Protecting Capital: An ETF Manager Results Example

May 12, 2011

Many people still equate ETFs with ‘passive’. While it is true that most ETFs track indexes, dynamically choosing and assigning allocations to indices is as active as anything you can do.

Recently, we listened in on a panel with an ETF investment manager that currently has $2 billion under management. This fund manager stated that it decides its exposures based on 3-factors:


1. 50% Momentum Models

2. 25% Valuation & Monetary Policy Considerations

3. 25% Sentiment Models


Here are the published returns:

Note that despite a successful hedge-fund profile of returns, the fund did lose money in over one-third of all months. This is similar to many of the (successful) backtests we run, there is a cap on the % of up months any return-oriented fund can accomplish. It should encourage you to reduce the volatility of your portfolio to know that you will likely lose money at least one-third of the time. This should help temper your risk appetite somewhat as the nature of compounding dictates you obviously do not ever want to drawdown a large percentage.

Below we lined up all the 1-month returns from low to high. We like this visual because it should be obvious that most of the time, you should expect some low return – plus or minus. Limit your drawdowns and then during some point of the year, you would like to catch some type of trend and be overweight that group -- be it in natural resource stocks, domestic REITS or intermediate treasury bonds.


The point is really that whether you are a conservative investor or an aggressive investor --- you can pursue strategies at different weightings with the core-satellite structure. If you are conservative, then your satellite strategies can be smaller and your core more defensive. If you are aggressive, then you can run your satellites at a higher weighting. But in the end, the goal is essentially the same --- protect and grow capital.


Addendum: In a recent conversation with a venture capital investor --- he called anyone who doesn't actively advise the company on strategy and help make introductions on behalf of the company to customers a 'passive' investor. Its all a matter of perspective I guess.


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