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Nathan Buehler Positions For 2016: Attractive Opportunities In ETFs

You don’t have to trade every day to make above average returns in the market. Patience is the key to any good strategy. For typical ETFs that track broader indexes, watch the management fees when considering a fund. The Fed will continue to provide distractions throughout 2016 with constant assessment and analyses of when they will raise again and what that means for the economy. Welcome to the ETFs section of Seeking Alpha’s Positioning for 2016 series! This year we have once again asked experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction. Nathan Buehler has been an author on Seeking Alpha since May 2014, specializing in the coverage of ETFs and volatility investments. In addition to writing on Seeking Alpha, he works full time as a Teacher in the Lee County School District, volunteers as his communities HOA President, and participates in local government. Most of his strategy is geared towards long term outlook with focuses on short term events or situations that create attractive opportunities. Seeking Alpha’s Carolyn Pairitz recently spoke with Nathan to find out what he is expecting from ETFs in 2016. Carolyn Pairitz ((CP)): While you cover a number of ETF topics, the VIX has been your focus on Seeking Alpha. What drew you to study and invest in volatility? Nathan Buehler (NB): I started investing in penny stocks when I was a teenager. I had no idea what I was doing and lost most of the money I invested. I didn’t give up and was always looking for ways to get rich quick. Getting rich quick also led to additional losses. As I grew up and matured I began to realize there was an opportunity to make money off of people that were either looking to get rich quick or panicking. I started researching volatility as an asset class and began practicing with options strategies and trying to learn everything I could about how volatility behaves relative to the market. Eventually I fine-tuned my knowledge of the VIX to the point I felt comfortable trading it. I love investor psychology and I will often have different takes and points of view on the VIX than other seasoned investors. This again comes from the fact I am self-taught. I learn something new every day and use that to continuously improve upon my investment objectives. CP: Do you have any advice for readers considering ETFs for their portfolios in 2016? NB: For typical ETFs that track broader indexes, watch the management fees. There are a number of very low cost funds run by very reputable companies. For volatility ETFs my only advice is to fully educate yourself before trading these products. This is also true for many ETFs that track commodities and have very specific objectives. ETFs don’t always behave like a stock and can lead to serious losses if an investor is not properly prepared. CP: Going into 2015, which asset classes are you overweight? Which are you underweight? NB: In my general portfolio I have moved overweight in select oil companies. I believe this is a cyclical pattern and as long oil prices stay low, demand will keep increasing. Eventually economics will take over and the present fear factor will clear itself up. These are positions I plan on keeping for 5-10 years so even if oil takes another year to recover, I am fine with waiting. CP: The SEC recently proposed rules that could shake up the current structure of leveraged ETFs. Could you elaborate on this further and how it could affect the ETF market in 2016? NB: The ETF companies have been on top of this from the start and ProShares even contacted me directly in response to one of my articles that covered the topic. For right now it doesn’t appear that this rule will have a real effect on any of the 2x leverage ETFs. However, many if not all 3x leverage products could be forced to close. I am not a fan of 3x leverage products and I feel this is the right decision to protect investors from themselves. At some point it is wrong to let people purchase a product that could wipe out their entire net worth in one day. Gambling is still legal if someone wants to bet it all on black. CP: With the Fed having raised fund rates this December, are you updating you VIX strategy or do you feel this change was already priced into the market? NB: I felt that the rise in rates was long overdue and well expected by the market. I was hoping for a hold which would have created an excellent opportunity for a sharp increase in volatility. The Fed will continue to provide distractions throughout 2016 with constant assessment and analyses of when they will raise again and what that means for the economy. To me, the Fed is just a bunch of noise. They get people hopped up and will calm the markets down. They have been a good tool in respects to volatility. CP: Are there any global issues on the horizon that ETF investors should pay particular attention to? NB: Geopolitical events always provide good opportunities for volatility. Two years ago Russia was providing regular spikes in volatility. The world loves a villain. We make movies about them and the super heroes that save us. Russia and China used to be those villains in regards to the stock market. Investors loved to gawk over what Russia was doing, who they were invading, and how China’s economy was collapsing. Now we have ISIS. Friends and foes alike have come together to take on ISIS. As far as I am concerned, this is a negative for volatility, a positive for the market, and a win for humanity. CP: As a teacher and an author on Seeking Alpha, do you have any advice for readers who work a full time job but also want to be involved in the markets? NB: There have been multiple studies out on how teachers make the best investors. Each of these studies cited one fact consistently, lack of trading. You don’t have to trade every day to make above average returns in the market. I constantly get questions on timing the market, when to get in, when to get out, etc. Investors need to chill out. My goal is to make a 15% return during the calendar year. Not 15% in January and then try for 80% by December. Patience is the key to any good strategy and if you are glued to your monitor all day watching the ticks of the market it isn’t healthy. I would conclude that a full time job gives you proper time to analyze the markets in the evenings and make more rational decisions by the next trading day.

Reducing Portfolio Risk With Help From Momentum Model

Reduce portfolio risk by activating momentum model. Reduce portfolio risk based on security volatility. Reduce portfolio risk through the use of stop-loss orders. Controlling portfolio risk is every bit as important as seeking portfolio return, particularly when markets are high and volatile. The following analysis takes readers through a process of controlling portfolio risk with help from a tranche momentum spreadsheet. Main Menu: We begin with the following Main Menu where the basic assumptions are laid out by the portfolio manager. In the following example we are using twelve (12) ETFs plus SHY as the cutoff security. Hence the name, Baker’s Dozen. Many of the ETFs carry low correlations with each other, an important factor to consider when identifying securities to populate a momentum oriented portfolio. In the follow screen-shot we set the number of offset portfolios to 8 and the period between offsets to two (2). What this means is that the securities are ranked multiple times (8) on different dates (separated by 2 days) based on two different look-back periods plus volatility. Using these three metrics, the ETFs are ranked each review period. My preference is to review a portfolio every 33 days so the review is rotated throughout the month. Not only are the ETFs ranked based on current data, but they are ranked two, four, six, eight, and etc. days ago so we know what the rankings looked like up to sixteen (8 x 2) days ago. The look-back periods are 60 and 100 trading days. A 20% weight is assigned to the volatility as we are looking for securities with low volatility. Only two securities are selected for each offset portfolio. This becomes more apparent in the second screen-shot so move down to that slide. (click to enlarge) Tranche Recommendations: Here we have what is called the Tranche Momentum model worksheet. This is the first of three risk reducing mechanisms. The tranche model is designed to reduce the “luck-of-trading-day” as this is a problem inherent in all back-tests as well as real portfolio management. Instead of splitting the portfolio into 50% VNQ and 50% MTUM , as the current offset recommends, we note that offset 3 recommended divisions between VNQ and TLT . Offset portfolio #5 recommended 50% allocation to SHY and 50% to VNQ. Using eight (8) portfolio offsets ends up dividing the portfolio into four securities where the percentages are based on the number of times the ETF shows up in one of the eight rankings. The worksheet permits as many as 12 portfolio offsets, but I tend to favor using eight. The following worksheet ranks the ETFs using both absolute and relative momentum principles. Readers will note that the current portfolio holds 200 shares in VTI, but the tranche momentum model recommends none as VTI is under-performing SHY, our “circuit breaker ETF.” Momentum becomes one of our risk reducing mechanisms as under-performing securities are screened out of the active portfolio. (click to enlarge) Risk Reduction Recommendations: The following worksheet combines recommendations from the above tranche data and adds a volatility factor to come up with a list of recommended ETFs. In the following slide the Maximum Trade Position Risk percentage is set to 2.0% so the total portfolio is not exposed to more than a 6% draw-down until the next review period. The still leaves individual ETFs at unacceptable risk levels which we control in the final screen-shot. Before moving to the final slide, look at the individual recommendations. Shares held in VTI and PCY are sold out of the portfolio as VTI is under-performing SHY and PCY has not shown up as a recommended ETF in any of the last 8 offset portfolios. The recommendations are to hold the following four ETFs. 75 shares of SHY – round up from 74. 300 shares of VNQ – rounded to the nearest 100 shares. 100 shares of TLT – rounded to the nearest 100 shares. 350 shares of MTUM – rounded to nearest 50 shares. (click to enlarge) Manual Risk Reduction Recommendations: For the final risk reduction activity the recommendations from the above worksheet are followed which still leaves a few ETF exposed to excess risk. The final step is to place stop-loss or Trailing Stop Loss Orders (TSLOs) on VNQ and MTUM. VTI is either sold at market or a 6% TSLO is used. While the current portfolio holds $8,000 in cash, the recommendation is to increase it to $32,500. Note that the current portfolio carries a risk of 4.8%, but if the suggested adjustments are made, the risk drops to 3.4%. (click to enlarge) With the aid of the tranche momentum spreadsheet we limit portfolio risk through absolute and relative momentum principles as these keep us out of deep bear markets. Further portfolio risk is controlled by placing stop-loss orders as a way of clamping down on excess draw-downs. Granted, these procedures work when we have an orderly market. Guarding against “flash crashes” is an entirely separate problem.

ETFs: Passing Marks For Liquidity, But What About Performance?

By Alliance Bernstein Proponents of credit exchange traded funds (ETFs) claim the last week of market turmoil was a test for these instruments-and that they passed. We think this takes grading on a curve to a new level. The cheerleaders say ETFs succeeded because they traded regularly after a high-yield mutual fund failed and barred investor withdrawals. Here’s what they’re not telling you: in exchange for this liquidity, investors ended up with instruments that have woefully underperformed active mutual funds-recently and over many years. For long-term investors who are saving to pay for college or retirement, that’s an awfully steep price to pay for something they don’t really need. The numbers speak for themselves: Over the first 11 months of this year, the two largest ETFs – HYG and JNK – have sharply underperformed the average active manager, not to mention their own benchmarks. They’ve also trailed the average active manager so far in the fourth quarter ( Display ) and since the start of December, one of the year’s most volatile months so far. ETFs’ longer-term performance falls short, too. In fact, not only have active managers outpaced ETFs over the long run, they’ve done it with lower volatility, as measured by risk-adjusted returns. The Sharpe ratio, which measures return per unit of risk, was 0.45 for JNK and 0.51 for HYG between February 2008, shortly after they began trading, and November of this year. For the top 20% of active high-yield managers, it was 0.71. How Much Liquidity Is Enough? Is the ability to get in or out of an ETF at any point in the day worth the underperformance? For asset managers and traders who need to trade frequently to hedge positions, maybe. After all, they’re not investing in these instruments as long-term income generators. But a large share of the people who own high-yield ETFs aren’t traders. They’re regular folks saving for college, or to buy a new home, or for retirement. In other words, they’re investors, not traders. Most probably aren’t doing any intraday trading at all. If they’re buying ETFs for the liquidity, they’re paying-dearly-for something they don’t need. In our view, an actively managed mutual fund is likely to offer higher potential returns over the long run – and give investors a better chance of meeting their goals. In fact, the data suggest that investors who want long-term exposure to high yield would do better to pick an active manager out of a hat than invest in an ETF. With Mutual Funds, Diversification Is Key All well and good, some investors are no doubt thinking. But what happens when mutual funds fail? That’s a fair question. Liquidity is important for everyone, as the failure of Third Avenue Management’s Focused Credit Fund illustrates. But it’s important to remember that this mutual fund was not a typical high-yield fund. It focused almost exclusively on risky distressed debt issued by highly leveraged companies. These types of assets are relatively illiquid, and that became a problem when large number of investors wanted to sell their shares. In other words, investors were promised “daily liquidity”-the ability to buy or sell shares in the mutual fund at the end of each trading day-but the assets the mutual fund owned could not be bought or sold on a daily basis. These types of strategies are bound to fail eventually. Most high-yield managers follow more diversified strategies that focus on a wide array of higher-quality assets. Of course, investors should still make sure their investment managers have a dynamic, multi-sector approach and are managing their liquidity risk effectively . Those who do a good job will be in position to meet redemptions during downturns and seize opportunities as they arise . That’s something Third Avenue couldn’t do. High-yield ETFs can’t do it, either . The recent turbulence in the high-yield market probably isn’t over. But we don’t think that should concern long-term investors too much. In our view, the best approach at this point is probably to ride out the storm. The intraday liquidity ETFs offer comes at a high price-and if you’re a long-term investor in high yield, you shouldn’t be paying it. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Disclosure: None