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Tactical Asset Allocation – February 2016 Update

Here is the tactical asset allocation update for February 2016. As I mentioned last month, I am now using a new data source for the portfolio updates. I am also maintaining the old portfolio formats, in Yahoo Finance, for a while. Here is the link to the Yahoo data. Let’s dive right in. Below are the updates for the AGG3, AGG6, and GTAA13 portfolios. The source data can be found here . The big change here is the use of FINVIZ data and more importantly that these signals are valid after every trading day. So, while I’ll maintain these month end updates, this means that you can implement your portfolio changes on any day of the month, not just month end. FINVIZ will at times generate signals that are slightly different than Yahoo Finance. Click to enlarge AGG3 is now 100% bonds and no cash. This is a significant change from last month where AGG3 was 66% invested. AGG6 is 33.3% cash and 66.6% bonds. AGG6 is more invested than last month’s positions. Below is the YTD performance along with some popular benchmarks. Once change in the performance figures this year is that I am know including the performance of cash when the portfolio sin cash (using SHY as the cash proxy). For the Antonacci dual momentum GEM and GBM portfolios, GEM is now in bonds, BND, and the bond portion of GBM is in cash. I’ve also made my Antonacci tracking sheet shareable so you can see the portfolio details for yourself. Here is the data. Click to enlarge Finally, I am receiving quite a bit of interest in the simple bond quant model I published previously . So, I created a spreadsheet to track one version of the model I presented. The spreadsheet ranks the bond ETFs by 6 month return and uses the absolute 6 month return as a cash filter to be invested or not. Several versions of this model work quite well as discussed in the blog post. Personally, I am now using a 3 month return, 3 month filter, top 3 model but the differences are not that big. That’s it for this month. These portfolios signals are valid for the whole month of February. As always, post any questions you have in the comments. **Note: an observation for this week. Ever notice the percentage of self-called ‘long term investors’ who know what the stock market did on a daily basis? Let me tell you that is long term detrimental to your portfolio performance. It is hard to ignore market data in today’s world. I try very hard to ignore it and have to take active action to avoid finding out about daily gyrations in the market. It’s one of the reasons I do not blog more often. My goal is to only check one per month, that’s it. And even that is too often. If I could auto trade my quant systems I would… I once heard it said that most investors would achieve higher returns if they lost their password to their investment accounts for years. There is a lot of truth in that statement….

XLF: The Heavy Financial Sector Exposure Doesn’t Appeal To Me

Summary The fund offers a reasonable expense ratio and incorporates more than banks. One of the challenges for investors is the combination of REITs and other stocks in a single ETF. Looking into the REIT holdings, I’d rather not see such a huge focus on the biggest companies. The historical volatility on the fund demonstrates the risk of going so heavy on the sector. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Financial Select Sector SPDR Fund (NYSEARCA: XLF ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Index XLF attempts to track the total return (before fees and expenses) of the Financial Select Sector Index. Substantially all of the assets (at least 95%) are invested in funds included in this index. XLF falls under the category of “Financial”. It sounds like the ETF would be very highly concentrated, but it includes everything from diversified financial services to REITs and banks. When I was first reading about the holdings, I was expecting more diversification than I found. You’ll see what I mean when I get to the holdings section. Expense Ratio The expense ratio is .14%. It could be a little better, but it isn’t too bad. Industry The allocation by industry is interesting. Investors that are new to the fund may simply assume that it allocates everything to “financials”, but the fund’s website goes much deeper in explaining which parts of the financial sector is going to get the weights. The allocation to banks is heavy, but it is also well below 100%. The fund also uses heavy allocations to insurance and REITs. I certainly prefer this strategy to going exceptionally heavy on the banking sector, but I find the holdings somewhat problematic as I prefer to run my REIT exposure through tax advantaged accounts. This is a challenge for any ETF that wants the diversification benefits of incorporating REITs. There isn’t much an ETF can do to get around this other than simply not holding REITs. Holdings Since I’m primarily a REIT analyst, the REIT exposure is the first part of the portfolio that my eyes are drawn to. The heaviest REIT allocation here is Simon Property Group (NYSE: SPG ) which I find a little disappointing. I find the REIT sector attractive for investing, but REITs should be divided between types the same way that banks and insurance companies were split up into different sectors. SPG is an absolutely enormous REIT, but I’d rather see exposure to Realty Income Corporation (NYSE: O ) or the fairly new STORE Capital (NYSE: STOR ). I simply prefer triple net lease REITs like O and STOR to most other types of REITs. Realty Income Corporation is included in the portfolio, but it is only .43% of the total portfolio. Since I prefer keeping REIT exposure inside tax advantaged accounts, there was already one challenge with the REIT allocation. I’m not thrilled with the allocation strategy for choosing REITs, which creates another challenge. Return History Historical returns shouldn’t be used to predict future returns, however the historical values for factors like correlation and volatility over a long time period can provide investors with a base line for setting expectations on whether the asset would fit in their portfolio. I ran the returns since January of 2000 through Investspy.com and came up with the following charts: (click to enlarge) Since 2000 the ETF has a total return of about 45% compared to the S&P 500, represented by SPY , having a return of 90.3%. The underperformance isn’t so much of an issue as the risk level. The fund had an annualized volatility of 33% compared to 20% for SPY. There were two market crashes during that period which leads to much higher volatility numbers, but the general premise remains. The fund is substantially more volatile. Since the holdings are also more concentrated, that makes sense. Unfortunately, when we switch to using beta as our measurement of risk the problem remains. The sector allocation simply lends itself to too much volatility for my portfolio. Conclusion XLF is a huge ETF for exposure to the financial sector. There are some bright spots for the fund, but the overall product is a little lacking for my tastes. The combination of other financial sectors with REITs may be acceptable for investors that have plenty of room in their tax advantaged accounts or investors that aren’t concerned with tax planning. Even moving past that, I’m not thrilled with the methodology for selecting REITs as it results in prioritizing enormous REITs. That is an area where I’d rather be adding individual stocks or using REIT specific ETFs with lower expense ratios. Seeing the enormous volatility reinforces my concerns about overweighting this particular sector. The fund may do very well in a continued bull market, but I’d rather keep a more defensive allocation. I just don’t like the risk of facing a third correction before the decade is over. I’ll keep most of my portfolio in equity, but I’ll stick to the more defensive companies and sectors.

A Year-End Analysis Of The Ark Industrial Innovation ETF

Summary The ARK Industrial Innovation ETF’s expense ratio of 0.95% coupled with the firm’s concentration on riskier holdings makes this an investment to avoid. The overvalued price to earnings ratio of the fund combined with the poor sales growth and historical earnings % makes this ETF unattractive. The leaders of the Ark Industrial Innovation ETF are Delphi Automotive and Nvidia Corp. The main laggard is Stratasys, Inc. In the comment section of my most recent analysis regarding the Robo-Stox Global Robotics and Automation Index ETF (NASDAQ: ROBO ), one person asked if there were any suitable ETF for an individual that craves exposure to robotics and automation. I gave a succinct answer with a mention of the Ark Industrial Innovation ETF (NYSEARCA: ARKQ ). While this ETF may be a bit more attractive than the ROBO-STOX Global Robotics and Automation Index ETF, it is not attractive enough to recommend as an investment. In mathematics, it is not merely sufficient to give the final answer. The math teacher will often insist that we show our work to support the final answer. Consider this article as my shown work. According to Yahoo Finance, here are the 1 month, 3 month, 6 month and YTD Returns for the Ark Industrial Innovation ETF. TIME PERIOD ARK INDUSTRIAL INNOVATION ETF RETURN ROBO-STOX Global Robotics and Automation Index ETF Return 1 MONTH 1.01% -1.16% 3 MONTH 9.15% 10.30% 6 MONTH -3.79% -9.31% YEAR-TO-DATE -1.13% -5.00% In comparison, the ROBO-STOX Global Robotics and Automation ETF only posted a higher 3-month return than the ARK Industrial Innovation ETF. Throughout this ETF, there is a whole lot of evidence that suggest that the fund manager may have invested in full of holdings that have unproven earnings and sales in spite of their overall potential. Evidence of this can be seen in the large percentage of mid-cap, small-cap holdings and micro-cap holdings that is displayed in the following chart. SIZE % OF PORTFOLIO BENCHMARK CATEGORY AVERAGE MEDIUM 30.65 18.63 23.79 SMALL 19.80 5.41 11.69 MICRO 13.15 0.32 1.39 The significant exposure to these riskier holdings seem more inconvenient when one considers the fund’s expense ratio. The ARK Industrial Innovation ETF’s expense ratio is 0.95%, which is 0.41% higher than the Morningstar category average . Investors may be willing to take on this exposure given a more attractive expense ratio. Unfortunately, this fund does not provide that. Value and Growth Measures Stock Portfolio Benchmark Category Average Price/Prospective Earnings Ratio 26.03 19.01 22.08 Price/Book 2.20 3.54 3.87 Price/Sales 2.30 2.61 2.74 Price/Cash Flow 16.77 11.69 11.49 Long-Term Earnings % 13.76 11.87 16.96 Historical Earnings % 3.96 9.38 15.18 Sales Growth 4.18 7.65 16.73 Cash Flow Growth % 16.86 9.82 12.78 If you look at the following chart, one can see that the statistics illustrate overvaluation of holdings with regards to stock price in the price/earnings ratio. One can also see that the fund holds many holdings with unproven sales and earnings as indicated by the fund’s undervalued price/sales ratio. This can also be seen by the paltry sales growth and historical earnings figures compared to their benchmarks and category averages. However, the fund does have a higher cash flow growth rate than the Morningstar benchmark and category average. This should provide some optimism for investors as increased cash flow could hopefully lead to a higher sales and net income in future earnings reports. LEADERS OF THE ARK INDUSTRIAL INNOVATION ETF Delphi Automotive PLC (NYSE: DLPH ) Delphi Automotive PLC is a manufacturer of vehicle components and provides solutions in terms of electrical, electronic, safety and thermal technologies to consumer and commercial vehicles worldwide. Delphi has the fourth highest portfolio weight in the fund at 4.67% and has a total YTD Return of 20.79%. Delphi’s last quarterly earnings report fell short of expectations. In spite of increased EPS and net income , Delphi’s revenue fell 3.6% year-over-year due to unfavorable currency impacts especially with regard to the euro. Delphi’s stock price fell more than 7% on the news but has rebounded by 8.5% since the date of the report. Delphi Automotive has just completed a $1.85 billion dollar acquisition of the HellermanTytonGroup PLC, a worldwide leader in cable management solutions. This acquisition will aid in the company’s effort to position themselves as a leader in the connected car phenomenon. It is expected to boost the firm’s potential EPS by $0.15 and provide 50 million dollars in synergies by the end of 2018. Delphi Automotive has just received an upgrade to “Buy” by Sterne Agee and is rated a “Buy” overall by analysts. Nvidia Corp (NASDAQ: NVDA ) Nvidia Corp is a visual computing company that operates across multiple regions. Nvidia Corp has the ninth highest portfolio weight at 3.41% and a YTD Return of 67.40%. NVIDIA’s stellar quarterly earnings sparked the firm’s stock price increase by 11.8% during the month of November. Nvidia’s revenue increased by 6.5% to a record revenue total of $1.305 billion dollars while its net income increased by 42% year-over-year to $246. Additionally, GAAP EPS increased 42% year-over-year to $0.44. NVIDIA made tremendous progress in its gaming segment with the introduction of the GEForce GTX 950 GPU. Additionally, NVIDIA made strides in the virtual reality space with the introduction of the NVIDIA Gameworks VR and NVIDIA Designworks VR. NVIDIA Corp has also gained firm control of the discrete graphics card market. At one point, the firm surpassed 80% in unit market share during its last fiscal quarter. The firm’s shareholders will be very thrilled with the firm’s 18% increase in quarterly cash dividend due in fiscal 2017. MAIN LAGGARD OF THE ARK INDUSTRIAL INNOVATION ETF Stratasys, Inc. (NASDAQ: SSYS ) It is rather puzzling why this stock has the most portfolio weight (6.71%) in the ARK Industrial Innovation ETF. As I have recently pointed out on Market Eyewitness , Stratasys is ripe for the picking due to increased competitiveness from the low end of the 3-D Printing market. Stratasys, Inc. has the second worst YTD return in the fund with a total of -67.77% Stratasys’s recent 6-K results were so poor that the firm would have had a net loss that was 6x as much as last year’s net loss in spite of the $695 million dollar impairment charge. Stratasys’s product revenue declined by 35.2% in the firm’s latest quarterly report. This is a clear sign that hobbyists and DIY enthusiasts have found other alternatives to the firm’s Makerbot division. In a recent list of the top 20 3-D desktop printers by 3-D Hubs, the Makerbot 3-D Printer did not made the cut. As a matter of fact, the two worst fund holdings in terms of YTD return are Stratasys, Inc. and 3D Systems (NYSE: DDD ). 3D Systems has an YTD Return of -68.06%. BOTTOM LINE: As stated above, I cannot recommend the Ark Industrial Innovation ETF as an investment even though it may be a better alternative than the Robo-Stox Global Robotics and Innovation ETF. In addition to the overvaluation in terms of the fund’s P/E ratio, the fund is too concentrated on riskier firms with an unproven history of sales and earnings. The lack of sales growth is disconcerting and the low price-to-book ratio may be indicative of investing in companies that may have fundamental deficiencies. Stratasys and 3D Systems could be considered Exhibit A and Exhibit B in that regard.