You probably saw on CNBC that Bob Pisani asked Jim Lowell, Matt Hougan and Tom Lydon to construct a series of half a dozen ETF portfolios with each of the six targeting a different expectation like bull, bear, sideways and so on. For what it's worth, I consider both Matt and Tom to be blogging friends of mine.
This whole exercise strikes me as a real effort by the mainstream media to produce some ETF 201 content which is unambiguously positive. I thought it would be fun and useful to deconstruct a couple of the portfolios to see what can be learned and whether there can be any improvements offered. Today I'll look at the Global Sideways Market Portfolio and maybe tackle the core portfolio next week for my regular Street.com article.
The reason to look at the sideways portfolio is that it seems almost like a continuation of yesterday's discussion about permanent portfolios. The target weights are as follows:
PowerShares BuyWrite Portfolio (PBP) 40%
iShares iBoxx Investment Grade Corporate Bond Fund (LQD) 15%
PowerShares G10 Currency Harvest (DBV) 15%, this is the carry trade ETF
iShares iBoxx High Yield Corporate Bond Fund (HYG) 10%
JP Morgan Alerian MLP Index ETN (AMJ) 10%
iShares S&P US Preferred Stock ETF (PFF) 5%
SPDR Barclays Convertible Bond ETF (CWB) 5%
First, a couple of bottom up observations. A few clients own PBP and it is a tough hold for people who are not patient or who cannot think in terms of the entire stock market cycle. I have a lot of faith that over an entire cycle this will look like a very good choice but anyone thinking in three, six or even 12 month increments will be frustrated by this one.
About 1/3 of LDQ is in financial companies, the average maturity is 12-years and the 30-day SEC yield is 4.58%. I think there is something to be said for choosing a few individual corporates that are AA or A rated--obviously, it would be prudent to assess the debt load for yourself and get familiar with cash flow numbers and not rely exclusively on the ratings.
The Carry Trade ETF was in the high $20s for a while and then hit a big air pocket to the low $20s and has been creeping up to the mid $20s for a while. One drawback here might be the tendency to overly rely on the back test to the point of not looking under the hood and being in touch with the dynamics of the various currencies.
The junk bond ETFs have, of course, done well in the rally but I want no part of the space. This might just be my hangup but I do not have faith that capital markets are all better which, if true, looms as a threat to any space that could be construed as aggressive yield chasing.
AMJ is an ETN and I am not a big fan of that wrapper when there are alternatives. I imagine the ETN wrapper bypasses some of the tax reporting issues with MLPs but if I wanted to go this heavy in MLPs I would rather pick a couple of individual names.
Looking at the top ten holdings of PFF I see Ford (F) and then nine different issues from financial companies--of course, it is mostly financial companies that issue preferreds. I have two preferred stocks that are widely held by clients. I feel more comfortable with individual issues in this space than a fund.
For the convertible space a fund of some sort is going to be the best way to access the space for most people but in an equity market downturn, using 2008 as a proxy, I think the fund could get smacked pretty hard. Of course, the portfolio is for people who believe the market will be range bound.
From the top down, the focus is obviously on yield which, if you know the market will be range bound, makes plenty of sense. The fund is obviously lacking for foreign exposure - the currency harvest product is billed more as an absolute return vehicle than a proxy for foreign assets - and there doesn't appear to be any counter strategy. I picked up the concept of counter strategies from my brief time at Fisher Investments.
Basically a counter strategy could be thought of as something you own so that if your baseline assumptions are wrong you have something that can still go up. The assumption of the portfolio is a sideways market but what if it goes up a lot or down a lot? In an up market this will lag and depending on what would push the market down this portfolio could get hit very hard.
Despite the criticisms I think there is a lot of utility here. I think this type of mix could make for one tranche or bucket of a properly diversified portfolio. The segments chosen make sense and most of the risks isolated above would not be that bad in a normal cyclical downturn. During the 2008 event many of them were crushed beyond what many people would have thought was realistic. Anyone who is concerned that the event is not over and that we will incur a similar downturn or continuation might want to structure this type of tranche with less reliance on funds and instead favor individual issues for some of the fixed income components.