Allocation ETF Overweight Example

Dec 01, 2012 in Ratio | Strategy

Quick mini-analysis of an ETF we are long in our Allocations Board models (EPP).



Here is a summary of the rationale:

We went long EPP on an Allocations Board portfolio during a small pullback in late August.  (members can see allocation board for details).  Why EPP and why then?

First, EPP is a regional ETF covering developed markets in the Pacific ex-Japan region.   This means companies based in Australia, Hong Kong & to a lesser extent Singapore and New Zealand.   Note that none of these are considered emerging markets --- though all are clearly closely tied to the growth of Eastern Asia, which in turn are all emerging Markets  (ex-Japan).

EPP began by performing well on a relative strength basis during the summer of 2012 vs various lists we keep on constant monitor.

EPP is very volatile -- so we wanted to expose the model to strong relative strength -- but also be sure to plan ahead in case things went adversely against us.    This can be a tricky situation because you absolutely must give yourself a chance to participate in the uptrend by giving it some room in the short-run ---- but we wanted also to have a plan in place to avoid large portfolio drawdowns.    Below is a snapshot using the Ratio MA module to manage the individual position.   Also included are some pullbacks which are normal for a volatile security like this.    These would be buying opportunities within a perceived uptrend.   This is not meant to be how anyone else should choose to manage a position.   This is just a snapshot of how we were thinking about it.    




The exact parameter settings should not be the focus here.  Investing is not a pure science, in our view.   It is much more like a game of poker,  partly mathematical and partly behavioral/psychological.   Good poker players don't take wild risks with no plan in place if things go adversely.   They start out with a plan for each part of the hand and then make adjustments and often have to make some tough decisions as more information is revealed that is adverse to their position.   Sometimes they make a mistake and fold the best hand (like a trading whipsaw) --- but over time, good long-term decision-making is what makes a good investor (and a good poker player).  PLAN YOUR HAND.

Note that the ETF in discussion here (EPP) was not chosen in the first place because of this ratio MA analysis -- that is just a second more detailed view of how we planned to manage the position.   EPP was instead originally chosen because we like what the ETF represents on a fundamental basis (companies based in Australia, Hong Kong & Singapore) AND it also was showing strong signs of a new uptrend beginning (this is what good relative strength analysis does -- it locates particular strength in the market that over time suggests continuation rather than reversal).
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ETF Movement as Research For Understanding Bigger Themes

Feb 03, 2011 in Strategy

"I measure what’s going on, and I adapt to it.” - Martin Zweig

ETFs represent well-defined baskets of securities --- indexes --- and we can use these index movements to better understand money flows and trends. The following list is a blend of ETFs that was based on the most popular securities at ETFreplay. This list of 15 ETFs represent a good sampling of bonds, stocks, commodities etc... Some editing to avoid duplicate indexes from different providers was used.

First lets take a look at what happened if we just held all 15 in equal-weight for the entire year 2010 using the Backtest Portfolio Allocations App (you can hand-input up to 10 symbols in the free version of the page).

Auto-Load Symbols From An Existing Portfolio:


Press 'Test Strategy' Button on Right To Run Chart Of Portfolio:

Scan Supporting Statistics:

Note that the correlation of this equal-weight portfolio is 0.97 to the S&P 500 (see SPY correlation figure in the top-middle of the 3rd chart image above) . This reading actually isn't that big of a surprise. Most buy & hold ETF allocations that contain a large allocation to equities will result in high correlation to an equity index like the S&P 500.   

Now let's take a look a little deeper at how one particular tactical asset allocation (TAA) strategy found leadership in 2010. We will study 2010 by creating a model and then observing which ETFs were held the most during the year within that model. Whatever was held most might be considered a 'theme' for the time period under discussion.

What relative strength does is tries to understand what is strongest and hopefully thereby find ETFs that are beginning to trend. Every leading ETF starts out with relative strength and then either trends or mean-reverts. Judgment based on experience will be necessary ultimately -- but having a quantitative process locate the strongest ETFs will give you thematic ideas as they develop to consider.

We used a monthly rebalance schedule and a basic 3-factor model to choose among the 15 ETFs. We set the backtest to include the top 3 at the end of each month and hold until they fall out of the top 3, at which point they are replaced with the new top 3.

The next table summarizes which ETFs were held using this strategy for 2010:

As this model correctly identified at the time, U.S. Tech stocks (QQQQ) U.S. Midcaps (MDY) were themes. Bonds had strong relative strength bull move into the summer and Treasuries (IEF) and U.S Corporate Bonds (LQD) both show significant days of being held. Using this strategy, Europe (VGK) was NOT held for even a single day during 2010. Below is a chart of a comparison of these 3 ETFs (QQQQ, MDY, IEF). You can easily visualize what the model was picking up.

Forwarding to more recent action, emerging markets have moved down the relative strength rankings while agricultural commodities remain highly ranked. Underweighting emerging markets equities and overweighting agriculture have been recent themes. Will this continue? It is to be determined --- but this is where a quantitative backtest would say to be --- but there will be future rotations in 2011 so we will just have to continue to...measure what is going on and adapt to it.





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MSCI Index ETF : World Focus (ACWI)

May 05, 2010 in Country Funds | Strategy

The MSCI Index ETF list is quite useful as a starting point for ways to think about the global investment landscape.  Moving from a domestic to a world focus expands the individual equity universe to well north of 8,000 securities (vs the typical Russell 1000 focus of domestic managers). Global exports are increasing on a secular basis as the world increasingly trades goods and services with each other ---- globalization is unstoppable.

Ironically, I say all of this as our models have been favoring domestic over international ETFs for months now and being short (or avoiding) Europe in particular seems like more than just a short-term trade.

Nevertheless, over the long-run it makes sense that more choices will offer diversification benefits in terms of enhancing return (long and short) and likely reducing risk (though this benefit becomes less as globalization increases).  Without going into a long dissertation on this topic, I will just instead show the current relative valuations of the MSCI World Index ETF (ACWI).   

MSCI Index ETF ACWI Weightings


Note that approximately 2/3 of this index is in the United States and Europe.   It is not AS out of balance as it may at first seem as companies like those in China have very low profit margins. In the U.S., a company like Google might not contribute a lot to GDP – but it does have very high overall profits.   Conversely, Wal-Mart contributes a lot to U.S. GDP but has very low margins – and China supplies Wal-Mart so you can imagine how their profit margins look.    So each country will have GDP changes and profit margin cycles to think about --- its not JUST about GDP growth and population trends.   

Over the very long-run though, these world weightings will likely change in favor of countries with stronger demographics --- (the above chart should only be viewed as a snapshot in time).  Importantly, it is not going to be a smooth ride -- even as it seems obvious that countries like China and India grow to be much higher percentages of the total.  

The next chart from the ETF Portfolios page re-creates the MSCI World Index ETF as a sanity check.  We can do this with regional and country funds.   It won’t be perfect because there are some anomalies with indexes regarding 'sampling' and starting vs ending weights etc.…



So within the context of a dynamic and volatile global marketplace, is based upon – finding quantifiable, back-testable methods to help the investor think about balancing reward and risk.  In other words,  to participate in global strength and to avoid/underweight/short regions of the world showing global weakness.  There will be many large corrections within secular themes.  You need to protect yourself by balancing the longer-term demographic trends with the realities of extremely volatile markets.  This is doable -- so long as you show proper respect for the markets inherent volatility.  

Finally, here is a look at our ETF Screener.    The ‘ Selected Betas’ grouping has most of these indexes scattered within it.  We don’t think its complete to just look at regions of the world --- we like to view Relative Strength across asset-classes as well, not just equities.   Note here that this is not properly done unless you are tracking total return  --- dividends and distributions can make a significant difference in your screens and models.  You need clean data to properly calculate relative strength -- especially across asset classes. As experienced professionals, we want to stress the relative benefit of a well-maintained total return database of 400 ETF's --- vs a 15,000 security database that simply reports trading numbers and ignores total return.  We have intentionally created a focused environment (based on ETFs) to minimize the data integrity issues that can greatly affect financial models.    

Details are important.   We cannot be perfect -- but we know that simply ignoring the issue (as others do) is particularly disingenuous.  ETFs are based on indexes.  Index returns are ALWAYS based on total return.  Price alone does not reflect total return, adjustments are needed.  We make these adjustments so you don't have to... 


ETF Screener

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Where Is Global Money Flowing Now?

May 03, 2010 in Screener | Strategy

Here is our read on global money flows as we begin May:

Asset allocations are the most important aspect to portfolio management. Our ETF Screener helps tell us where global money is flowing. We think it’s a good idea to use experience and market savvy in conjunction with the quant models. There are countless ways to actually implement a given higher-level ‘strategy.’ We would strongly suggest staying with the theme of the backtested models -- but also keeping a watchful eye on overall portfolio volatility as a sanity check. Volatility is a good way to think about the potential for drawdown – so this focus protects you when there are strong rotations within the global marketplace.

Our models have not seen much change recently. Stay overweight US equities and underweight (or short) international equities, particularly Europe. Given instability in Europe and the already large outperformance of US Equity this year, a large divergence like this is a bit of a concern.

Other regions of the world, such as Latin America, Emerging Asia and the Pacific countries do not appear to be worth an investment at this time --- these regional ETFs have high volatilities and are not showing relative strength.  Interestingly, US REIT’s have been showing strong movement within the rankings – indicating global money continues to have a risk appetite for segments of the U.S.

It makes sense to us to stay aggressive on the non-equity portion of the investment landscape. U.S. treasuries do not look interesting at this point as yields are low and the global economy – outside of Europe – appears to be fine. If the U.S. were not strengthening, why are junk bonds continually making new 6-months highs?

Outside of the primary indexes (and REITs) – 2 interesting developments we have noticed over past 4-6 weeks:

1) Precious metals are rising in the relative strength rankings
2) Emerging market bonds look good in the rankings (note that EMB/PCY are dollar-denominated) -- they tend to trade a lot like U.S. high-yield bonds -- and they have pulled back recently.

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ETF’s --- The Mainstreaming Of Advanced ‘Basket-Trading’

May 01, 2010 in Backtest | Strategy

In a recent institutional research piece by Goldman Sachs targeted at European portfolio managers, they offer various ways to trade ‘the divergence theme in the Eurozone.’

In the note, they discuss the problems with domestic demand in Europe within the construct of strong global growth, led by the BRIC (Brazil, Russia, India, China) theme. This note was on April 28th and followed a similar note discussing a similar theme targeted at US portfolio managers.

The basic idea of the note is to “Go long international growth & short Eurozone domestic demand.” In both research pieces, they do a lengthy analysis of long lists of ‘basket trades’ that portfolio managers could do to implement this longer-term trend. The bottom line of these studies was to create a long basket of stocks (to be long) that has companies with high sales exposure to the strong parts of the world and create another basket with high sales exposure to mainstream Europe and go short that basket.

To execute this, you would submit a list of trades, with quantities of shares, to a firm like Goldman or Morgan Stanley or Merrill Lynch and say ‘buy(sell) this basket of 70 stocks on the market close today.’ Then, Goldmans quantitative ‘experts’ figure out how they are going to both ‘guarantee you closing price’ – and make money for themselves. They ultimately do some kind of elaborate combination of trades that hedges themselves --- and can use the liquidity in the futures market with a hedge ratio or whatever else they do to create a profit for themselves – and then they charge an extra fee to the buyside firm to do the program trade.

Now – enter ETFs. Think about what you can do now – you can buy any of 1000 pre-set trading baskets that were created by index construction experts at MSCI, S&P, Russell etc. In some cases, such as at Schwab or Fidelity, you can do this for zero transaction fee. Its like the world has aligned in favor of the small investor/advisor here. This is very powerful.

I should go on to note that in this most recent research piece by Goldman on ‘trading the divergence’ --- they spend nearly 1/3 of the report going into backtests of their newly created trading baskets.

Well, with ETF’s – the trading history total return chart of the ‘basket’ is known. You don’t have to simulate it with portfolio management software --- you can just run the total return chart on our site.

So this is the power in ETFs: 1) the index has been constructed for you by index experts already (the people at firms like MSCI are every bit as smart (I would say smarter) as the people at your typical large financial institution) – they know what they are doing. 2) the trading history of the ETF ‘basket’ is known and 3) you haven’t done any actual work yet and you are already analyzing the characteristics of the ‘ ETF basket’ (its volatility, out/underperformance, historical relationships etc).

The bottom line is that banks makes good money recommending these kinds of things for portfolio managers. The longer the list, the more the profits. Big portfolio managers with huge assets under management cannot buy most ETF’s – the ETF’s just aren’t big enough. But you – as the small advisor, small hedge fund or individual investor can -- and that is what our site is all about -- leveraging the inherent and underrated power that ETF’s bring to neutralize the investment landscape.

(by the way, our relative strength model pointed towards this weakness in Europe months before Goldman wrote research on this – just go into the ETF screener and move the date back to January and see for yourself)

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Simple Strategy Using The Relative Strength Themes of our 'Screener'

Apr 26, 2010 in Screener | Strategy

While it may not be particularly interesting from a global perspective -- the relative strength model in our Screener has been quite clear for past few months. Long US Equity and Negative on Europe. Here is an example using the relative strength model as of the last day of February to create a subsequent long-short portfolio that is representative of the broad themes in the marketplace:

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