Tag Archives: etfs

A Dynamic Equity Strategy For A Volatile Year Ahead

Introduction Global stock markets have had their worst start to a new year in decades. Many developed markets are down over -20% from their respective highs. The S&P 500 is down approximately -12% from its May 2015 peak and -8% in January alone. Approximately one-half of the S&P 500 Index’s components are down -20% or more from their 52-week highs. We’re most likely in for a challenging investment environment in the year ahead. A combination of low-volatility, momentum and liquid alternatives (liquid alts) will likely generate alpha in 2016. Low-Volatility Numerous studies have shown that low-volatility investing offers superior risk-adjusted returns compared to its high-volatility counterpart and market-cap weighted benchmark portfolio over a full market cycle. We have argued that low-volatility funds such as the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), PowerShares S&P 500 Low Volatility ETF (NYSEARCA: SPLV ), iShares MSCI EAFE Minimum Volatility ETF (NYSEARCA: EFAV ), iShares MSCI All Country World Minimum Volatility ETF (NYSEARCA: ACWV ), and the iShares MSCI Emerging Markets Minimum Volatility ETF (NYSEARCA: EEMV ) should be used as a continuing strategic component or core holding of an investor’s overall portfolio, rather than a tactical component. Less volatile stocks help provide a smoother performance pattern and stronger downside-risk protection. USMV vs. SPY One-Year Chart Click to enlarge Two-Year Chart Click to enlarge Three-Year Chart Click to enlarge Momentum Momentum investing is a time-tested strategy for building portfolio efficiency and diversification, while generating excess returns. It identifies securities with good relative performance in rising, neutral and falling markets. A momentum strategy consistently reduces the risk of holding poorly performing securities. It is particularly beneficial when combined with a value component, and thus would complement low-volatility strategies. Momentum and value each deliver positive excess market returns, but because they are negatively correlated, the combination lowers risk and improves portfolio efficiency. You can expect higher risk-adjusted returns by adding a momentum component to your portfolio. The iShares MSCI USA Momentum Factor ETF (NYSEARCA: MTUM ) tracks the performance of an index that measures the performance of U.S. large-cap and mid-cap stocks exhibiting relatively higher momentum characteristics. It currently holds 123 stocks and has an annual expense ratio of 0.15%. Consumer Discretionary (30%), Information Technology (26%), Consumer Staples (17%) and Health Care (12%) represent 85% of the fund. Its top three holdings include Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Home Depot (NYSE: HD ) and Starbucks (NASDAQ: SBUX ). Click to enlarge MTUM happens to be at a new high relative to the total market, which may be a bullish sign for the momentum names. Click to enlarge MTUM vs. SPY One-Year Chart Click to enlarge Two-Year Chart Click to enlarge Three-Year Chart Click to enlarge * MTUM began trading on April 16, 2013 Several other momentum-based ETFs may be worth a look. The First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ) targets the five sector and industry based ETFs which offer the greatest potential to outperform on a continuous basis. Another Dorsey Wright-based fund is the PowerShares DWA Momentum ETF (NYSEARCA: PDP ). It follows the Dorsey Wright Technical Leaders Index, a benchmark that adheres to the Dorsey Wright relative strength methodology. Goldman Sachs has recently entered the ETF space with a successful fund. The ActiveBeta US LargeCap Equity ETF (NYSEARCA: GSLC ), which is powered by a proprietary methodology based on the Goldman Sachs ActiveBeta index, was cited as one of the best new ETFs for 2015 by Morningstar. It has one of the lowest annual expense ratios (.09%) in this ETF space. Momentum is found across all asset classes and is not constrained by geographical boundaries. The iShares MSCI International Developed Momentum Factor ETF (NYSEARCA: IMTM ) takes its factor-driven approach to the EAFE countries. This new ETF, which came to market in early 2015, features an almost 32.92% weight to Japan with another combined 21% allocated to Germany and the United Kingdom. None of IMTM’s 292 holdings command a weight of more than 2.60%. The ETF’s top 10 holdings include Novo Nordisk (NYSE: NVO ), SAP SE (NYSE: SAP ) and Unilever (NYSE: UL ) Liquid Alts Liquid alternatives put hedge-fund-like strategies into mutual funds and ETFs. They aim to diversifying away from stocks and bonds, and dampen volatility. Liquid Alts work well in a higher-volatility environment. “Market neutral” is a popular hedge fund strategy that uses both long and short position, or borrowings, to make a profit. Long-short strategies are best suited to investors who expect low returns from stocks going forward. The AQR Long-Short Equity Fund (MUTF: QLEIX ) invests in individual equities and equity-related instruments of companies in global developed markets. It combines three independent sources of potential returns: security selection, passive market exposure and tactical market exposure. QLEIX vs. SPY vs. AGG One-Year Chart Click to enlarge Two-Year Chart Click to enlarge Three-Year Chart Click to enlarge We also like the AQR Equity Market Neutral Fund (MUTF: QMNIX ). Its annual expense ratio is capped at 1.35%, which is low in comparison to other similar funds. It goes long and short equities based on fundamental measures of value, momentum and quality. The Fund strives to produce positive absolute returns by taking long and short positions in equity and equity-related instruments that, based on proprietary quantitative models, are deemed to be either undervalued (and likely to increase in price) or overvalued (and likely to decrease in price). QMNIX is not restricted by market-cap size or geography, but it invests primarily in developed markets. QMINX was up +17.60% in 2015, and this year is far outperforming the S&P 500. The fund is ahead almost 3% vs. a decline of about -8% for the S&P 500. Conclusion Investors should expect a more volatile year ahead. Low-volatility, momentum and liquid alternative investments can add meaningful alpha relative to the broader market. Utilizing a combination of all three strategies in your portfolio will likely allow you to lower your portfolio’s risk while creating excess returns. Additional disclosure: George Kiraly Jr., CFP, MBA is the president of LodeStar Advisory Group, LLC, an independent Registered Investment Adviser located in Short Hills, New Jersey. George Kiraly, LodeStar Advisory Group, and/or its clients may hold positions in the ETFs, mutual funds and/or any investment asset mentioned above. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.

The Fat Pitch Lurking In Frontier Markets

The Fat Pitch Lurking in Frontier Markets 2015 was a challenging year for most investors as global growth concerns reduced risk appetites globally. Frontier Markets were no exception with all major Frontier Market indices posting double-digit negative returns. That said, I have not been this excited about opportunities within Frontier Markets since 2008 and the work recently completed confirms my enthusiasm. To borrow a phrase used by my former boss and mentor at GMO, Jeremy Grantham, there is a “fat pitch” lurking in Frontier Markets – a baseball reference to game situations when odds of getting an easy pitch to hit are high. This fat pitch is in value stocks in Frontier Markets. Relative valuations of Frontier Markets value stocks are near their 2008 low relative to Frontier Market growth stocks. We define “value” as the bottom two quintiles of our investible Frontier Market universe based on price-to-book and “growth” as the top two price-to-book quintiles. By creating “value” and “growth” indices, we analyzed the yearly returns of each subset of stocks. The value and growth indices were rebalanced each quarter and were calculated both by equal weighting and market capitalization weighting the constituents. The results are as follows: For the period of 2007 to the end of 2015, the value index had an average price-to-book discount to growth stocks of approximately 70% ranging +/- 10% over the nine-year period. Not surprising, value does not do well during periods of heightened market risk. Regardless of whether the indices are weighted equally or by market capitalization, value massively underperformed during 2008 and 2015 relative to growth stocks. In fact, value stocks performed abysmally, underperforming by 1,600 basis points versus growth stocks in both years. The performance of value versus growth when market risk abates and valuations mean revert is powerful. During 2009, value stocks trounced Frontier Market growth stocks by a whopping 4,200 basis points. This is remarkable and highlights the low intra-correlation among Frontier Market stocks given that the two indices are created from the same Frontier Market universe and are not separate asset classes such as stocks and bonds. In addition, by comparing the difference in performance between the market cap weighted value index and the equal weighted value index, it is clearly evident that large cap value does much better than small cap value during subsequent rebound periods. Admittedly, this is a small sample size, but it is hard to make an argument why today value should be permanently impaired. Some investors may find it psychologically easier to allocate to an asset class as it is rising. However, the recent sell-off has provided a plethora of undervalued Frontier Market stocks that are less exposed to global uncertainties. For long-term investors, the recent market rout may prove to be an excellent entry point for those who have been contemplating an allocation to Frontier Markets.

Franklin Templeton To Jump Into Smart Beta ETF Jungle

With just one ETF currently in the market, Franklin Templeton looks to make a bigger splash with a new range of equity ETFs. The company recently filed paperwork with the Securities and Exchange Commission (“SEC”) effectively announcing the firm’s plan to launch a quartet of smart-beta ETFs. Each of the funds in the LibertyQ series will track custom, rules-based indices calculated by MSCI. The four ETFs slated for release are: Franklin LibertyQ International Equity Hedged ETF Franklin LibertyQ Emerging Markets ETF Franklin LibertyQ Global Dividend ETF Franklin LibertyQ Global Equity ETF Multi-Factor Weighting All four ETFs are “multi-factor,” each with a different focus ranging from currency-hedging to dividend-themed. Instead of market cap, investments within the funds will be weighted according to a mix of quality, value, momentum, and low volatility. The Franklin LibertyQ International Equity Hedged ETF will invest in qualifying large- and mid-cap stocks from Europe, Australasia and the Far East, with no individual stock accounting for more than 2% of the fund’s total assets. The fund’s goal is to provide superior risk-adjusted returns compared to the MSCI EAFE (“Europe, Australasia, and the Far East”) Index, which is cap-weighted. The new Emerging Markets ETF is somewhat similar, but with holdings culled from the MSCI Emerging Markets Index. Unlike the International Equity Hedged ETF, though, the Emerging Markets version is not currency-hedged, and its holdings may be more highly concentrated in individual countries, sectors, and individual holdings. Franklin’s new LibertyQ Global Dividend and Global Equity ETFs also follow customized MSCI indices, with the former boasting a dividend theme while the latter seeks to outdo the risk-adjusted performance of the MSCI ACWI (“All Country World Index”). Industry-Wide Movement Barron’s reports that a Franklin Templeton spokesperson wouldn’t offer comment beyond what’s in the SEC filing, but CEO Gregory Johnson said “our intention is to enter the marketplace with smart beta ETFs and rule-based ETFs” back in June, in a post-earnings call with analysts . In doing so, Franklin Templeton joins Legg Mason, John Hancock, and Goldman Sachs as recent boarders to the smart-beta bandwagon. Management fees and ticker symbols for the new funds were not included in the filing.