Tag Archives: portfolio-strategy

Examining An ETF Strategy For Your U.S. Equity Exposure

Summary Reviewing several ETFs with exposure primarily to the U.S. equity space to see which combination will produce the highest risk-adjusted returns. I have used a mixture of large, mid, and small cap ETFs to get broad exposure to the U.S. stock market. Using fifteen years of historical data, I believe increasing exposure to a smaller-cap ETF will produce higher long-term risk-adjusted returns. With Christmas just around the corner, many investors begin their focus on asset allocation and reviewing their portfolios. It has been a turbulent year for global equities with many different macro events affecting returns throughout the world. With the recent economic news coming out of the U.S., specifically the Friday jobs report and the imminent rate hike from the Fed later in December, I’ve turned my focus onto the U.S. equity space to ensure my exposure to this market is balanced, poised for long-term growth, and well-diversified in terms of sectors. For the purposes of this article, I have narrowed down my selection of ETFs to include those that are simply focused on different market capitalizations within the U.S. equity space. That means I have eliminated funds that may be dividend-focused, value/growth focused, sector-specific, or other specialty funds. I’ve done this to keep my analysis simple and ensure I get as broad and diversified as possible. Once I narrowed it down my list, I had three broad categories – Large Cap, Mid Cap, and Small Cap – as defined by the fund companies themselves. Next, I wanted to focus on just a few from each category to see which performed better. For the Large Cap ETFs, I chose the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and the SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA ). For the Mid Cap space, I chose the iShares Core S&P MidCap ETF (NYSEARCA: IJH ) as well as the SPDR S&P MidCap 400 ETF (NYSEARCA: MDY ). Finally, for the Small Caps I only had one fund that had enough historical data to do the simulation, so I chose the iShares Core S&P Small-Cap ETF (NYSEARCA: IJR ). Timing When I was narrowing down my list of ETFs, I wanted to ensure they have been active long enough to see some of the more significant events of the last decade and a half. That way, the results would capture the tech bubble, the financial crisis, as well as the bull markets that accompanied them. Since most of the iShares ETFs were launched in May 2000, I chose to begin my analysis on July 1, 2000. SPY data by YCharts Assumptions All the daily share price data was pulled from Yahoo! Finance and I used the adjusted close price for all of my analysis. In addition, I used the 3-month treasury bill rates from the Federal Reserve website for each calendar year to calculate excess returns and risk-adjusted returns. Finally, I pulled the most recent MER information for each fund from Yahoo! Finance as well and reduced each year’s gross returns by that percentage before calculated the excess return information. Analysis Below is the summary of each of the five funds performance over the 15 years of data. To make my analysis easier, I used the last trading day of each year to calculate the yearly portfolio return to compare against the risk-free rate. (click to enlarge) Sources: Yahoo! Finance, Federal Reserve website As can be seen above, the small cap fund IJR offers the highest risk-adjusted return profile of the five funds I analyzed. Furthermore, you should note that as you move from the large cap funds of SPY and DIA to the mid-caps and then small, both absolute and risk-adjusted returns become stronger. I found this to be quite interesting as typically smaller cap funds comparatively have higher risk profiles. Since I wouldn’t recommend having all your U.S. equity exposure in one fund, I calculated some hypothetical portfolios with different weights for each of the three categories. From the data above, I also was able to narrow down which fund to use for each category; DIA for the Large Cap, IJH for Mid Cap and IJR for Small Cap. I also used $10,000 as a starting investment for each portfolio. Portfolio #1 – One third (1/3) invested in each of the three funds Portfolio #2 – 50% invested in the small cap, 25% in the others Portfolio #3 – 50% invested in the large cap, 25% in the others I found it quite interesting, although not surprising, just how much stronger the performance was on portfolio #2, which had 50% invested in the small cap ETF and ultimately how it also offered the strongest Sharpe Ratio. Overall, portfolio #2 outperformed the “standard” portfolio #1 by over 4.3% and the large-cap focused #3 by almost 12%. I also wanted to look at the sector breakdown of each fund to see if there was a significant difference in the three portfolios based on how the funds would be split up. As you can see below, there is some variance in the sector breakdown of each fund as you move from the large to small caps as well as with each portfolios’ hypothetical breakdown, but there is nothing overly significant to note. Most of the funds keep a relatively similar balance in the sectors with the exception of Real Estate which has zero exposure in the DIA. Conclusion I’ve always been well aware of the fact that, over longer periods of time, small cap stocks will tend to outperform large caps. For the most part, I was always of the impression that this higher return came with higher risk. However, after doing this analysis and seeing the results I would be inclined to increase my overall U.S. equity exposure to smaller cap companies as I am looking to hold onto this portfolio for an extended period of time. This sort of analysis is something I will continue to do each year to ensure if there are significant changes in the performance and risk profile of each fund that I capture them and adjust my investments accordingly.

10 Ways To Destroy Your Portfolio

With the increased frequency of heightened volatility, investing has never been as challenging as it is today. However, the importance of investing has never been more crucial either, due to rising life expectancies, corrosive effects of inflation, and the uncertainty surrounding the sustainability of government programs like Social Security, Medicare, and pensions. If you are not wasting enough money from our structurally flawed and loosely regulated investment industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio: #1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans. #2. Invest for the Short Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions. #3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors. #4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf). #5. Panic-Sell out of Fear And Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “Following the herd often leads to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when in investing when he states, “If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions. #6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Valuation may not cause all of your investments to win, but this factor should be an integral part of your investment process. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly- or incorrectly-priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return. #7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. #8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient. #9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in a generation, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will lead to a penny depreciating rapidly. #10. Forget Your Mistakes: Investing is difficult enough without naively repeating the same mistakes. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but will not help your financial returns. As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio. Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Making The Case For Liquid Alternative Strategies

Hedge funds may make sense for some investors, especially when the opportunities are unique and the allocation is small. Because of their typically high fee structure, lack of transparency, illiquidity, capacity limits, and challenging due diligence process, hedge funds may not be the best choice for institutional investors. That accounts for the growing popularity of liquid alternative investments (LAIs), systematic investment strategies that employ similar return sources as traditional hedge funds. By Wei Ge, Senior Researcher Hedge funds may make sense for some investors, especially when the opportunities are unique and the allocation is small. Hedge funds also offer great potential alpha opportunities for accredited investors or investors with access to information, opportunities, and investment acumen who can extract favorable fee terms from hedge fund managers. Hedge funds are historically organized as limited partnerships, limited liability companies, or similar vehicles that are sold through private channels, allow only a limited number of accredited investors, and typically have minimum investment thresholds in the millions of dollars. Because of their typically high fee structure, lack of transparency, illiquidity, capacity limits, and challenging due diligence process, hedge funds may not be the best choice to be used en masse by the majority of institutional investors. As our understanding of investment returns grows, however, hedge fund returns that were traditionally attributed as manager alpha can now be explained by exposure to alternative beta, and it is increasingly common for analyses of hedge fund returns to be divided into: traditional beta, alternative beta, and finally, “true manager alpha.” True manager alpha is usually elusive, temporary, limited in capacity, expensive, and hard to capture for most investors. In response to these challenges, liquid alternative investments (LAIs) have been growing in popularity and variety. LAIs are systematic investment strategies that employ similar return sources as traditional hedge funds, including: managed futures, event driven trading, carry, liquidity, momentum, value and volatility selling, and others. Because many LAI funds are designed to help investors capture the unique risk-return characteristics of hedge funds, it is not surprising then that such investments are experiencing rapid growth with an increasing array of choices being offered. Today, LAIs come in the form of separate account portfolios, mutual funds, closed-end funds, or ETFs. LAIs have some limitations, too, many of which caused by their shorter and less familiar histories in the market. Because the underlying investments of LAIs need to remain liquid and scalable, they cannot take advantage of the same limited, illiquid, transitory, or more elusive opportunities exploited by hedge funds. Similarly, LAIs cannot replicate many of the highly leveraged strategies used by hedge funds. Nonetheless, investors who are dissatisfied with hedge funds may find LAIs more attractive in terms of reasonable cost, greater transparency, liquidity, a more user-friendly format, and simpler due diligence. Lower Fees – LAI funds usually charge a flat fee, which is much lower than the sliding fee structure of hedge funds. Lower fees leaves a greater share of the return in the investor account, and can represent a significant saving over time compared to hedge fund fees. Higher Transparency – In contrast to hedge funds that have undisclosed strategies and often focus shifts in search of investment opportunities, LAIs typically attempt to monetize on defined strategies and risk premiums, and is fully transparent with its investment objective. A clearly defined investment focus may help investors to construct a portfolio that includes different potential sources of return. Improved Liquidity – LAIs can also be much more liquid than hedge funds, many of which have limits on withdrawals or redemptions. Since LAIs predominantly invest in exchange-traded instruments, they are by design easier to liquidate than hedge fund investments, and can provide reliable daily pricing information. Easier Accessibility – There are several features that make it potentially easier for investors to use LAIs. Because of no limits on the timing or size of withdrawals, and less stringent limits on the number of investors, LAIs may provide more investors access to the alternative asset class. The straight forward construction of LAIs may also create a more even playing field by providing liquid and standardized formats, with a large enough capacity to be available to more investors. Within a diversified portfolio, investors may utilize the core-satellite framework to make asset allocation decisions for the alternative asset segment. They can invest a large portion of the alternative allocation to a core set of LAI funds, utilizing different investment styles, risk exposures, and hedge fund betas as return sources, with generally lower costs and the benefit of transparency and liquidity. The rest of the alternative assets may be invested in high-conviction traditional hedge funds (satellites) that may supply true after-cost alpha and give investors a chance to enhance returns. The core-satellite framework is flexible and comprehensive, easily adjusted to suit the needs of different investors under a wide range of circumstances, especially with the complex decisions regarding liquid alternative investments versus hedge funds.