They want to get more tactical with their investing. That’s where ETF strategists come in.
These investing professionals put together the diversified, risk-managed strategies that today’s investors increasingly seek. They’re part of the reason iShares MSCI USA Minimum Volatility (USMV) is a best-performing ETF this year, up 7.1% through May 12 vs. 1.8% for SPDR S&P 500 (SPY).
Tactical ETF strategists champion a proactive response to shifting market currents. They seek to tilt investors’ portfolios toward rising asset classes, while avoiding falling ones, according to CMG Capital, a thought leader in tactical investing with exchange traded funds.
At the same time, they never lose sight of investors’ long-term goals, whether it be buying a home or saving for retirement. They’re not in the business of making speculative bets. Theirs is a considered approach to being tactical.
CMG’s chief and a couple of other investing pros recently sat down with IBD to discuss what tactical investing is and, just as importantly, what it isn’t.
IBD: Are you de-risking portfolios for 2016?
Steve Blumenthal is chairman and CEO of Pennsylvania-based CMG Capital Management Group, which has $552 million in assets under advisement. CMG believes portfolios should be dynamically managed: We currently favor the following investment allocations: 30% to equities, 25% to fixed income and 45% to liquid alternatives. This is due to excessively high equity market valuations and ultra-low fixed income yields.
Joe Ezernack is CEO and chief investment officer of Trademark Capital Management in Watkinsville, Ga.; $160 million in assets under management. Trademark focuses on portfolio management based upon appropriate and active adjustments in response to market change: Yes. We have made material tactical shifts in our portfolios to lower risk exposure.
We lowered our exposure to index equity beta by exchanging it for smart beta ETFs like USMV and iShares MSCI USA Quality Factor (QUAL).
Herb Morgan is founder, CEO and CIO of Efficient Market Advisors in San Diego, Calif.; AUM: $849 million. The firm describes itself as a strategic, tactical and opportunistic ETF strategist: De-risking implies reducing equity exposure. We think that is unwise today. The alternatives to equities are cash, which pays nothing, and fixed income, which pays nearly nothing. And fixed income carries large downside risk should rates rise more quickly than most people anticipate.
From a tactical standpoint, we are overweight risk assets of equities and commodities. My overall investment allocation is to be overweight equities, underweight fixed income, near zero on cash, and a small weighting (0% to 10%) in inflation-sensitive assets such as commodities. Inflation is coming, and bonds are not the place to be.
The entire world of central bankers and other policymakers are desperately trying to inflate, i.e., massive monetary stimulus. The debt burden globally is massive. Austerity is not politically expedient, so we will see inflation. Not the rip-your-face-off variety, but certainly above normal, above trend and above current expectations.
Equities and commodities do well in this environment. It also means a return to growth — yes, growth — which today is anemic. I don’t invest for today, I invest for two to five years out, when I believe we will have a large growth burst globally.
IBD: What does tactical investing mean to you?
Blumenthal: We view tactical two ways:
- The first is strategic tactical asset allocation. Think of this as how much to strategically allocate to equities, fixed income, alternatives and cash. It’s also deciding which investment categories to overweight, equal weight or underweight.
- Then there are tactical investment strategies, such as trend-following and relative strength.
Trend-following compares the short-term price action of a security against the same security’s longer-term price trend. Comparing recent price action vs. a longer time period can help identify trends for all types of securities.
Relative strength compares the price momentum of one security against another security or a select group of securities. The security with the strongest relative strength price momentum is selected. Sector rotation is a common relative strength investment strategy. Individual equities can be ranked to identify the strongest price leaders. For example, IBD posts a Relative Strength Ranking of all of the stocks it follows and ranks them by percentile. Relative strength seeks to identify the securities with the strongest price leadership and position accordingly.
Ezernack: Tactical investing means providing an investor an emotional advantage over a traditional portfolio. We attempt to accomplish this by aligning a portfolio with the current market risk environment, within the boundaries of the portfolio objective. For a retiree, that may mean going fully defensive in bear market conditions. For an aggressive investor, that could mean tactical portfolio shifts with the goal of improved relative performance in changing market environments.
Tactical investing is not a system to pick market tops or bottoms, nor is it a way to get rich quick.
Morgan: Tactical investing is a bastardized term. In the textbook world, it means making moves within the confines of a policy statement, which is what we do. In recent years, however, the term tactical has been hijacked by charlatans who make false promises to investors that they can time the market. In fact, market timing failed miserably in the last decade and has now re-branded itself “tactical.” That’s too bad because tactical has merits when properly implemented in the traditional, academic sense of finance textbooks.
A good tactical move would have been to raise equity weights to 60% in early February, if you had a strategic target of 50% to equities, with a permitted range of 40% to 60%. Or within your permitted range to buy a beaten-down asset class. We bought Alerian MLP (AMLP) in late January and have since had a great return.
Tactical investing is not market timing. How ridiculous is it to trust your life savings to a computer program that goes all in or all out of the markets?
Our changes are measured and constrained; they are also based on fundamental analysis. The market timers are relying on signals that are created and refined to suit their desires. We evaluate both fundamentals and technicals. They rely only on technicals.
IBD: What is working, and what hasn’t worked, in your portfolios lately?
Blumenthal: Most recently, we’ve seen strong relative strength price leadership in iShares Latin America (ILF), Vanguard FTSE Emerging Markets (VWO), SPDR Dow Jones REIT (RWR), Utilities Sector SPDR (XLU), Vanguard Materials (VAW) and Vanguard Information Technology (VGT).
Ezernack: Low volatility has worked well for us this year. One standout position is iShares MSCI EAFE Minimum Volatility (EFAV), which has shown significant outperformance over its more traditional counterpart, Vanguard FTSE Developed Markets (VEA).
In the same theme, traditional equity beta exposure hasn’t worked as well as our smart beta positions. For example, year to date our holdings in iShares MSCI USA Minimum Volatility have performed better and, as the name implies, with less volatility than have our holdings in Vanguard S&P 500 (VOO).
Morgan: So far 2016 has been very good for us.
In equity, we are overweight international and emerging markets. All have done well. Domestically, our small- and midcap exposures are working.
In fixed income, spreads in high yield and bank loans have narrowed, and we have been overweight there. We haven’t benefited from the drop in 10- to 20-year rates this year because we mostly have shorter-term or adjustable fixed-income ETFs in the portfolios.
I have no regrets. Risk/reward is very bad on the long end of the duration/maturity curve. Even if it worked, the risk wasn’t worth the trade.
In alternatives, we have benefited from MLP (master limited partnerships) and commodity positions.
IBD: Is the traditional 60-40 stock-bond portfolio dead?
Blumenthal: We believe the traditional 60/40 stock bond portfolio will not meet investor expectations over the coming 10 years. Due to the current high median price-to-earnings equity valuations, the 10-year forward annualized returns are likely to be in the low single digits. Expect just 2% to 4% before inflation. The same problem exists for fixed income. With the 10-year Treasury yielding less than 2%, the 10-year forward annualized returns will be less than 2% and close to 0% after factoring in inflation (assuming the Fed hits its inflation target mandate).
We believe a broader portfolio mix that includes allocations to other return drivers, such as managed futures, global macro, long/short equity and tactical investment strategies, will create better diversification and better return opportunity. In this high equity valuation, low fixed-income yield environment, find strategies that may generate return yet do so in an unconstrained and uncorrelated way.
The next recession will create a better buying opportunity for equities. For now, 60/40 is flat to dead.
Ezernack: The traditional 60/40 portfolio’s effectiveness is being questioned primarily because fixed income is at the end of a long-term debt cycle. The end of the long-term debt cycle will likely bring a bad season for the 60/40 portfolio, however, it’s not its death. A favorable environment for the 60/40 portfolio will cycle back around. However, I would expect a continual evolution to the portfolio’s makeup.
Smart beta, active, tactical and new styles of ETFs will continue to drive the evolution of the 60/40 portfolio. Yesterday’s 60% Vanguard S&P 500 (VOO) and 40% iShares Core U.S. Aggregate Bond (AGG) will not be the 60/40 portfolios that millennials will own.
IBD: What’s the universe of ETFs you draw from?
Blumenthal: Our CMG Opportunistic All Asset Strategy selects up to 11 ETFs from a broad universe, allocating to those showing the greatest potential to outperform the others in the selection universe.
The ETFs considered include traditional style-box ETFs (large cap, midcap, small cap, value and growth), sector-specific ETFs, international developed and emerging market ETFs, various fixed-income ETFs, and gold and commodity-based ETFs such as REITs (real estate investment trusts) and MLPs. The ETFs demonstrating the strongest relative strength price leadership are selected and held for a defined period of time.
(Editor’s note: CMG Capital Management Group may have positions in the ETFs and mutual funds discussed in this piece.)
Ezernack: We choose among the products whose underlying positions are liquid. We also select ETFs that have significant market liquidity and have good authorized participant access for larger trades.
IBD: In what ways are you tactical, in what strategic, and in what opportunistic?
Morgan: We are strategic in that we have long-range equity, fixed-income and alternative targets for investor portfolios. These are targets derived from their needs (age, time horizon, risk tolerance/aversion, personality etc.) We are tactical within the permitted ranges.
Opportunistic is my favorite thing. This is 0% to 10% of our portfolio, where we take on a sector, industry or specific country ETF for a fundamental reason around valuation.
For example, we bought SPDR S&P Homebuilders (XHB) when they were beaten down. We also picked up iShares U.S. Preferred Stock (PFF) and PowerShares Variable Rate Preferred (VRP) when people were worried that the banks were going to get nationalized.
Opportunistic ideas are unique, real-time, unexpected and usually need to be acted on quickly. There can be sell opportunities as well, like when REITs were getting taken out via leveraged buyouts in 2007. The REIT valuations were sky-high, so we opportunistically sold iShares Cohen & Steers REIT (ICF) and Vanguard REIT (VNQ).