A Lazy ETF Portfolio With U.S./Foreign Mixture

I had a unique (I think) thought about a lazy portfolio of ETFs.

One appeal of a lazy portfolio is that it minimizes the number of decisions that the investor needs to make. There are those who would say to just buy an S&P 500 index fund and be done with it. Like all strategies, this idea has pros and cons.

The S&P 500 is made up of ten big sectors. Forgetting the cost for a moment, the S&P 500 could be replicated by buying a proportionally correct amount of each of the ten sectors via sector ETFs.

The unique aspect I am spelling out here requires two decisions. Well, one decision made ten times - so one time for each sector, and then one decision about just one sector. The idea would be to weight each sector consistent with its weight in the S&P 500, so you are not making any sector bets you would be equalweight to the S&P 500, but for each of the sectors you make a decision about foreign or domestic.

So for example:

Financials 18.59% of the S&P foreign sector ETF
Tech 16.09% domestic
Healthcare 12.14% foreign
Energy 11.76% domestic
Industrials 11.62% foreign
Staples 10.07% domestic
Discretionary 8.93% foreign
Telecom 3.65% domestic
Utilities 3.55% foreign
Materials 3.28% domestic

A couple of notes before I go on. If the percentages don't add to 100, you can take it up with iShares which is where the data comes from. And these are not my picks - I just alternated between the two to make the idea easier to understand.

So for each sector you would decide foreign or domestic and then decide (OK, so maybe there is more than one decision...) the best ETF to capture what you think is going on in the sector. I believe that value could be added versus the S&P 500 by getting the foreign or domestic issue correct. This would not require anyone to get the country right, or do stock picking, or make sector bets - it would just boil down to foreign or domestic.

Obviously, making a decision about foreign or domestic for each sector would require some work, but I am not so sure it requires a lot of work relative to lazy portfolios. Yet I won't argue with anyone who says otherwise.

If you are correct about, for example, foreign for a given sector, then getting the best fund becomes less important than the foreign/domestic issue the majority of the time.

I would think this could be done with other benchmarks too.

The other "decision"(which may not even be a decision) would involve the financial sector, so we are drifting into a sector bet. When the yield curve inverts, reduce the financial sector by some portion of your choosing. Maybe reduce by 25-30%, not a big bet, just some recognition that financials struggle when the yield curve is inverted.

One thing to keep in mind is that some theme funds could be proxies for a given sector. For example the SPDR/FTSE Macquarie Global Infrastructure Fund (GII) could easily be a proxy for global utilities--not a pick just an example-- or the new Timber ETF (CUT) could be a proxy for global materials. No doubt there are plenty of others.

Like all portfolio ideas, this one has plenty of drawbacks. It lacks REITs, commodities, small cap (but that could actually be worked in) and obviously ignores fixed income and there are probably some others that escape me at this early hour.

This post is intended to be academic, hence no ticker symbols - which should help me avoid compliance issues. If you play around with the concept and compare returns of foreign and domestic sector ETFs you will see some dispersion in performance and if you look at the components you will see where foreign would be the better choice for some sectors and domestic better for others. Taking it that far would, I believe, allow you to see the extent to which very simple decisions can add value to a portfolio that you might actually implement for yourself.

I think an exercise along these lines would be very constructive for learning more about top down portfolio construction.

Editor's note: Here's our complete list of primary U.S. sector ETFs and foreign Sector ETFs.

Comments

[goatfarmer]

This is a very interesting concept, made possible by the recent proliferation of global ETFs. I made a tally from ETF connect and count around 150 global, regional and country funds. My comment would be that domestic/foreign needn'tbe an either/or decision. Rather, one could easily have twenty ETF's: 10 domestic and 10 foreign. Ratios of holdings could be according to a chosen benchmark, domestic or international and varied according to preferences such as the inversion of the yield curve.

This is a tantalizing proposition for the conservative investor. It has the benefit of diversification, globalizaation and benchmarking without picking stocks.

One potential problem is counterparty risk. Are ETF's as safe as the underlying shares? Is there a risk that Ishares could make a computer error, or suffer from fraud? Should one consciously diversify among ETF holders to avoid such a risk?

[RogerNusbaum]

Needn't be either/or is absolutely valid but does move further away from lazy.

It does not make sense to me that one ETF provider could have the best product for each sector. I would think that as an investor looks any sector (or any other themes) products from various providers they would find some from each provider. For example, just an example, maybe the best financial ETF is from iShares, the best telecom ETF from PowerShares and so on.

[advisor tom]

for a so- called low correlated investment it seems to track dia closely with an increase in beta by some 56%. I know this etf has not been out for very long, but with time one would think that more offerings will be available that may increase alpha without using high beta and highly correlated investments.


On Nov 17 08:27 PM goatfarmer wrote:

> This is a very interesting concept, made possible by the recent proliferation
> of global ETFs. I made a tally from ETF connect and count around
> 150 global, regional and country funds. My comment would be that
> domestic/foreign needn'tbe an either/or decision. Rather, one could
> easily have twenty ETF's: 10 domestic and 10 foreign. Ratios of holdings
> could be according to a chosen benchmark, domestic or international
> and varied according to preferences such as the inversion of the
> yield curve.
>
> This is a tantalizing proposition for the conservative investor.
> It has the benefit of diversification, globalizaation and benchmarking
> without picking stocks.
>
> One potential problem is counterparty risk. Are ETF's as safe as
> the underlying shares? Is there a risk that Ishares could make a
> computer error, or suffer from fraud? Should one consciously diversify
> among ETF holders to avoid such a risk?