We are in full training mode for our annual one day south rim to north rim hike of the Grand Canyon. We live two hours from the south rim so it is easy to get to.We are going to do the hike on October 6. We went nine miles this morning so I am off to a late start today.
A reader sent an email asking for an update to an ETF portfolio that I wrote about previously.
I think he was referring to a post from June 27 that you can read here.
I need to disclaim that this type of thing is not my first choice for any portfolio. Please keep that in mind as you read this, you know, that this is not my best suggestion to anyone.
The starting point for me for portfolio construction is how I want to weight the sectors. Right away this means that the large/mid/small cap ETF are off the table (for me). As I wrote earlier this week I am convinced that value can be added by making active decisions with all ten S&P 500 sectors. At this point let me concede all the flaws that go with using the S&P 500 as a benchmark but it is what I use.
For the do-it-yourselfer willing to learn about what sectors usually do well at different points in the economic and stock market cycle and also able to catch the really big themes like tech in the late 90s (kept in reasonable proportion) or energy and commodities in the last couple of years can add measurable value to their results without being correct about any stocks or taking single stock risk. Adding individual stocks could either help or hurt returns depending on some combination of skill and luck (don't underestimate luck's importance).
A great resource to know how the benchmark of your choice is weighted for sector is to look at the iShares fund that mimics your benchmark at the iShares website. The financial sector comprises about 21% of the S&P 500. An inverted curve means that lending is unprofitable. If lending is unprofitable it is not a stretch to think that financials will struggle. That has been my thinking and for the last month or so it has been wrong. I target that sector at about 15-16%, the stocks have been doing well (actually most of my exposure is in foreign banks from Canada, UK, Australia and Ireland). The important point is that the consequence for be wrong is almost nil because I have not made a big bet.
There are sector ETFs from iShares, StateStreet, Vanguard and PowerShares. Some of the other providers (First Trust comes to mind) have the occasional sector ETF here and there. Given my preference for foreign, I use the iShares Global ETFs, where available. Given the myriad of unique client circumstance I have exposure to all the Global ETFs for at least one client, not the same client mind but spread across our practice.
The global sector ETFs include Financials (IXG), Health (IXJ), Energy (IXC), Telecom (IXP) and Tech (IXN). There is no such fund for the Industrials, Utilities, Staples, Durables or Materials. WisdomTree has ten sector ETFs in the registration pipeline that will have global exposure.
I do use the occasional narrow-themed ETFs as well. I have been most public about my exposure to the PowerShares Water ETF (PHO). The theme of water seems very obvious to me. As a secondary effect, I view PHO as a way to get smaller cap exposure in the industrial sector as PHO is 57% industrials and the average cap size of the fund is $10 billion. All of the narrow ETFs offer the potential for a secondary effect. You may not want or need the secondary (or primary) effect of a given ETF but the potential is there.
Another example of this is the IPO ETF (FPX). FPX is a decent proxy for small cap growth.
The notion of ETF secondary effects is not something I have read anywhere else so I may be an island but think this is a very important benefit to the product and can help do-it-yourselfers isolate some very narrow effects without single stock risk.
8 comments:
Perhaps you have addressed this already, but in your hypothetical etf portfolio I understand how you derived the industry groups and the percentages, but what was the reason for selecting those particular etfs within each industry group? Volume? Assets? Performance? Weighting strategy?
Roger,
I have found your thinking on secondary effects of ETFs to be very useful.
As far as anyone else exploring this idea, I agree that there is very little out there but one example would be at the Index Moose site that a commentor on this site mentioned a long time ago:
http://www.decisionmoose.com/Moosecalls.html
Hi Roger,
Based on his metrics, John Hussman thinks the market is over valued:
www.hussmanfunds.com/wmc/wmc060619.htm
Bill Cara thinks earnings are not growing at a 16% clip as indicated by the media. The number is grossly exagerated by share buybacks, employee terminations and walking away from pension liabilities.
Eddy Elfenbein uses his metrics to tell us the market is grossly undervalued.
www.crossingwallstreet.com/archives/2006/08/sp_1300.html
Personally, I am negetive on the market for the next few months and taking appropriate defensive measures. I am not good at measuring market valuations (unless of course it's 2000 - then I was dead certain we had a bubble) and Eddy Elfenbein's graphs and measures seem to be making a point.
I know near term you are cautious as well. Could you share your take on these opinions? I suspect the answer will be they are all right in their own way.......
Not a nice way to treat the host by questioning him, but we learn by sharing differences. What makes the s&p gospel? (Not talking about the benchmark issue per se.) By using this index's allocations and weightings I think one is creating constraints of which I do not understand the justification. Some years it will work, but I am not sure it is the most effecient and safest way to capture variance. It would be nice if someone would do a multi year evaluative study to determine pros and cons of portfolio construction: allocate by industry or by morningstar matrix factors. FWIW I have used price comparison charts with ytd outcomes. Cap-style etf's plus efa follow.
http://stockcharts.com/webcgi/perf.html?IWF,IWD,IWO,IWN,IWZ,IWB,IWM,IWS,IWR,efa
Value trumped the impact of cap. Amazing how a single and very broad index got the job done, and the distribution of performance is well north of the distribution that you get with the chart below of spdr sectors.http://stockcharts.com/charts/performance/SPSectors.html
After one's weightings, perhaps, the two approaches maybe would be similar. What could be another plus for the former approach, at least for the diy investor, using a few w etfs instead of a lot of stocks, offers a more nimble way to flex the total portfolio...making those small bets to do better than the mkt avererage. Roger, I would go crazy(crazier) keeping up with such a large basket of stocks, but the use of stocks is another issue.Pull up those performance charts. Is this an atypical outcome? Appreciate the opportunity to read and post here while I heal up from some injuries. OTIL
The S&P500 -- large cap US equities -- remains the 'gold standard' benchmark for many investment houses but there are always alternatives including just focusing on real total return; e.g., 5% above non-seasonally adjusted CPI, etc.
Value does seem to trump growth on average and, in the past few years, international has trumped domestic as have metals and real estate but reallocating seems essential no matter what. For example just right-click on that chart for which you posted the link and tell it it animate. After it runs though, click on one of the ETF's to make it the benchmark for all the others and animate the chart again; leadership changes all the time -- particularly in the rolling, choppy market we've had since 1998 -- but it usually doesn't happen very fast so it can be followed to some degree at least.
So the question becomes allocate among what and by what criteria should those adjustments be made. If I believed I had the 'best' answer for that I'd probably be publishing a newsletter or something, if I _really_ had the answer I'm not sure what I'd being doing but it would probably not be what I'm doing now.
Hope your healing happens fast.
On the currency front: "The Japanese yen, which is frequently used as a proxy for the Chinese yuan in foreign exchange trading, rose slightly to 115.75 against the dollar after the announcement." This occurred after the Chinese increased their cost on borrowing money in order to surpess inflation/growth. Is there not a lot of talk about just how far the Chineese will need to go to make the Yuan stronger? Does this mean steady pressure on the USD? Does this mean the use of allocation to foreign currencies may become even more important? Does it mean that megacap domestic companies will outshine? Their products will be more affordable, stimulating demand, and they will be paid in foreign currencies. KO and GE are due for a better performance cycle and OEF is looking good. Roger, what do you think about the relationship hypothesized: stronger Yuan, cheaper dollar, and rise of mega intl domestic companies? Large cap has been prognosticated for a long time, but it finally looks to be happening. Could this be a reason, also, underlying better than expected finace sector (big central banks)? OTIL
If both the Financials and Big Tech could take over leadership here I'd feel much more confident that we might be coming out of the woods but despite some recent strength in both sectors I'm not seeing a great deal of sponsorship.
PS: Roger, I'm assuming you're going through Phantom Ranch for the rim-to-rim hike? Are you going down Bright Angel or S. Kaibab? If the latter guard then your toes and shins: First time I did that particular hike I didn't realize what backpacking (50 lbs) 6 miles of relentlessly steep trail could do to your shins and toes but certainly learned by next morning (had trouble standing up w/ shin splints and the toenail on my left big toe was turning black - came off 5 days later).
Good luck though on the hike and of course enjoy: personally I think the Kaibab trail (South & North, rim-to-rim) is one of the most beautiful slogs in the world.
Wow, lots of comments.
RW, your comment about financials and tech are very important. This is a notion I have touched on before (but did not come up with). The 2 make up 35% of the market, it will be tough to make progress without them.
As for the Canyon, S. Kaibab (about 2 miles shorter). We live and hike in the mountains so we are used to the downhill plus we have hiked the Canyon trails quite a few times. As it is just a one day thing we don't even have 20 lbs on us. Water in the camelback, snacks, molskin and other first aid things, an extra shirt and Gatorade about covers it.
To the comment about "those particular ETFs" there is only one line of ETFs that are global and sector. Some of the narrower ones have no competition either. Where there is competion I try look at compostion method and probably would take the one with better stock diversification, all of the telecom ETFs (for example) will capture msot of the effect and correlate closely.
Decision Moose appears to have a great track record I did not recall content about the ETFs they use. I will take another look, TY.
I read John Hussman more than the other two. His caution is very important to me. It keeps me in touch with a very logical bear case. While valuations are unfavorable they can be unfavorable for a long time. He has done more number crunching than most folks including me but my experience leads me to think that big macro is a good starting point for trying to figure up or down most of the time. His work could and does contribute to the big macro but it is not the first or even the second thing I would look at but it is an important ingredient.
Bill seems to be more horse sense (close to my way of doing things) but he tends to see more extreme outcomes than I do or his idea of extreme is different than mine. I tend to agree with Bill most of the time with regard to direction but very rarely in magnitude.
The market may not be overvalued but I have trouble thinking the market is undervalued here.
Interesting comment about the time needed to watch a lot of stocks. Frankly most people are in the same camp as you. Although spending 70 hours a week on this is a lot of fun for me I can easily see why most people do not want to make their portfolios a full time job. Using things like ETFs can go along way to relieving some of the burden. Too many ETFs and you will miss things but here we are talking about a balance and getting into lifestyle issues. The idea is very reasonable.
Good question about the yuan. The way it is worded (sorry if this is wrong) I think it is asking from the standpoint of the yuan/yen as the center of the forex market. I do not think the yuan/yen is the center of the forex market. The US' dependence on China is one big piece of the puzzle. As was mentioned in Barrons, Russia owns $250 billion of our debt and they were just about bankrupt in 1998. That, to me, is another piece of the puzzle.
The bigger macro with this and something I have been writing about since the start of this site is visibility for less demand for the dollar. The extent to which this has played out so far and will play out in the future makes for a good debate but the issue is easy to see even if it never happens. China is a symptom and not the problem IMO.
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