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"A waffle is like a pancake with a syrup trap" -Mitch Hedberg.

After spending a little over 5 years observing the international equity, fixed income and forex markets I have become somewhat of a cynic. From my simple observations, although information can be accessed by the second, when large financial institutions and central banks make their decisions and announcements, markets shift from one direction to the next. Retail investors will never be able to receive the full potential of these movements, unlike the said institutions. This may be as a result of the systems and tools (laptops, cable television and the internet) retail investors utilize which are insufficient to compete with the institutions. Retail investors need to abide by different rules and systems, so that their needs will be met rather than mimicking institutions' systems and tools. As such a strategy and portfolio are proposed versus the benchmark (NYSEARCA:AGG) as seen below.

Ticker

Long Name

Market Cap. (US$)

% of Portfolio Size

Average Life

Modified Duration

Annual Distribution Yield

Current Yield

YTD Return

(NYSEARCA:FLOT)

iShares Floating Rate Bond ETF

2.8Bn

20%

1.71

0.12

0.65%

0.59%

0.78%

(NYSEARCA:BSV)

Vanguard Short-Term Bond ETF

13.24Bn

20%

2.8

2.7

1.65%

0.90%

-0.40%

(NYSEARCA:BIV)

Vanguard Intermediate-Term Bond ETF

3.63Bn

15%

7.3

6.5

5.37%

2.70%

-3.63%

(NASDAQ:VCIT)

Intermediate-Term Corporate Bond ETF

3.13Bn

20%

7.6

6.5

3.81%

3.55%

-3.95%

(NYSEARCA:BLV)

Vanguard Long-Term Bond ETF

580.75Mn

10%

24

14.1

6.43%

4.50%

-9.39%

(NASDAQ:VCLT)

Vanguard Long-Term Corporate Bond ETF

610.05Mn

10%

24.1

13.4

5.22%

5.10%

-8.38%

iShares Core Total US Bond Market ETF

14.14Bn

5%

6.78

5.03

2.87%

2.34%

-3.08%

YTD Return

Average Life

Average Modified Duration

Average Distribution Yield

Average Yield

A US FI ETF Portfolio Strategy

-3.19%

8.67

5.84

3.34%

2.49%

Benchmark

-3.08%

6.78

5.03

2.87%

2.34%

The constructed portfolio performs similar to the market, pays a higher coupon but was not created through market indexing but 'Box metrics'.

BOX ASSUMPTIONS AND MARRIAGE

Given the international market structure, retail investors should always assume they are wrong. This is because assuming the worst or worst case prevents ruin but leaves room for gains. It is a personal put option. Hence, before taking any position over any period of time, a stop loss should be set. Then, investors' views should be constructed on fundamental and technical data as well as the time horizon of your investment. When this is done, your price target should be clear.

Investors' views on the markets should be their significant other. Investors should have a series of views, thus, in the society of finance, polygamy trumps monogamy. However, the marriages will never last as it is assumed the views are ultimately wrong. The stop loss orders form prenuptial agreements. Conviction in views should be maintained until you believe you're wrong or become wrong (through stop loss) and then you should court and marry new views.

BOX METRICS

The only instance where investors should think outside the box occurs when they are courting and marrying their views. After that, investors should abide by the fundamental triggers and events, as well as the technical levels set. Please see below the box of the US Fixed Income ETF Portfolio.

Fundamental/Technical Event/Trigger

Assumptions/Reasoning

ETF Reference

25% Stop Loss

A 25% move lower on a security represents a significant bear move. Thus conditions have changed.

All ETFs in the portfolio.

Portfolio Benchmark is .

AGG represents an investor with USD with 5-7 years until retirement and is increasing his portfolio to fixed income from equities. The focus would be income generation and principal preservation.

UST 10-Year and 30-Year will not trade over 3% and 4% respectively. If this occurs and lasts for more than 1 month, exit ETFs with an average life greater than 10 years and utilize proceeds to enter floating rate ETFs as well as ETFs with tenor 0-5 years.

The view exists that the Fed's thresholds will not be met until December 2013. Technically the UST 20-Year and 30-Year yields also appear to be losing momentum to the upside (as seen in the charts below).

, , , .

Weighted Average Annual Distribution Yield should be greater than US CPI percentage change year over year.

The fixed income ETF portfolio should be created to beat inflation.

All ETFs in portfolio

ETFs should have an investment grade credit rating or rating equivalent.

The portfolio should meet the risk profile of the investor.

Chart 1- UST 10-Yr


(Click to enlarge)

Chart 2- UST 30-Yr


(Click to enlarge)

The box was created from the outside. Investors should stay within these parameters until the triggers are hit. The box was made to prevent chasing or attempting to compete with a person suffering from MPD (Multiple Personality Disorder). The markets consist of millions of different buyers and sellers providing it with multiple personalities, making it extremely difficult to read, unless you are a professional psychologist like the financial institutions and they do not always get it right. Retail investors should not focus on sticking to their own rational metrics and not the metrics of others..

Source: A U.S. Fixed Income ETF Portfolio: Box Paradigm