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How I Created My Portfolio Over A Lifetime – Part V

Summary Introduction and series overview. The hardest lesson I have ever learned. The asset that always goes up in value when all other assets go down. Summary. Back to Part IV Introduction and Series Overview This series is meant to be an explanation of how I constructed my own portfolio. More importantly, it I hope to explain how I learned to invest over time, mostly through trial and error, learning from successes and failures. Each individual investor has different needs and a different level of risk tolerance. At 66, my tolerance is pretty low. The purpose of writing this series is to provide others with an example from which each one could, if they so choose, use as a guide to develop their own approach to investing. You may not choose to follow my methods but you may be able to understand how I developed mine and proceed from there. The first article in this series is worth the time to read based upon some of the many comments made by readers, as it provides what many would consider an overview of a unique approach to investing. Part II introduced readers to the questions that should be answered before determining assets to buy. I spent a good deal of that article explaining investing horizons, including an explanation of my own, to hopefully provoke readers to consider how they would answer those same questions. Once an individual or couple has determined the future needs for which they want to provide, he/she can quantify their goals. If the goals seem unreachable, then either the retirement age needs to be pushed further into the future or the goals need to become attainable. I then explained my approach to allocating between difference asset classes and summarized by listing my approximate percentage allocations as they currently stand in Parts III and III a. Part IV was an explanation of why I shy away from using ETFs and something akin to an anatomy of a flash crash. In this article I will explain one of the most difficult concepts for most investors to grasp. It certainly was for me. Why? Because we keep reading (or at least I do) that to do the opposite it is the best thing we can do. I will explain my education process as we go along in the article. The hardest lesson I have ever learned Growing up as a teenager in the 1960s I had to listen my Dad complain about inflation… a lot. Everything was getting more expensive and he owned his own business. Raising the prices he charged his customers was difficult for him but he had to do it because the cost of everything he used in his business, a small resort on the Canadian border waters of Minnesota, was rising. He kept telling me that the value of a dollar was going down. That lesson stuck with me. As I got a little older I went off to college after spending two glorious, all-expense paid year-long vacations in Southeast Asia, courtesy of my Uncle Sam. Yes sir, I got to spend time hiking trails and communing with nature with plenty of activities to keep my adrenaline flowing. What a rush! While in college I took a full load of classes and worked full time to pay my own way, helped once again by my good old Uncle who sent me 36 monthly checks to help with the cost of college. Every time I noticed that my savings had burgeoned to over two thousand dollars (I do not know why that number trigger an urge, but it did), I had to buy something. Otherwise, inflation would just eat away at that money as it became worth a little less each year. Thanks, Dad! Actually, I should not blame him because he did teach me how to save. He just stopped with that lesson and the one about inflation. The spending thing I came up with on my own. Then came my first professional job with a company car, liberal expense account, great pay, stock bonus and profit sharing. It was a nice start right out of college. This time I was so busy that my savings piled up faster than I could spend it. This was back in the late 1970s and interest rates were rising. At that point I knew nothing about stocks and very little about real estate. I had no interest in bonds, something that now I really wish I had understood well back then. By 1980 I had saved $25,000. That does not sound like much today, but in 1980 it seemed like a small fortune to me. If I had understood how bonds worked then I would have used all of it to buy 30-year U.S. Treasuries. I must admit right now that I did nothing very good with all that savings. I could explain but none of it would be very instructive nor beneficial to understand. To summarize, I did not have the same level of income but I did not adjust how I lived. While this is not the lesson of the article, it was a good one to learn early in life. Eventually, the money began to run low and I was forced to change some spending habits. Life would have been better had I had the foresight to make adjustments earlier. Live and learn. Looking back something that did not sink in at the time but has since become clear is that when interest rates are extremely high and housing values fall it is a great time to buy real estate. Interest rates will eventually drop providing an opportunity to refinance resulting in lower mortgage payments. Falling interest rates also tends to help boost real estate values at a higher rate than average. But that is not the lesson of the article either. The lesson that was so hard to learn was to unlearn what I learned from my Dad and from many other sources: holding cash without receiving any interest or income is a sure way for your savings to lose value because of inflation. I learned that not earning more than inflation on my money would cause me to permanently lose buying power. That is what I had learned all of my life. The hard part was to learn that what I had learned was wrong! Am I losing you? Stick with me a little longer and you will understand that what I am saying is true. It is not what any financial institution wants you to understand. Having money sitting in an account that may not keep up with inflation seems ridiculous, does it not? That is what we keep hearing. But that way of thinking just gets people to invest when they should be on the sidelines waiting for a better opportunity. Wall Street cannot make a profit on your money if you let it just sit there. They need transactions! The asset that always goes up in value when all other assets go down Cash is the one asset class that goes up in value when all other assets go down. Think about it for a few moments. If you have $10,000 in cash that you could invest in a the stock of a great company at $50 with a dividend of $1.25 now, would you do better than holding the cash until the share price went down to $40 two years later with a dividend of $1.40? The answer should be obvious. But rather than looking at a hypothetical situation I want to offer two real examples from my own portfolio. I decided back around the beginning of 1997 that I wanted to own shares of PepsiCo (NYSE: PEP ). My reason for liking PEP so much was that I was drinking several cans of the stuff every day at work. Most people drank coffee for the caffeine, I drank soda and my favorite was Pepsi. I know that is not a great reason, but I was just starting out. Besides, I knew I was not the only one who liked Pepsi products. After studying the stock I had some regret for not having bought it earlier and decided that I would only buy it if the price dropped back to $33 per share again. All of 1997 went by and the price did little other than rise. It was little different over most of 1998. I almost threw in the towel and bought the stock in March of 1998 at around $40. But at that price the dividend yield was under one percent. I decided to wait. Finally, sometime in late summer I learned about good-until-canceled buy orders. So, I placed an order to buy some shares at $33 per share, good-until-canceled and stopped worrying about it. In early October the shares traded down below $30 and I go my fill. I ended up buying the shares at $33. I could have done better, but I reminded myself that I was doing better than if I had bought at $40. It helped. I have since made another purchase of PEP and will go through that example in a minute. Now I want to show you how I did and the difference in results between my actual purchase and what would have happened had I pulled the trigger earlier at $40. To keep the math simple I will assume in both this and the next example that I had $10,000 to invest each time. If I had invested in PEP at $40 per share in March 1998, I would have gotten 250 shares. I would have collected a couple more dividend payments but the total of dividends I would have collected from then to now would be $5,814. My total gain would be $13,617. My original $10,000 investment would now be worth $29,431 and my dividend (as indicated) this year would be $680 for a 6.8 percent yield on my original investment. That all sounds pretty good. Here are the results of what the type of return I got by waiting for the price I wanted compared to the above example in table form. Date Price Shares Total Dividend Gain Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 03/98 $40 250 $5,814 $13,617 $10,000 $29,431 11.4% $680 6.8% 10/98 $33 303 $6,967 $18,625 $10,000 $35,592 13.5% $814 8.1% The column for Compound Annual Return (Comp Anl Rtn) does not include reinvested dividends. The column labeled Yld represents the annual yield now earned on the original investment. Next I want to take a look at what I did later in life, after I had learned a little more about how the value of cash increases when other assets go down. But first, a little rant. I get tired of hearing that it does not matter if an investor buys shares in a company at the peak of a bull market or at the bottom of a bear market as long as they hold those shares long enough. The difference will become less over time, we are always told, and eventually become inconsequential. The problem with the examples they use to explain the difference is that they usually assume that the investor buys the same number of shares in both instances. Such examples do not consider the reality that an investor will be able to buy more shares at a lower price with the same amount of cash. Those additional shares result in more gain and a higher dividend yield and the difference increases over time. If I had followed the conventional wisdom that says it does not matter when you buy and invested $10,000 in PEP shares two months before the stock hit its high in 2007 I would have bought 142 shares at about $69.96, the average price on September 1, 2007. The stock traded as high as $77.41 in November 2007, so I am not taking the top of the market. I actually made a purchase on June 1, 2009, almost two years later. I missed all the dividend income that would have been collected for those two years, but I am glad I did. Check out the results in the chart below. Date Price Shares Total Dividends Total Gains Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 9/1/2007 $69.96 142 $2,358 $3,480 $10,000 $15,772 5.9% $386 3.9% 6/1/2009 $52.82 189 $2,467 $7,872 $10,000 $20,339 9.3% $514 5.1% The results are obvious. Waiting for a better buying opportunity allowed me to buy more shares, collect more dividends, lock in a much higher yield and created a superior compound annual return. Again the returns do not include reinvested dividends or any income on the cash accumulated from collecting those dividends; doing so would only make the comparison more lopsided. Each time we go through another cycle I try to get better at identifying when an asset such as equities no longer offer me a bargain. At that point I stop buying and just begin to accumulate until the next time we experience a significant economic recession. I provided the two examples of my purchases of PEP shares for a reason. The first example, in 1998, represented a modest bear market swoon. The second example, 2007-2009, was a much more sever recessionary period. The point of the two examples was that it can be beneficial to wait whether the bear market is deep or relatively small. Summary The main point that I hope I have made clear is that when stocks, or any other asset, fall significantly in value the amount of that asset an investor can purchase with the same amount of cash increases. Stated differently, when the value of other assets falls, the value of cash increases. We need to stop thinking in terms of inflation eating away at the value of our cash and begin thinking in terms of how much more of an asset the same cash today will buy when the value of that asset drops. Cash has value, not only in terms of the everyday items that we buy. As an investment we need to think of cash as increasing or decreasing in value relative to other assets. This does not mean that we should only buy at the bottom after an asset class has crashed. What it does mean is that buying assets that are deeply undervalued will provide better returns than buying when those assets are fairly valued or above. After a crash like we experienced in 2008-09 real estate and equities remained deeply undervalued for several years. There were bargains everywhere I looked. I didn’t have enough cash to take advantage of all the opportunities. But I had more than most. And I benefited from my patience. Do not expect to be perfect. Just try to do better through each cycle. At our current point in time I believe that cash is king, but that does not mean I plan on selling any of my long-held holdings. I like my positions in most of my portfolio and I also like the dividends that help me accumulate more cash. In the next article of this series I plan to explain how I do trim some of my holdings systematically and why. After that I want to address the topic of tax efficiency in the following article. That is an area where some very simple planning can help a lot over a long holding period. I do not plan to cover the entire universe of tax planning because most of us do not need to understand it all. What I will cover are the simple things that we can all do if we just understand a little more about how to invest to avoid or defer taxes better. After that I would like to delve deeper into how to develop a plan for saving and investing, especially for those starting out, but also for those mid-stream of their accumulation and investing phase of life. One can always make adjustments and improve a little here and there. As always I welcome comments and questions and will do my best to provide details and answers. This is one of the best aspects of the SA community. We can learn from each other and share our perspectives so that other readers can benefit from the comprehensive knowledge and experience represented here.

Beating The Market With Profit And Beta: An Exercise

Summary Having established that low-beta stocks outperform, I posited that stocks with returns on invested capital much greater than their cost of capital would also outperform. I further posited that a portfolio comprised of the lowest-beta of these stocks would produce further risk-adjusted outperformance. Using the S&P 1500 as my pool of stocks to choose from, I simulated these strategies over the past 5 years. Here’s what I found. Having recently established in a separate article that low-beta stocks can strongly outperform the market, I wanted to see whether other approaches might outperform the market in an independent fashion, or else add to the alpha of a low-beta approach. I decided to look at whether or not companies with “economic moats” might outperform the broader market as well. The idea is certainly appealing. A company capable of sustaining an economic profit over time would probably benefit from what Morningstar typically contends are moat sources : Network effect, Intangible assets, Efficient scale, Cost advantage, and Switching costs. Certainly, a company imbued with these qualities would be expected to outperform the broader market over a full market cycle, and any discount on such a high-quality firm would be expected to dissipate relatively quickly as the market reestablished a premium reflective of these characteristics. This is the rationale behind certain exchange-traded funds like the Market Vectors Wide Moat ETF (NYSEARCA: MOAT ), and to some degree behind value-based methodologies practiced by Warren Buffett and others of his ilk. The problem, unfortunately, is that moatish qualities are difficult to quantify and may fade over time. A rough guess for the presence of an economic moat for a given firm has been posited by some as the firm being able to post a return on invested capital greater than its weighted average cost of capital, though certainly any given firm in a cyclical industry might be able to do so unreliably. What is probably more predictive is a demonstrated, sustained ability of a firm to generate an economic profit. These might be more readily found in stable industries with predictable dynamics. I posited that a strategy focused on firms with demonstrated sustained economic profits with business models suggestive of stable dynamics would outperform the broader market, and that this strategy would be also prove superior to a low-beta strategy alone. Experimental Method: I gathered 10-year financial data from Morningstar on each of the 1,500 components of the S&P 1500, as well as 10-year price data. I calculated yearly returns on invested capital for each company, and, starting with 2009, calculated a rolling 5-year average ROIC for each company between 2009 to the present. Beta was calculated in rolling 5-year increments using the S&P 500 (NYSEARCA: SPY ) as a benchmark, and a 5-year rolling cost of equity was calculated with the risk-free rate being a rolling average of 10-year treasury interest rates. Weighted average cost of capital was calculated using the normal method, with the cost of debt informally assumed to be either the yearly interest payment over the sum of short and long-term debt versus the interest rate suggested by the company’s interest coverage, whichever was higher. Economic profit was calculated as EVA = ROIC – WACC. From these metrics, the following strategies were simulated: A low-beta strategy, with monthly rebalancing into an equal-weighted portfolio of 12 stocks. On a monthly basis, the entire portfolio would be redistributed into the 12 stocks with the lowest rolling beta values, regardless of valuation. An economic-profit strategy, with monthly rebalancing into an equal-weighted portfolio of 12 stocks. Pre-screens for yearly profitability (e.g., positive yearly EPS) in addition to a positive 5-year rolling EVA were applied. On a monthly basis, the entire portfolio would be redistributed into the 12 stocks with the lowest price to economic-profit ratio (hereafter, “PEVA”). A combined strategy, wherein the top 50 stocks with the lowest PEVA ratios were selected (using the aforementioned pre-screens), and, from these, the 12 with the lowest beta scores would be selected and equal-weighted on a monthly basis; this strategy was repeated using a quarterly rebalancing rule. These 3 strategies were then compared to the S&P 500 and S&P 1500, looking prospectively over the past 5 years. Results: (click to enlarge) As noted previously, a low-beta strategy generated significantly higher annualized returns than the broader market, by a significant amount (26.6% CAGR over the past 5 years versus 15.4% for the SPY and 18.4% for the S&P 1500): (click to enlarge) In comparison, a strategy focused purely on PEVA generated significantly higher returns than even the beta strategy, with a CAGR of 32.76%. (click to enlarge) Returns using a monthly rebalancing rule using a combination of PEVA and beta outperformed a lone beta strategy by nearly 1000 basis points, with a CAGR of 35.3% yearly. (click to enlarge) On a risk-adjusted basis, using a long-term risk-free rate assumption of 4.5%, the PEVA-beta strategy outperformed all other strategies, with a Sharpe ratio of 1.77 (versus 1.64 for low-beta alone). (click to enlarge) Overall, a combined PEVA-low beta strategy offered the strongest risk-adjusted returns over the past five years, and produced the strongest absolute annualized returns over the past 5 years with reasonable compensation for overall risk. Discussion: The results of this exercise suggest that a low-beta strategy may be enhanced by pre-selecting only those firms demonstrating the ability to generate sustained economic profits over time. The success of the PEVA strategy also suggests an underlying valuation component as well, as the strategy focused only on those stocks which had the highest economic profit yield relative to the price. It is worth noting that this strategy did not focus on a single year’s worth of data but rolling 5-year averages; additional study might consider looking at longer rolling averages of ROIC to see if this would affect returns. The astute reader will undoubtedly point out a significant limitation of this study is the relatively low volatility of the overall market during this timeframe, during which time there was virtually no period in which a yearly loss might be recorded. This obviously affects the relative performance of the low-beta or PEVA-beta strategies, though one would probably expect that, if anything, these strategies would be expected to outperform in bear markets. Finally, despite the encouraging results, the PEVA-beta strategy clearly has limitations. Changing the rebalancing period to quarterly shaves off nearly 1000 basis points worth of outperformance and puts the PEVA-beta strategy about on par with the beta strategy alone, reducing the Sharpe ratio to a pedestrian 1.17. Given that an ostensible goal of a focus on sustained economic profits would be to focus on companies capable of outperforming over years at a time, why quarterly rebalancing would diminish returns relative to monthly rebalancing remains a bit unclear. Conclusion: Though generating strong economic profits over time is not necessarily indicative of a stable, high-quality firm, doing so certainly can be suggestive. The success of the PEVA-Beta strategy in this study suggests that focusing on such firms may produce significant outperformance. Though monthly rebalancing costs might be substantial (and capital gains tax burdensome), such a strategy may be worth considering in sideways or downward markets where uncertainty reigns and volatility is high. Current stocks suggested by the PEVA-beta strategy include Coca-Cola (NYSE: KO ), Monster Beverage Corporation (NASDAQ: MNST ), the Brown-Forman Corporation (NYSE: BF.B ) and The Hershey Company (NYSE: HSY ). Other consumer defensive firms make the list, like Altria (NYSE: MO ); trucking firms Knight Transportation (NYSE: KNX ) and Landstar (NASDAQ: LSTR ) are also included.

Consumer Staples Momo ETF Is A Winning Smart Beta Selection In A Defensive Sector

Investors looking for an ETF that is both defensive and has the potential for out performance should review PowerShares DWA Consumer Staples Momentum ETF. FINRA recently chimed in on Smart Beta ETFs with a Caveat Emptor opinion. As long as the US Dollar remains strong, this ETF should continue to excel. As with many previous market downturns, money has been flowing into the “safer” sectors of utilities, consumer staples, and telecom. If one looks at the recent high of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) at $213.50 on May 21, the markets have fallen -9.3% as of Sept 23. Popular ETFs for these sectors are the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the SPDR S&P Telecom ETF (NYSEARCA: XTL ). Since May 21, utility and consumer staples investors have been rewarded with better relative declines of -5.9% and -4.9%, respectively, while telecom lost about market average of -9.8%. However, if one looked at the declines of these sector ETFs from their most recent highs, the carnage is a bit worse. Utilities peaked on Jan 29 and has declined -15.1%, telecom peaked on June 18 and has fallen -11.9%. Consumer staples peaked on Aug 5 and has declined -7.2%. On a year to date base, SPY is down -2.9%, XLU -8.5%, XTL -3.3%, and XLP -1.2%. Within these popular defensive sectors, consumer staples would seem to be the best performer for relative performance against a backdrop of an overall market decline. There are 13 consumer staples ETFs listed on ETFdb.com . YTD performance ranges from 9.39% for the PowerShares DWA Consumer Staples Momentum Portfolio ETF (NYSEARCA: PSL ) to -46.1% for the Global X Brazil Consumer ETF (NYSEARCA: BRAQ ). The top three YTD US performers were: PSL, the PowerShares Dynamic Food & Beverage Portfolio ETF (NYSEARCA: PBJ ) at 5.3% and the Guggenheim S&P Equal Weight Consumer Staples ETF (NYSEARCA: RHS ) at 2.5%. On a 1-yr, 3-yr and 5-yr basis, PSL has outperformed both the SPY and XLP, with the majority of its relative strength clocking in since Oct 2014. Prior, PSL mirrored SPY and bested XLP and the recent outperformance has lifted overall returns. According to etfdb.com, during the past year, PSL has returned 18.5% vs 7.5% for XLP, on a 3-yr basis, PSL has returned 70.5% vs 41.9% for XLP, and on a 5-yr basis, PSL has returned 123.7% vs 93.9% for XLP. A 3-yr graph of PSL vs SPY and XLP is below. What is the investment strategy of PSL that creates the outperformance? As a “smart beta” ETF, the underlying portfolio shifts quarterly centered on individual stock’s technical performance relative to the sector. PSL is a PowerShares ETF offered by Invesco. From their website : “The PowerShares DWA Consumer Staples Momentum Portfolio ((Fund)) is based on the Dorsey Wright® Consumer Staples Technical Leaders Index (DWA Consumer Staples Technical Leaders Index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index. The Fund and the Index are rebalanced and reconstituted quarterly.” Zack’s comments on PSL: “Consumer staples sector is on the rise as it is directly linked with improving economic fundamentals, in particular the spending power, which has increased owing to cheap fuel and rising income. As such, PSL has been able to withstand global worries, gaining 2.6% so far in the second half. The ETF provides exposure to 32 stocks having positive relative strength (momentum) characteristics by tracking the DWA Consumer Staples Technical Leaders Index. It has amassed $203.4 million in AUM and trades in lower volume of 56,000 shares a day on average. Expense ratio came in at 0.60%. The product is pretty spread out across securities, with each holding less than 4.9% of assets. It has a definite tilt toward mid cap stocks while the other two market cap levels take the remainder. Food products, beverages and household durables are the key industries in the ETF having double-digit exposure each.” Momentum investing, aka “momo”, is a strategy of buying stocks that have generated high returns over the past three to twelve months, and selling those that have experienced poor returns over the same period. The ETF seeks investment results that correspond to the price and yield of the DWA Consumer Staples Technical Leaders Index, which evaluates companies based on a variety of investment criteria, including fundamental growth, stock valuation, investment timeliness and risk, comparative to others in the sector. From DWA website concerning their relative strength and top-down approach: “Relative Strength: Relative Strength, the measurement of how one security performs in comparison to another, is a key concept within Dorsey Wright’s methodology. Before investing in UPS, one should understand its recent performance relative to FedEx, or the S&P 500. The same logic can be applied to sector analysis, asset class evaluation, mutual funds, ETFs, commodities, fixed income, and even foreign countries. A relative strength matrix is like a massive tournament, where a huge quantity of investment options can be compared to one another – and we see who is strongest. Relative strength is the basis for virtually all of our managed products, where we select the best investment options from within a large universe of options. Top-Down Approach: We use primary market indicators to get a measure of overall risk, and then analyze broad industry sectors to determine which are in favor. We want to invest in sectors that are controlled by demand. We then select investments that have positive relative strength and have a good probability of outperforming the market. We do not feel compelled to be fully invested in stocks when an alternative investment (cash reserves) offers a more attractive opportunity. In fact, it is our belief that avoiding severe losses is extremely important in achieving strong market performance over the course of an entire market cycle.” PSL is one of 14 momentum driven ETFs utilizing various Dorsey Wright Technical Leaders Indexes and a list of other Indexes is found here . DWA offers an in-depth White Paper on the Dorsey Wright Strategy titled ” Relative Strength and Portfolio Management ” pdf. PSL was rebalanced on June 30 and the most recent list of stocks is below: (click to enlarge) Due to its focus on owning the top momentum stocks with quarterly rebalancing, investors should not be surprised at a high 83% Annual Turnover Rate. According to Morningstar, of the companies listed above, one was purchased in 2012, three in 2013, nineteen in 2014 and nine in 2015. The ETF’s industry allocation is broad based within the consumer staples sector and is reported by Invesco as follow: As the strategy includes NASDAQ stocks, PSL’s portfolio will have higher exposure to mid-caps and small-caps than its large cap S&P ETF brethren. Not only are smaller companies known for higher earnings potential, but usually are focused on domestic US markets rather than an extensive international network. Recently, the strength of the US Dollar has weighted on revenue growth and exchange rates for large cap companies, and this concern is usually less with smaller companies. The strength in domestic markets and reduced currency risk exposure may be a factor in these specific company’s current individual outperformance. The outperformance of PSL compared to XLP coincides with the meteorically rise in the US Dollar starting in Aug 2014. The average market cap in the portfolio is $14.5 billion and 72% of the portfolio are mid-caps or smaller. Below is a table offered by Morningstar of PSL valuation and growth matrix compared to the Benchmark of S&P 1500 Consumer Staples and the Category of Morningstar Defensive. While the comparison indicates PSL is trading at a higher valuation than the Benchmark and Category, its growth profile is also quite a bit higher. With Cash-Flow Growth 25% above the benchmark and Book-Value Growth more than double the Benchmark, a higher valuation would seem appropriate. This week, FINRA issued an Investor Alert titled, “Smart Beta-What You Need to Know”. The bottom line of the alert is the old adage: Know what you are buying and what the strategy is of the specific ETF. There are about 840 products that fall into a smart beta category, representing almost half of all the exchange-traded products listed in the U.S. and investors should understand that any strategy that aims to beat the market carries its own risks. “Recently, there has been significant growth in the number of financial products, primarily ETFs, which are linked to and seek to track the performance of alternatively weighted indices. These indices are commonly referred to as “smart beta” indices. They are constructed using methodologies that rely on, for example, equal weighting of underlying component stocks, or measures such as volatility or earnings, rather than market-cap weighting. Investors need to understand there is no free lunch here. Any time you are deviating from the market, you’re taking some kind of tilt. Understand what is the fund doing that is different than the market. That is a risk.” Investors looking for an ETF that is both defensive and has the potential for outperformance should review PSL to evaluate how it may fit into their current portfolio construction. As long as the US dollar stays strong and the international economies remain in question, this ETF should continue to reward long term investors. However, FINRA is correct: Caveat Emptor. Author’s Note 1: NASDAQ OXM (NASDAQ: NDAQ ) agreed to acquire privately-held Dorsey Wright Associates in Jan for $225 million. This will push NASDAQ into the smart beta ETF market in an aggressive manner. Author’s Note 2: Please review disclosure in Author’s profile.