My ETF Portfolio: Chapter 4, The First Switch

by: John Crossman

Click to view the Introduction, Chapter 1, Chapter 2 and Chapter 3.

As you can see from the system readings taken at Friday's close, it is time to switch out of India (NYSEARCA:EPI) and into the food commodity ETF (NYSEARCA:DBA). This is one of the key mechanisms of the system. It ranks the underlying momentum of the assets (in this case, ETFs) so that your selling decision is a switching decision. The main idea is to keep my portfolio invested in the most promising assets at any given time.

Farewell to India?

Am I sorry to see EPI go? Not really, I have been in and out of EPI a number of times over the last two years. Most of the time, it is profitable. In this case, it has not been. I think the long term case for India is still intact, which is why I will probably keep EPI when I review the universe on a quarterly basis. What about hanging onto the position until I can sell it at a profit? That is a very dangerous road although all of us have travelled it at one time or another.

Using the System to Separate

So, as you can see, I am using this system to separate the investment case (strategic) from the investment decision (tactical). That may sound a little strange at first but think about that statement and you should recognize it as classic investment advice. The alternative is to let recent market movements drive your asset selection process. Isn’t that what everyone makes fun of when people buy last year’s top performing fund on Morningstar?

Let’s take a paragraph or two to see how the feelings I have developed for an investment are systematically separated from the decision to buy and sell that investment. I think you will agree that this is a useful way to structure the process.


On the investment case side, I have good reasons to believe that India will grow at a faster rate than many of the other countries and sectors that are on offer. I could go on about the young vibrant population, the gradual freeing of restrictions that hold the economy back, strength in IT services and the large middle class (who are quite fond of gold, by the way). Others can argue that the place is still a mess, Pakistan has nuclear weapons, that certain castes are still treated badly and so on. Differing opinions are what make markets. The point is, one should look at the opportunity and decide if it is a good investment or not. Since it is hard to completely suppress our emotions when it comes to investing, one should try to contain them to this part of the investment process.


Just because an investment shows promise doesn’t mean that I should hold EPI all the time and at any price. The valuations may have gotten ahead of the fundamentals. Or, the price action may have nothing to do with India at all. Perhaps, as year-end approaches, fund managers in the US and Europe are pulling money back from the peripheral markets. The point is, I can “take a break” from owning EPI without feeling the emotional need to repudiate everything I have discovered about India in my research. I don’t need to search the web for “why India is a bubble” articles to make myself feel better about switching out. I don’t need to “care” about EPI. And that is an important level of separation to achieve because neither EPI nor the stocks in the fund “care” what I think, either.

How about DBA? Didn’t it take a hit the other day when sugar got slammed (12.5% of the basket)? Isn’t the US dollar going up? Yes and these events are already in the past and therefore not very actionable. Is there a risk that DBA could fall further? Well, yes but that is a risk I was prepared to take when I put this list of fairly aggressive ETFs together in the first place. If your risk appetite is lower, then you need to substitute in less risky assets.

So what is in DBA that gets me excited? The weightings are available on the Invesco Powershares information page. These are the primary tradable foodstuffs that account for most of what we eat (except for Sugar in the US but that is a different story). With global population approaching 7 billion, a rapidly growing global middle class (more demand for meat, coffee and sugar), global warming, resistance to GM foods, potential friction in the food trade and the US dollar spigot left open by QE2, there are some reasons to think that we may yet see a bit of food price inflation in US dollar terms. The only caveat is that all of these are “soft commodities”. That means higher prices will spur more production which will serve to moderate prices from time to time.

How Is the Portfolio Doing?

Well, we are only a few weeks in but they have been eventful ones. The reopening of the euro wound and the shelling of an offshore island in South Korea has reminded the financial markets that there are still a few big unresolved risks in the world at large. I was going to make some bad puns about TUR getting slaughtered on the day after Thanksgiving but after trying them out on my children, I have been convinced to spare any wider audience of my wit.

The portfolio gave up 5.3% this week (-7.3% since we started) which tells me in no uncertain terms that money is running away from the “risk trade”. Will that continue? I think part of the answer will lay in the holiday retail numbers in the US. If they are OK, I think money will start flowing back out into the riskier markets. If they disappoint, fears of double dip recession will push us back towards the US Treasury/Precious Metals end of the investment spectrum.

And, if they pull a surprise on the upside, we could see a short year end surge into the US markets at the expense of emerging markets.

So at the end of the trading session I will be looking to sell 370 shares of EPI and buying a bit over 300 shares of DBA.

Disclosure: Author holds long positions in EWH, EPI, DBA, TUR