This is the first piece in Seeking Alpha's Positioning for 2013 series. This year we have taken a slightly different approach, asking 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.
As in years past, long-time Seeking Alpha contributor Roger Nusbaum is kicking off the series. Roger is an Arizona-based financial advisor at Your Source Financial who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger's popular blog, Random Roger, focuses on 'top down' asset allocation. Roger is also the manager of the newly-launched AdvisorShares Global Alpha & Beta ETF (RRGR), a globally-diversified equity ETF which leverages Roger's vast knowledge of global markets and investing themes. Regular readers of his blog know Roger is an avid global traveler, and he is constantly on the lookout for fresh foreign investment ideas. RRGR's full holdings are regularly updated here.
Seeking Alpha's Jonathan Liss recently spoke with Roger to find out how he planned to position clients in 2013 in light of his understanding of how a range of macro-economic and geopolitical trends were likely to unfold in the coming year, both domestically and globally.
Jonathan Liss (JL): 2012 was a big year for you with the launch of your very own managed ETF (RRGR). Before we get into specifics, how would you describe your investing philosophy, broadly speaking?
Roger Nusbaum (RN): We use a top down approach to portfolio construction. We start with the big picture and whether the current environment is favorable for equities or not. From there we make decisions on sector weightings, which countries we want to own, and other tilts like size or volatility. The portfolio is constructed with individual stocks and narrow based ETFs.
JL: As we approach 2013, are you bullish or bearish?
RN: The terms bullish and bearish don’t offer much real value. We try to sort out the various positives and negatives that exist to create a baseline scenario. Typically this means taking what we know about market history and combining it with what we think is going on now to try to make a forward looking analysis. The nature of stock market and economic cycles in the US is that they usually last four or five years. We are almost at four years from the bottom for stocks and the economy and so it makes sense to expect that we are near the end of both cycles. The nonsense going on in Washington could be a trigger for ending these cycles, or it could be coincidental but for now we are wary.
JL: To which index or fund do you benchmark your performance?
RN: We benchmark to the S&P 500 and have done so for years. The reason for this is that the index is easy for clients to look at, follow and understand.
JL: Considering the foreign tilt of RRGR relative to the S&P 500, and thus the different risk profile, is there some other index or benchmark you use internally to determine if you are providing true ‘alpha’? If not, do you feel ‘benchmarking’ performance is overrated when it comes to choosing a manager or fund?
RN: Like most managers, we benchmark to an index so that clients that are interested in these comparisons can easily understand the current positioning we have versus the generic fallback of just buying an S&P 500 index fund. This question gets into what the actual objective of the client is, what the manager is trying to do, the manager’s ability to convey his strategy in order to set the right expectation for the client, and the client’s ability to understand the expectation and decide whether it is right for them. For example, someone who feels they must beat the S&P 500 every quarter would not be happy with our firm. We target a result that adds value and smooths out the ride over the course of an entire stock market cycle.
JL: Your 2 largest positions (by far) in RRGR are 2 Tech ETFs – the dividend focused First Trust NASDAQ Technology Dividend Index ETF (TDIV) and iShares Dow Jones US Technology ETF (IYW). Please explain your thesis for overweighting Tech relative to other sectors.
RN: Actually we are slightly underweight technology. As of when this was written, tech made up 18.9% of the S&P 500. IYW, TDIV, Apple (AAPL) and KLA-Tencor Corporation (KLAC) make up all of our tech exposure and they add up to just under 18%. Tech is the largest sector in the index these days and we have used sector funds to account for most of our exposure to the sector for many years now. RRGR has a 4% weight to Vanguard Telecom Services ETF (VOX), which is an overweight when compared to the S&P 500 weighting of 3.1%.
JL: Please elaborate on why you are overweight VOX at this time?
RN: We target VOX at 4% versus a telecom sector weighting of 3.12% so it is not much of an overweight. We generally have wanted to increase the yield of the portfolio for the last few years and a slight overweight to telecom is an efficient way for us to do that.
JL: What is your highest conviction pick heading into the new year and why?
RN: In our portfolio we usually have 30-35 holdings. One will be the best performer and one will be the worst. If I knew which one would be the worst, we would not own it. Invariably the one that turns out to be the top performer is not the one that would be chosen in this context. If the market does go down next year, then something defensive in nature would likely be the top performer. If the cycle does not end next year but we instead have a huge rally, then something cyclical and volatile would probably be the top dog.
JL: Which global issue is most likely to adversely affect US markets in the coming year?
RN: I would be less concerned about trying to prioritize global threats as opposed to keeping tabs on the ones we know about currently, monitoring how they develop (either to fruition or to fizzling out) and looking out for any new global threats. These things come and go perpetually, markets always have issues to sort out and 2013 will be no different.
JL: At what point do geopolitical risks become too great for you to continue to invest in a foreign stock or ETF? Do you generally bail at the first signs of trouble, or do you take a more ‘sit and wait’ type of approach?
RN: As I read this question I perceive an assumption that one geopolitical event is like another which is not the case. The task here is understanding as best you can the dynamics of the current geopolitical event. For example, the Iranian nuclear threat interests us in terms of what that means for Israel. Our Israeli exposure is Teva Pharmaceuticals (TEVA) which is hardly a narrow bet on a specific outcome related to the Israeli economy. While Middle East tension of some sort has been around forever (almost literally), meaning this business with Iran is not something brand new, owning Teva instead of some discretionary stock means there is less need to be correct about how this plays out for Israel’s economy.
JL: Which countries are you currently most bullish on and why?
RN: We own about a dozen foreign countries (through individual stocks) and similar to what we said about individual stock performers, one country will be the best and one will be the worst. If we knew ahead of time what the worst would be, we would not own it. Our hope for each country is that it offers diversification for the long term versus a domestic-only portfolio. If we can find countries that do offer diversification, then we believe over the long term we can achieve a better result and deliver a smoother ride to clients.
A perfect case in point is that both Norway and Brazil kept going for eight months after the US peaked in October 2007. We had exposure to both countries (and still do) and so those holdings were still going up which helped to offset the decline in our domestic holdings. The effect being captured here, I believe, is that certain countries, because of the makeup of their respective economies, tend to be on different economic cycles than the US. If that is true, then I further believe that these countries would be on different stock market cycles than the US which like in the example above is a reasonable expectation for shorter term diversification.
JL: How much diversification can US investors realistically expect from non-US equities? Does it matter if the economies of the countries in question are structurally more similar (i.e. other developed countries) or dissimilar (emerging and frontier economies) to the US?
RN: The best argument for longer term diversification with foreign investing comes from a piece put out by Bespoke Investment Group at the end of 2009 showing the decade returns for most global markets. While the US was declining 24% on a price basis, Brazil was up more than 300%, Chile was up 190% and Norway was up about 120%. Those markets, and many others, went on just fine without the US offering normal or better than normal returns. If the US ends up having another poor decade in the teens, there will be plenty of markets that offer normal or better than normal returns, again over the course of the decade. There can be no such assurance for a random six or 12 month period where global markets might all decline.
JL: For investors with a long-term horizon and a reasonable risk tolerance, what is the correct mix between US and foreign stocks?
RN: There can be no single answer to this question because there are too many variables on the front end of everyone’s individual situations to simply put out one number. What I can say is that too many people are underweight equities versus the reality of life expectancies and how inflation tends to work (at 3% annualized inflation, expenses will go up by 50% in 15 years). A healthy 60 year old with either or both parents still alive needs to plan on their money lasting for at least 30 years—I have an older brother in this exact situation, he just turned 60 and both of our parents are alive and healthy. By putting too much in bonds the odds increase that your money will not be able to keep up with inflation. The result of this could be running out of money before you die.
The flipside of this of course is losing all your money for being too aggressive with equities. If you are 83, healthy and have just run out of money what difference does it make if you ran out because you were too aggressive or too conservative? It makes no difference, you are in the same spot, but with equities you at least would have given yourself a chance to have enough to last.
Dialing back the extreme outcomes, a well-diversified portfolio can be managed in such a way as to be disciplined with its construction, disciplined with its management and disciplined with the withdrawals so that it provides a very good chance of lasting as long as needed.
JL: You currently hold a 2% position in PowerShares DB Gold ETF (DGL). Do you believe gold and other precious metals are a genuine hedge in uncertain markets? Where else are you turning for potential downside diversification?
RN: We own GLD in separate accounts and DGL in the ETF we subadvise, RRGR, because the DGL structure is preferable under the hood of an ETF. If any precious metal offers a hedge in uncertain markets it would be gold over the others, because it is less cyclical. We own gold as a form of insurance against shorter term events that create uncertainty. I expect gold to go up in the face of some sort of external shock that sends equities lower and that has been the case more often than not. In 2008 GLD was up slightly as the S&P 500 fell 38%. Since GLD’s inception it is up 268% versus a 21% gain for the S&P 500 so I believe the diversification benefit is alive and well for investors able to focus on the long term. Again, over some 6-12 month period anything goes.
JL: What advice would you give to a ‘do-it-yourself’ investor looking at global investing opportunities in the present environment?
RN: First thing would be to make sure you are investing for the correct time horizon. The typical 50 year old investor (as opposed to a trader) probably has a goal that involves needing his money in ten to 20 years. When that currently 50 year old person is 60 he will not remember how his portfolio did in 2013 without looking it up but will know where he stands in relation to having enough money or not, which makes the point of how important the long term is versus the short term.
In thinking about the foreign portion of a diversified equity portfolio, I would take a long term view on the fundamental prospects on a country by country basis. Most of Western Europe and Japan seem to have serious fundamental and demographic problems that don’t seem anywhere close to resolving. Compare that to many other countries, many of which are emerging market countries but not exclusively, that have better balance sheets, younger populations and stuff in the ground that the world needs.
DGL is a holding in the AdvisorShares Global Alpha Beta ETF.
GLD and RRGR are client and personal holdings.
To read other pieces from Seeking Alpha's Positioning for 2013 series, click here.