Tag Archives: etf

Using Momentum And Hedge Funds To Build A Better Portfolio

Welles Wilder revolutionized the investment world in 1978 when he developed the Relative Strength Indicator (“RSI”). RSI was one of several new technical indicators that helped individual investors move away from static “60/40” or “70/30” stock/bond asset allocations as trading commissions plummeted in the wake of discount brokerages displacing more expensive “full-service” offerings. Now, nearly forty years later, Berkeley Square Capital Management has a new take on RSI – and the traditional “70/30” allocation. The firm combines the two concepts, while adjusting RSI from a short-term indicator based on the past 14 days to a longer-term momentum indicator based on the past 12 months , and also adding hedge funds to the allocation mix – “50/30/20.” What’s more, Berkeley Square’s momentum strategy differentiates between the best and worst sectors within each asset class, taking advantage of reduced commission charges by rebalancing its portfolios as frequently as warranted to maximize risk-adjusted returns. Sector Breakdowns Rather than allocating 50% to the S&P 500, 30% to the Barclays Aggregate, and 20% to the HFRI Hedge Fund-Weighted Composite (“FWC”), Berkeley Square breaks each of the broad indices down into its composite sectors, and then assigns RSI rankings to each. The top five sectors from each asset class are then weighted to comprise the total “50/30/20” portfolio. Among equities, Berkeley Square looks at the S&P 500’s ten composite sectors: Energy Materials Industrials Consumer discretionary Consumer staples Health care Financials Information technology Telecommunications Utilities For fixed-income, Berkeley Square looks at the following Barclays Total Return indices: S. Corporate Investment Grade Intermediate Corporate Long U.S. Corporate S. MBS GNMA S. Long Credit S. Aggregate Government/ Credit And for hedge funds, the following HFRI strategy style indices are considered: ED: Merger Arbitrage EH: Equity Market Neutral EH: Short Bias Emerging Markets (Total) Equity Hedge (Total) Event-Driven (Total) Fund of Funds Composite Macro (Total) Frequency of Rebalancing The frequency of portfolio rebalancing should always be scaled to maximize risk-adjusted returns. According to Berkeley Square’s findings, equity holdings are best rebalanced monthly, which has historically yielded a return per unit of risk of 0.76 – compared to risk-adjusted returns of 0.56 for annual rebalancing, 0.59 for semi-annual, and 0.66 for quarterly. By contrast, bond holdings perform best when rebalanced annually, and hedge-fund holdings when rebalanced quarterly. Independent Returns Adding hedge funds to the asset allocation has slightly improved returns, historically, but more greatly improved risk-adjusted returns. As Modern Portfolio Theorist Harry Markowitz said, “Expected return is a desirable thing and variance of a return is an undesirable thing” – so rational investors should prefer more stable returns to more volatile returns, all other things being equal. From 1991 through 2014, the S&P 500 Total Return Index generated compound annualized returns of 10.18%, compared to the HFRI FWC’s 10.81%. But the S&P’s annualized standard deviation of 18.39% yielded a return per risk unit of 0.55, while the HFRI FWC’s much lower 12.11% annualized standard deviation yielded a 0.89 return per unit of risk. The Barclays Aggregate Index of bonds, by contrast, yielded much lower annualized returns of 6.39%, but with even lower annualized volatility of 4.97%, its return per unit of risk was the highest at 1.29. Putting it all Together What’s important, of course, is how the three asset classes act together, within a single portfolio: According to Berkeley Square’s research, the “50/30/20” portfolio – even without rebalancing – outperformed “70/30” with annualized returns of 9.58% from 1991 through 2014, compared to the “70/30” portfolio’s returns of 9.48% over that same time. More importantly, “50/30/20” outperformed on a risk-adjusted basis, with a return per unit of risk of 0.85 compared to the “70/30” portfolio’s 0.72. But what about when Berkeley Square’s dynamic reallocation system was followed? In this case, the “50/30/20” portfolio’s annualized returns were boosted to 10.92% with return per unit of risk of 1.16, besting even the long-only S&P 500 Total Return Index’s 10.18% returns, and with much less volatility. For more information, download a pdf copy of the white paper . Jason Seagraves contributed to this article.

Pessimistic Outlook? Maybe You Should Manage A Bond Fund

Ever notice how pessimistic bond fund managers are? They are some of the most “glass half empty” people you will ever come into contact with. Even the ones who have successfully built legacies that will endure for generations are consistently talking down on the economy, central banks, growth, and other unfavorable data points. Jeffrey Gundlach recently hypothesized that emerging markets could fall as much as 40%. He has also been an outspoken critic of the Federal Reserve’s rate hike agenda and the lack of inflation in the developed world. Gundlach is the head of DoubleLine Capital, which manages $85 billion in fixed-income assets. Similarly, renown bond investor Bill Gross railed about the problems with government debt and social service liabilities in his 2016 investment outlook . He seems very concerned about demographic trends and workforce shortages. Gross ran one of the biggest bond funds in the world at PIMCO prior to his separation from the firm he founded and transition to Janus Capital Group. These are just two of the most vocal and well-known bond managers in the world, but there are countless others that are quick to point out cracks in the global economic picture. Talking Your Book In the business we call this “talking your book” or simply slanting the facts and opinions towards a conclusion that favors your trade. Volatility, uncertainty, and fear are a bond managers dream come true. They have built empires on the back of investors fleeing the stock market in a rush to safety. Stocks usually drop in tandem with interest rates, which means that bond prices rise in kind. This favors their performance story and leads to a wave of new assets that quickly enter and are slow to leave. The returns are steady, the volatility is low, and the fees are reasonable – why would you ever want to depart that warm cocoon? These bond fund titans are simply saying ” take my hand and I’ll guide you around all the pitfalls and uncertainty “. Bless their hearts. Active managers in particular are able to shape the underlying holdings of their funds in accordance with their views. They have certain limits and mandates according to the prospectus guidelines. However, there is always some leeway to reduce exposure to areas they are concerned about, add to undervalued opportunities, or build in hedges as appropriate. This can lead to a measurable boost in performance over the benchmark if they are on the right side of the market. The best bond fund managers have risen to their status because they are right more often than they are wrong. My review of Gundlach’s predictions for 2015 were pretty spot on with the exception of his call on gold. I have been a long-time fan of his flagship strategy in the Doubleline Total Return Bond Fund (MUTF: DBLTX ) and continue to hold it in my own account as well as for my clients. The rigors of managing billions in bonds is a stress that I will likely never have to endure. As a result, I have a more even-keeled outlook for the future that balances the dangers of a bear market or recession against the opportunity for a resurgence in risk assets. This allows for a more flexible (if guarded) approach that has served me well in riding out the ups and downs of this fickle market. The Bottom Line Understanding the motivations of an investment manager can be useful in deciphering their market calls and help frame their message in the context of your personal outlook. In addition, it’s always advantageous to dig a little deeper to see how their actual portfolio is positioned versus what they are saying publicly. If there is a disconnect between these two points, it may be best to err on the side of their actions versus their words. Remember that everyone has a motivation or bias in the investment world (even me). By understanding this perspective, you can more acutely discern brains from bullshit and act accordingly.