Tag Archives: broad

How Do You Manage Risk?

By Andy Hyer That is the question that has been top of mind for many investors over the past several weeks as the markets have done their best imitation of the Twisted Colossus at 6-Flags. As it relates to our family of separately managed accounts, the answer really differs by portfolio. Here is the overview of the approach to risk management for our 7 Systematic Relative Strength portfolios: Aggressive Owns 20-25 U.S. mid and large cap stocks. Buys stocks out of the top decile of our ranks, and sells them when they fall out of the top quartile of our ranks. Overweights sectors up to approximately 2x the weight of that sector in the broad universe; no minimum required sector exposure, so if a sector is weak, it is possible that we have zero exposure to that sector. Fully invested at all times. Core Owns 20-25 U.S. mid and large cap stocks. Buys stocks out of the top quartile of our ranks, and sells them when they fall out of the top half of our ranks. Overweights sectors up to approximately 2x the weight of that sector in the broad universe; no minimum required sector exposure, so if a sector is weak, it is possible that we have zero exposure to that sector. Fully invested at all times. Growth Owns up to 25 U.S. mid and large cap stocks. Buys highly ranked stocks, and sells when they fall out of the top half of our ranks or have sufficient trend or technical attribute deterioration. Overweights sectors up to approximately 2x the weight of that sector in the broad universe; no minimum required sector exposure, so if a sector is weak, it is possible that we have zero exposure to that sector. Can raise up to 50% cash as dictated by market conditions. International Owns 30-40 small, mid, and large cap ADRs from both developed and emerging markets. Buys stocks out of the top quartile of our ranks, and sells them when they fall out of the top half of our ranks. Overweights sectors up to approximately 2x the weight of that sector in the broad universe; no minimum required sector exposure, so if a sector is weak, it is possible that we have zero exposure to that sector. Fully invested at all times. Balanced Owns 20-25 U.S. mid and large cap stocks and U.S. Treasurys in an approximately 60% equities / 40 % fixed income weight. Buys stocks out of the top quartile of our ranks, and sells them when they fall out of the top half of our ranks. Fixed income exposure to intermediate U.S. Treasurys. Overweights sectors up to approximately 2x the weight of that sector in the broad universe; no minimum required sector exposure, so if a sector is weak, it is possible that we have zero exposure to that sector. Fully invested at all times. Global Macro Owns 10 ETFs from a broad range of asset classes, including U.S. equities, International equities, Inverse equities, Currencies, Commodities, Real Estate, and Fixed Income. No minimum constraints in asset class exposure, so that if an asset class is weak, it is possible for us to have zero exposure to that asset class. Strict buy and sell discipline based on relative strength. Tactical Fixed Income Owns 2-6 Fixed Income ETFs from a broad range of sectors of Fixed Income, including U.S. Treasurys, TIPs, Corporate Bonds, Emerging Market Bonds, High Yield, and Convertible Bonds. 40% of the portfolio will always remain invested in some form of U.S. Treasurys (Short-Term, Long-Term or TIPs). Strict buy and sell discipline based on relative strength. The chart below is based on Dorsey Wright’s opinion of the likely relationship between volatility and return in each of the different strategies over a long period of time. The actual results may differ from these expectations. Greater volatility may result in greater gains and greater losses. (click to enlarge) Life is full of trade-offs, and the financial markets are no different. Good results are likely to be achieved when a caring financial advisor takes the time to understand their clients’ needs and risk tolerance, and then to build the right allocation for that client. For those advisors using our SMAs as part of that allocation, they will find that these 7 portfolios have very different approaches to risk management. All of them employ some form of risk management. Even the fully invested portfolios are managing risk through individual position management (i.e., cutting them back when they become too large a percentage of the portfolio, or completely selling them when dictated by relative strength rank) and through sector exposure. Others, like “Growth”, can raise up to 50% cash to seek to mitigate some of the downside risk. “Balanced” benefits from the time-tested benefits of combining equities and fixed income. “Global Macro” is our “go anywhere” portfolio that can completely shift away from weak asset classes if needed. Share this article with a colleague

Is Hope For Active Management Right Around The Corner?

By DailyAlts Staff Investors are looking closely at the role of active management relative to passive investing products such as indexed ETFs, and for good reason: Between March 2009 and the end of 2014, less than one-third of active managers beat the broad stock market’s returns. Why should investors pay management fees for active products that fail to generate positive alpha? Perhaps they shouldn’t, but Neuberger Berman’s Juliana Hadas, CFA, and Andrea Pompili argue that the major factors that have contributed to active managers’ underperformance over the past five years are about to change, and that the investment environment is likely to become much more hospitable to active managers in the very near future. Ms. Hadas and Ms. Pompili make their case in the recently published whitepaper, Can Active Management Make A Combeback? “Post-financial crisis underperformance by active portfolio managers is easily explained and, we believe, only temporary,” they write, before outlining three major fundamental factors suppressing active managers’ returns: Unprecedented central bank stimulus leading to ultra-low interest rates; The magnitude of the bull market in U.S. stocks since 2009; and Flows into passive investment vehicles, such as index ETFs. Ultra-Low Interest Rates Ms. Hadas and Ms. Pompili argue that the Federal Reserve’s policy of keeping benchmark interest rates near 0% have created “valuation distortions in the market.” When companies can borrow at low interest rates, they can finance expansion with debt, rather than with cash flow from operations. What’s more, low interest rates narrow the valuation gulf between near term and more distant cash flows, making further out and more speculative cash flows comparatively more attractive than they would be in a higher interest rate environment. The good news for active managers is that the Fed appears to be preparing for an interest rate hike some time in 2015; quite possibly as early as June. Higher interest rates will result in higher financing costs, thereby sharpening the distinction between firms that have been generating profits with easy money financing, and those that have been generating profits through efficient operations. This discrepancy between companies will make it easier for active managers to beat the broad market’s beta returns, whereas the low level of return dispersion in the U.S. stock market over the past five years has made generating alpha difficult. The Stock Bull Market Since ’09 Low interest rates have helped propel the bull market in stocks since 2009, since low financing costs make it easier for U.S. companies to generate profits. According to Ms. Hadas and Ms. Pompili, 70% of the S&P 500’s returns over the past 20 years have been based on earnings, and with earnings generally easier to come by, there has been a low level of dispersion between U.S. large-cap stocks. Another way low interest rates have contributed to the bull market in stocks has been by suppressing bond yields, and thereby encouraging greater risk-taking by income-oriented investors. Stocks are generally viewed as riskier assets than bonds, and investors are taking on greater risk in the face of bond yields well below 3%. But with interest rates expected to rise later this year, that trend is likely to reverse, which should provide opportunity for active investment managers. Passive Indexing Trends With U.S. large-cap stocks generally trending higher over the past five years, it has been more difficult for active managers to beat the market’s “average” (beta) returns. This is a function of the math: If the S&P 500 returns 30% above the risk-free rate of return, and an active manager had a portfolio with a beta of 0.9, then the portfolio would have to generate more than 3% alpha to outperform the market. But if the S&P 500 only exceeded the risk-free rate by 5%, then an active portfolio would only have to generate a little more than 0.5% alpha to beat the market. In somewhat of a vicious cycle, this mathematical reality has led more investors to dump funds into passive index funds, but these funds are inadvertently momentum investments, since they’re market cap-weighted. Investors buying the SPDR S&P 500 ETF (NYSEARCA: SPY ), for example, buy into all 500 components of the S&P 500 in proportion to their index weightings, without regard to the specifics of each company. Large companies that get even larger end up taking up a greater share of the index. Should the markets turn, and active management delivers, then the trend of migrating to indexed ETFs may slow. Conclusion As Ms. Hadas and Ms. Pompili point out, the performance of active managers versus the broad market’s benchmarks tends to be cyclical and to improve during less exuberant bull markets. Once interest rates begin rising, the “valuation distortions” caused by “aggressive central bank easing” will likely reverse, in the view of the whitepaper’s authors, “creating a market environment in which underlying company fundamentals start to once again matter more.”