Casey Smith Positions for Q2: Still Bullish on Emerging Debt Despite Global Instability

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 |  Includes: BND, DWM, EFA, EMB, HYG, IEO, IGOV, IJH, IJR, IVV, MINT, SHV, SPY, URA, VWO
by: Casey Smith

Casey Smith is President of Wiser Wealth Management, Marietta, GA-based fee-only fiduciary wealth management firm offering asset management, tax preparation, estate planning and financial planning services. Wiser’s unique investing techniques have earned Casey speaking engagements at top ETF conferences around the world.

Seeking Alpha's Jonathan Liss recently spoke with Mr. Smith to find out how he planned to position clients in the second quarter in light of a range of macroeconomic and geopolitical issues:

Seeking Alpha (SA): Welcome back, Casey. This has been an extremely eventful quarter with many geopolitical events driving global markets. Before we get down to specifics, how would you characterize your general approach to portfolio building and asset allocation strategies in your client accounts?

Casey Smith (CS): Thank you for inviting me back. Seeking Alpha is a great leader in ETF commentary and we are happy to participate.

We build portfolios using long-term healthy global asset classes. We manage five models of which most of our clients fit easily into. Our portfolios are unique in that we are using all Exchange Traded Products, with each model holding around twelve of these highly diversified vehicles. In fact, on average a portfolio will hold over 6,700 global securities and 14,000+ bonds. Company risk is minimal, allowing our team to focus on overall market risk.

We start with standard deviation and the S&P 500 as our risk benchmark. We will rebalance annually or as market conditions dictate. We will alter our models based on a three to five year outlook, not based on daily news, technical or emotional reactions. I believe that it is important to understand short term market issues but longterm is were passive management is the most competitive in respect to active managers. Our clients are drawn to us from high frequency traders and non fiduciary commission based firms.

SA: Where would you plot U.S. equities as an asset class on the risk curve right now?

CS: I have not see the actual inflows of money into U.S. equities in the form of raw data, but we keep reading articles stating this is where new investments are headed. When everyone starts either piling in or moving out in mass exodus from any asset class, we tend to do the opposite. As I mentioned in my opening statement, we focus on long term healthy asset classes. Owning the S&P large, Mid and Small cap indexes through SPY, IVV, IJH and IJR long term is good for any investor.

Over the last three years the standard deviation of large caps was 24. Over the last 10 years it was 16. Looking into the past, risk is obviously higher. Forward looking I could see the S&P 500 moving down the risk curve, however we have some significant issues that the market seems to be ignoring. Since we last spoke I believe that political risk here in the U.S. has dropped significantly. With the President's approval rating well below 50%, he is out of political capital to completely wreck capitalism.

However the bigger risk is what, how and when the Federal Reserve will begin pulling the stimulus out of the system. What happens when the "patient" goes off the medicine? This is where I look to our great nation to pull us through. The political system, tax rebates and your Congressman's ear marks will not save the US Economy. It is the hard working everyday American that will pull us thorough this. I have traveled the world speaking about Exchange Traded Funds and one thing I have noticed is no country matches our work ethic and freedom to succeed or fail. This is unique to America. It is great to see faith back in U.S. Equities, however we are not changing our long term allocation because others see this asset class as the place to be over the next six months.

SA: Are you still holding the iShares JP Morgan USD Emerging Market Bond ETF (NYSEARCA:EMB)? Do you feel risks have significantly increased to emerging sovereign debt in light of the geopolitical events of Q1?

CS: Yes, we have not changed our allocation percentage to EMB. Since my interview with Just One ETF (in August 2010), EMB still remains one of my favorite ETFs to talk about. Year to date EMB is down about 1% with a 5.2% yield. As we rebalance our portfolios, we have been taking long-term gains from EMB and reallocating into our core bond fund, Vanguard's BND, or in some cases taking gains from US Equities and purchasing additional shares of EMB.

One of the many great benefits from Exchange Traded Products is diversification. In our Emerging Market bond holding, EMB, Egypt represents 0.51% of the fund according to iShares. During the Egypt crisis we watched EMB closely and saw very little reaction in the fund's overall performance. There's no question in certain nations there has been increased risk with sovereign debt. In our case diversification drops this risk significantly. Overall we believe that this is an asset class that we want to be a part of for the next ten years.

SA: The situation in Libya and general unrest we've seen throughout the Middle East during the first quarter demonstrate the inherent risks involved in frontier and emerging market investing. When we last spoke you mentioned a 3-10% emerging market equity exposure via VWO depending on a client's risk tolerance. Have you decided to underweight these markets as a result of the regional situation or have you put more money to work in client portfolios on the assumption that the push towards democracy will ultimately be beneficial for these markets?

CS: I am not convinced that democracy is what will become of regime change in these countries. I think that this is a U.S. media assumption. If you look closely at the Muslim Brotherhood and these other organizations, they pretty much look the same, just different faces. Neither party cares for Americans and certainly they do not tolerate Christians in or out of their countries. This being said the countries that I am referring to make up less than 0.5% of our Vanguard Emerging Market ETF, VWO. VWO and SPY were moving in opposite directions in performance up until the US markets rebounded from the Japan disaster. Year do date we are looking at VWO at close to 3% and SPY at 6% gains. From our 5-10 year outlook, I see no reason to underweight emerging markets. We do not participate in frontier markets. It sounds really "sexy" but we have not been able to claim that asset class as a long term healthy choice.

SA: In the wake of the triple disaster there, are Japanese equities undervalued right now? Has a Japan play crept into your client portfolios in any way?

CS: Short term plays will never creep into our strategy. It was interesting to look at the economic side of this terrible disaster. I personally even looked at which ETFs could be used to "play" the disaster and recovery such as EWJ and SCJ . In the end quick plays require precision execution in market timing. Market timing is statistically a losing game, thus we focus on long term. Japan is 22% of EFA. iShares' EFA is our core international holding.

SA: Oil - how high is it heading and how are you planning to play? Will rising crude prices significantly impede the economic recovery, or will it not be as bad as feared? Are you hedging against rising oil in any way in client portfolios?

CS: The price of oil is certainly a concern in regards to economic growth. I will have to leave the price prediction to the oil tycoons and analysts, but I feel certain that $80 oil is gone for the foreseeable future and feel that a visit to $130 could at least temporarily be visited in the next 12 months. We have used the iShares Dow Jones US Oil & Gas Exploration Index ETF (NYSEARCA:IEO) as our energy play. IEO has 65 holdings in the oil exploration and production sector. Year to date it is up over 13% and has an expense ratio of 0.48%.

As oil rises, the cost of going to work, flying to a business meeting, and industrial production and shipping increases. The reality here is that the United States does not have a oil at $130+ energy policy. I do not see a current benefit to investing in clean energy, but certainly an investment in IEO would help a portfolio benefit from the increase in oil prices. Middle East peace would certainly bring down the risk premium in oil, however any peace in that region historically seems to be temporary.

SA: How are you positioning with regard to the situation in the EU? Do European equities remain a bad bet right now? How much are we in the U.S. at risk of contagion from the situation in the eurozone?

CS: We reduced our European exposure in our lower risk portfolios over two years ago. I would agree that the future of Europe's economic vitality is in question but there is still a Euro to Dollar currency play. If you believe that the dollar will continue to decline vs. the euro, then euro large cap dividend paying companies might be worth looking into. WisdomTree's DEFA ETF (NYSEARCA:DWM) is an option for this kind of Europe investing. We have no plans to change our EU exposure going forward. Many of the S&P 500 companies get a large portion of their revenues from European Countries. We can not have a full recovery without Europe, especially in the large cap asset class.

SA: Moving over to fixed income, how do you view the fundamental case for bonds heading into Q2? You mentioned holding EMB last we spoke. Do you have any exposure to the U.S. fixed income market and if so, what?

CS: Our core bond holding is Vanguard's BND. We complement BND with international treasuries (NASDAQ:IGOV), U.S. High Yield Bonds (NYSEARCA:HYG), Emerging Market Bonds (EMB), Short Term Treasuries (NYSEARCA:SHV) and Short Term Corporates (NYSEARCA:MINT). Many managers have abandoned U.S. Treasuries, but Treasuries still have a place in portfolio risk management. We saw this during the Japan crisis. U.S. Treasuries were the safe haven for the world. Bonds will not generate the price growth that we have seen in recent years, but we will continue to add positions in bond holdings with new money and during rebalancing simply to be diversified for the unknown.

SA: Name one ETF investment that worked out particularly well during Q1 and one that did not.

CS: U.S. Oil Exploration and drilling stocks have done well in 2011. In Q1 we saw iShares' IEO rise 13+ percent vs. a gain for the S&P 500 of 5%. State Street's XOP gained 22%.

The Uranium ETF (NYSEARCA:URA) gave up 27% in Q1. This is an investment that many investors saw as a solid choice as the world looks for clean energy. Obviously this has a direct correlation with the nuclear crisis ongoing in Japan.

Disclosure: I hold positions in BND, IGOV, HYG, SHV, SPY, IJR, IJH, IVV, EMB, EFA and VWO.