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Positioning Your ETF Portfolio For 2014

02 January 2014 at 11:01 am by Staff     Bookmark and Share    Follow EtfExpert on Twitter

Seeking Alpha’s Abby Carmel and Jonathan Liss recently spoke with Gary to find out how he selects specific ETFs and plans to use them to position clients in 2014.

SA Editors (SA): How would you describe your investing style/philosophy?

Gary Gordon (GG): Information processing is the best way to describe the way that I invest. I gather information from a variety of credible sources (e.g., fundamental, technical, contrarian, economic, historical, etc.), select ETFs based on that information, and control the investment outcome of every decision.

Using quality information is the input, choosing ETFs with stop-limit loss order protection is the process, and the output is always a big gain, small gain or small loss. Controlling the output – a.k.a. the investment outcome – is the key to success. Whether I choose a hedge, a stop order or a trendline breach, no big losses are permitted in portfolios.

(SA): As we approach 2014, are you bullish or bearish?

(GG): In truth, the crystal ball question is irrelevant for trend followers, risk managers and information processing advocates like myself. This is because technical weakness can arise in any given year and I would reduce portfolio risk of assets that have fallen below critical support levels.

For example, going into 2014, the vast majority of Pacific Park Financial clients have no direct exposure to REITs, precious metals, long-term bonds or the bulk of emerging market ETF possibilities. If this makes me bearish on those asset classes, so be it. However, I recognize that, with modest provocation, rates could turn dramatically lower, potentially benefiting the very same asset classes that higher rates have hindered. If circumstances change, moving averages and ETF fund flow will provide the info needed to make any allocation changes.

Similarly, based on articles that I wrote as far back as October of 2012 and as recently as December of 2013, one may deem me bullish on dollar-hedged foreign equities in Europe and Asia for 2014. For example, WisdomTree Hedged European Equity (HEDJ) is above its 200-day moving average. Mario Draghi and the ECB’s ongoing need to battle deflation with more central bank intervention will mean more economic stimulus and more upside for investors. What’s more, European equities trade at 20% discount to U.S. counterparts, while European major indexes remain roughly 35% below all-time peaks.

(SA): Which asset classes are you overweight? Which are you underweight?

(GG): Noting the reality that things are at least as likely to change as they are to remain the same, I am overweighting equities that may benefit from the battle against global deflation and underweighting the ones that would not. In the income-producing arena, I am overweighting shorter-term high-yield corporate and short-term investment grade assets. I particularly like to ladder the held-to-maturity Guggenheim Bulletshares series, funds like GuggeheimBulletShares High Yield Corporate 2016 (BSJG) and 2017 (BSJH). Short-term and intermediate term munis may be appropriate for taxable accounts.

So what investments should perform well in the ongoing battle against global deflation? WisdomTree Hedged Japan Equity (DXJ) and WisdomTree Hedged Europe Equity (HEDJ) should both benefit from a probable weakening of the euro and yen versus the dollar. Stateside, I am sticking with U.S. stock ETFs that are most capable of handling any deflationary scares. Whereas 2013 may have had a slightly negative impact on dividend growers and dividend yielders due to a rapid spike in interest rates, a more stable rate environment will be kinder to companies that do not necessarily wither in the face of deflation. Most companies view dividend cuts as a last resort. It follows that I like both Vanguard Dividend Appreciation (VIG) and Vanguard High Dividend Yield (VYM). I also overweight tech, as falling prices (deflation) tend to be part of the sector’s regular cycle.

(SA): Which benchmark do you use?

(GG): While the last few years may have skewed people’s sense and sensibilities, this is still a highly interconnected world for market-based securities. Not everything should be compared against a 100% allocation to Dow stocks in the U.S., nor should all income assets be compared to investment grade U.S. treasuries. That said we tend to use MSCI All-World Index for a client’s stock component, and we tend to utilize Citigroup’s World Government Bond Index for the income component of a portfolio. And in those instances when “the world” is of less importance to a particular client, we may take a look at Lipper Balanced Fund averages.

(SA): How do you determine which newer products/strategies are worthy of further consideration, and which are just a passing fad?

(GG): Some new ETFs do not require explanation on whether they provide unique value. If the ETF represents a top 50 economy, the country merits consideration. Moreover, if an ETF provider’s vehicle does not represent the economy well, another provider’s version is worth looking at as well. As far as strategies, if I cannot explain the strategy to a client, I probably won’t be using the ETF… and if I can, then the new strategic fund is worthy of discussion.

For example, certain sectors of the economy may be less volatile than others, historically speaking. A risk-averse investor should certainly consider a fund like PowerShares Low Volatility (SPLV) for its emphasis on healthcare, staples, telecom and utilities. Another “low vol” approach rebalances the 100 least volatile stocks in the S&P 500, iShares S&P Minimum Volatility (USMV). In a rising rate environment where utilities and telecom may get crushed, USMV may work better. In essence, “low-vol” is hardly a passing fad.

A passing fad is most easily spotted by the limited liquidity of the vehicle; it does not make sense for most people to invest in ETFs where the average daily dollar volume of the fund is less than $100,000. Similarly, if AUM does not surpass $50 million at the 6 month mark, that is a bad sign and the fund may close down.

(SA): Say two funds with an identical objective are both flashing very positive momentum and fairly similar gains. What additional factors do you use to determine which fund is right for client portfolios?

(GG): You need to open up the wrapper on each of the ETFs. Even though each is moving in a similar direction and achieving similar gains, you’d want to know whether one is more concentrated in a single sector, like financials, while the other may represent segments more evenly to provide better diversification. Equally important is one’s understanding of the “sell side.” You are also going to look at net costs of ownership as well as annual yield. Equally critical is the liquidity of the ETF. In general, a fund with more assets under management, a tighter bid/ask spread as well as larger average daily dollar trading volume is preferable. As a money manager who does not buy-n-hold-n-hope, I make certain to own assets that can be sold easily such that the proceeds can be protected in cash if desired.

(SA): How much of an allocation do you feel alternative investing strategies generally deserve alongside ‘core holdings’?

(GG): In truth, I challenge the premise that alternative investing strategies should merely be a complement to something that others designate as “core.” If the info that I value shows enormous strength in the dollar over the euro, why must I invest in a “core” unhedged European fund like Vanguard European Stock (VGK)? I would prefer the dollar-hedged WisdomTree Hedged Europe Equity (HEDJ) spy, under these circumstances. Similarly, if I have a conservative client who requires stock risk, and info is telling me that a correction is likely to do far more severe damage to higher beta stocks in the S&P 500 SPDR Trust (SPY), why shouldn’t I prefer iShares S&P Minimum Volatility (USMV)? “Alternative strategies” and “core” are often in the eye of the beholder.

(SA): Even with the 10-yr Treasury now paying close to 3%, rates are still at relatively low levels historically speaking. Where have you been having yield-hungry investors turn for income in this environment?

(GG): For the most part, yield-hungry investors may need to taper the appetite. That said, I see plenty of value in short-term high yield corporate via PIMCO 1-5 Year High Yield (HYS). Or, for those who are particularly risk averse, I ladder the held-to-maturity Guggenheim Bulletshares Series. Even in the financial collapse of 2008-2009, high-yield corporates only averaged a 10% default rate. It’s difficult to imagine any scenario where the overwhelming majority of bonds in a diversified held to-maturity ETF (2015, 2016, 2017, 2018) failed to mature and failed to provide an investor with the yield to maturity. An investor is likely to secure a 4% annualized yield in these diversified vehicles without the same uncertainty as a fund that does not mature.

(SA): Which global issue is most likely to adversely affect U.S. markets in the coming year?

(GG): Deflation. U.S inflation is only 1% year-over-year, and has been declining steadily. Meanwhile, Europe’s latest consumer price reading logged an appalling four-year low of 0.7%, with Spain at a paltry 0.1% and Germany at an exceptionally modest 1.2%. And Japanese authorities have actually been celebrating the fact that the country has managed to get prices to rise at a rate of 1%. Deflation will not necessarily impact markets adversely, as long as the European Central Bank (ECB) continues to cut rates, and as long as the Federal Reserve does not remove stimulus too quickly, and as long as the Bank of Japan keeps being aggressive.

If, however, the world’s central banks declare that the deflation battle is over too soon, and if central banks appear to be tightening the reins, U.S. equities would suffer. In other words, it’s all about the central banks, electronic money creation, and the artificial manipulation of interest rates. I am by no means saying that what the central banks have been doing for five-plus years is the right thing for the longer-term well-being of economies… that’s a different discussion entirely. Yet the global issue that could knock the bull market for a loop in 2014 is the possibility that central banks like the ECB fail to move (shades of 2011 eurozone crisis) and/or the U.S. Fed moves too quickly towards ending its high-powered QE and zero-interest-rate-policy.

(SA): What advice would you give to a ‘do-it-yourself’ investor in the present investing environment?

(GG): Focus solely on the things in the investing world that are under your control. You can control costs, so keep costs as low as possible by using ETFs. You can also control the income portion of your assets. In other words, do not neglect the power of dividends, interest and/or distributions. If one orange offers 2% and another orange offers 3%, buy the one that offers 3%. I am not suggesting investors chase yield… quite the opposite. I am suggesting that when you compare two assets that are practically the same, choose the asset that gives you more than the hope of price appreciation.

Most importantly, control the outcome of every investment decision you ever make. Understand the circumstances under which you would sell a position to secure a big gain, small gain or small loss. In that manner, you won’t ever experience a devastating big loss. Only a big loss can keep you from achieving your financial goals.

You can listen to the ETF Expert Radio Show “LIVE”, via podcast or on your iPod. You can follow me onTwitter @ETFexpert.

Disclosure Statement: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationship.

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