Concentrate On These ETFs

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 |  Includes: DEF, EFAV, IDV, PIZ, PWV, RFG
by: The Amalgamator

I still laugh out loud when I catch bits from the '80's movie, Airplane! Who can forget the classic scene of Ted Striker's thoughts echoing as he desperately tries to land the plane in stormy weather:

I've got to concentrate... concentrate... concentrate… I've got to concentrate... concentrate... concentrate… Hello?... hello... hello... Echo... echo... echo... Pinch hitting for Pedro Borbon... Manny Mota... Mota... Mota... Mota.

With passengers panicking, and a nun singing Aretha Franklin's Respect, Striker (sweating buckets) and Elaine eventually land the plane skidding past gate after gate. It makes me smile just writing about it.

Striker's mantra to "concentrate … concentrate" is apropos for how to invest part of your equity allocation. Rather than buying ETFs that cover the broad general indices (S&P 500, EAFE, etc.), consider pairing a few funds that together cover some portion of all market sectors but hold only the "best of breed" securities by given style, market cap, or risk orientation. This creates a diversified multi-strategy portfolio, with a risk profile somewhere between buying the entire market and selected stocks.

Other reasons to "concentrate":

  • The ETF space is extremely competitive. Guggenheim Investments, Invesco PowerShares, and BlackRock iShares (highlighted below) want to win. They have built up research capabilities, hired quantitative analysts and staff with hard science expertise, and forged alliances with specialty firms. The ETFs discussed are spawned from these alpha seeking teams, and provide access to strategy tilts formerly available only to institutional investors.
  • A portfolio of pure style funds gives you control to measure and customize the weightings of distinct categories that will invariably outperform or underperform.
  • Truly exceptional stock pickers are a rare breed. The concentrated index approach may provide better risk-adjusted returns along a narrower theme without getting burned from someone's failed "best idea."
  • Pooling together several concentrated funds to allow reasonable diversification results in a unique hybrid of active and passive management, with a cost around .50%-.70% (versus 1.5% for many active mutual funds).

This approach has the potential to deviate from the norm, both positively and negatively. The industry disclaims this fact in disclosure documents with rather circular legalese:

Concentration Risk - If the fund concentrates in an industry or group of industries, the fund's investments will be concentrated accordingly. In such event, the value of the fund's shares may rise and fall more than the value of shares of a fund that invests in securities of companies in a broader range of industries.

The fund sponsor then usually unveils a close cousin of concentration risk:

Non-Diversification Risk - The fund may invest in a limited number of issuers and therefore may be considered non-diversified. If the fund focuses its investments in a limited number of issuers, its NAV per share, market price and total returns may fluctuate more or fall greater in times of weaker markets than a more diversified fund.

Now that you have been both tempted and warned, perhaps you will heed Striker's advice to concentrate... concentrate. Below are some relevant ETFs to consider:

U.S. Focus

GUGGENHEIM S&P MIDCAP 400 PURE GROWTH (NYSEARCA:RFG)

GUGGENHEIM DEFENSIVE EQUITY (NYSEARCA:DEF)

POWERSHARES DYNAMIC LARGE CAP VALUE (NYSEARCA:PWV)

GUGGENHEIM MULTI-ASSET INCOME (NYSEARCA:CVY)

With RFG, you are buying 91 mid-cap companies with collective annual earnings and cash flow growth above 20%. You will pay a high multiple, but should continue to see strong performance as GDP recovers. The "defensive trade" captured by DEF has generated substantial alpha with the lowest beta of the group (a touch over half SPY's), resulting in a 3-year Sharpe Ratio of 1.55. DEF focuses on 101 quality, low volatility securities and pays a dividend in excess of the benchmark. In this schizophrenic environment, DEF should continue to thrive even as investors reach out for more cyclical growth orientation. PWV is a large-cap value and recovery story. Its 50 holdings have a Price/Cashflow ratio around 75% of SPY's, Price/Sales around 50% of SPY's, and Price/Earnings of 63% of SPY's. CVY is like a bond surrogate, as its price has trailed SPY while paying a healthy 5%+ dividend. Its portfolio of 150 REITs, MLPs, Closed-End Funds, preferred and other income producing securities should do well in an inflationary environment for financial and real assets.

5-Year Chart

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Developed International Focus

ISHARES MSCI EAFE MINIMUM VOLATILITY INDEX (NYSEARCA:EFAV)

POWERSHARES DWA DEVELOPED MARKETS TECHNICAL LEADERS (NYSEARCA:PIZ)

ISHARES DOW JONES EPAC SELECT DIVIDEND INDEX (NYSEARCA:IDV)

Since its launch in 2011, EFAV has been a rock among the volatile set of developed market ex-US products. It holds 173 lower risk companies from the EAFE index (Europe, Australasia and Far East) with reasonable earnings if not recently flat cashflows. EFAV has outperformed the EAFE index over the past year by nearly 4%, with a beta of .66 and Sharpe Ratio of 1.23. PIZ is positioned to soar in a continued uptrending market (witness its nearly 26% return since mid-Dec 2011), but would have less protection during a strong correction. It holds 100 names in more cyclical sectors using Dorsey Wright & Associates' technical screen for relative strength. PIZ's valuation multiples may be more expensive than the others, but it shows strong earnings, cashflow and sales growth. IDV is your income and recovery play, a way to generate yield from various foreign currencies diversifying away from the dollar. Its 101 companies posted a combined annual dividend yield of 4.75%, Price/Sales ratio of .68, and Price/Cashflow ratio of 5.63.

1-Year Chart

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15-Month Chart

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Data

RETURNS Market Cap / Style Number of Holdings Total Return (5 Yr) Total Return (3 Yr) Total Return (1 Yr) Div. Yield (Annualized)
U.S. Focused
SPDR S&P 500 ETF (NYSEARCA:SPY) Large Cap Blend 501 4.78% 13.36% 13.10% 2.05%
POWERSHARES DYNAMIC LARGE CAP VALUE Large Cap Value 50 7.35% 14.73% 18.90% 2.23%
GUGGENHEIM DEFENSIVE EQUITY ETF Multi Cap Blend 101 7.52% 16.09% 15.28% 2.40%
GUGGENHEIM MULTI-ASSET INCOME ETF Multi Cap Blend 150 7.07% 14.75% 11.69% 5.07%
GUGGENHEIM S&P MIDCAP 400 PURE GROWTH Mid Cap Growth 91 13.40% 18.21% 9.13% 0.61%
International
ISHARES MSCI EAFE (NYSEARCA:EFA) Multi Cap Blend 889 -1.03% 6.64% 10.23% 3.02%
ISHARES DOW JONES EPAC SELECT DIVIDEND INDEX FUND Multi Cap Blend 101 0.93% 9.91% 10.75% 4.75%
ISHARES MSCI EAFE MINIMUM VOLATILITY INDEX FUND Multi Cap Blend 173 -- -- 11.15% 1.90%
POWERSHARES DWA DEV MRKTS TECH LEADERS PORTFOLIO Multi Cap Blend 100 -1.11% 8.76% 10.35% 1.88%
RISK STATISTICS Alpha (3 Yr) Alpha (1 Yr) Beta (3 Yr) Beta (1 Yr) Sharpe Ratio (3 Yr) Sharpe Ratio (1 Yr)
U.S. Focused
SPDR S&P 500 ETF -0.08 -0.10 1.00 1.00 0.94 1.48
POWERSHARES DYNAMIC LARGE CAP VALUE 1.86 5.01 0.92 0.93 1.05 1.93
GUGGENHEIM DEFENSIVE EQUITY ETF 7.37 3.8 0.57 0.66 1.55 1.65
GUGGENHEIM MULTI-ASSET INCOME ETF 4.38 1.08 0.78 0.86 1.24 1.46
GUGGENHEIM S&P MIDCAP 400 PURE GROWTH 4.56 0.3 1.11 0.89 1.08 1.25
International
ISHARES MSCI EAFE -0.08 -0.04 0.99 1.00 0.43 1.03
ISHARES DOW JONES EPAC SELECT DIVIDEND INDEX FUND 3.07 0.93 1.03 1 0.58 1.07
ISHARES MSCI EAFE MINIMUM VOLATILITY INDEX FUND -- 3.05 -- 0.66 -- 1.23
POWERSHARES DWA DEV MRKTS TECH LEADERS PORTFOLIO 1.7 -0.55 1.07 0.94 0.49 0.95
FUNDAMENTALS Price/Cash Flow Price/Sales Price/Earnings Price/Book Cash Flow Growth % Sales Growth % Earnings Growth %
U.S. Focused
SPDR S&P 500 ETF 9.51 1.38 15.63 2.18 4.66% 3.38% 11.55%
POWERSHARES DYNAMIC LARGE CAP VALUE 7.16 0.73 9.86 1.63 2.28% 1.58% 5.57%
GUGGENHEIM DEFENSIVE EQUITY ETF 7.76 1.17 18.27 2.09 -0.20% 3.38% 1.85%
GUGGENHEIM MULTI-ASSET INCOME ETF 7.43 1.08 12.06 1.7 3.44% 3.80% 9.61%
GUGGENHEIM S&P MIDCAP 400 PURE GROWTH 12.21 1.46 19.68 2.63 23.33% 8.70% 26.76%
International
ISHARES MSCI EAFE 7.59 0.85 12.93 1.44 -36.92% -20.74% 8.88%
ISHARES DOW JONES EPAC SELECT DIVIDEND INDEX FUND 5.63 0.68 11.18 1.58 -20.10% -5.23% 1.90%
ISHARES MSCI EAFE MINIMUM VOLATILITY INDEX FUND 8.78 1.29 15.65 1.85 -1.54% 1.77% 8.27%
POWERSHARES DWA DEV MRKTS TECH LEADERS PORTFOLIO 11.11 1.52 16.89 2.8 10.43% 8.33% 17.08%
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Source: Fidelity.com

Disclosure: I am long CVY, DEF, EFAV, IDV, PIZ, PWV, RFG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.