Smart Beta: Just One Tool in Building a Better Outcome

In the article below, Sean Clark provides a good overview of how advisors can use Smart Beta strategies to achieve certain outcomes for their clients, hence the term “outcome-oriented solutions”. However, as we move further away from the 2007-2009 financial crisis, some advisors and their clients maybe forgetting about another outcome that can have a much bigger impact on performance, and subsequent withdrawal streams…DRAWDOWNS.

Most Smart Beta strategies are not tail-hedged. Meaning they can still have significant losses during bear markets, and crisis periods. They may offer slightly lower drawdowns given the factor tilts, but they don’t provide an added layer of risk management to defend against drawdowns. Fortunately, there are tactical ETF Portfolio Strategists that provide drawdown overlay strategies to Smart Beta ETFs to deliver more robust “outcomes” that many advisors and their clients seek.

The challenge becomes managing the hidden costs of the drawdown overlay strategy, the whipsaw events, and their tax impact. All tactical strategies are prone to whipsaw events, when the investment strategy makes a wrong trade in an effort to limit drawdowns. The “opportunity cost” of that whipsaw can drag down performance, and add to the cost of the active strategy. Since the U.S. stock market began its recovery in March of 2009, there have been a a number significant whipsaw events worth noting: May-June 2010, when the S&P 500 lost 13.7%, only to quickly rebound and continue its upward trend; May-Sept 2011, when the S&P 500 lost 19.25%, but quickly reversed course; May 2012, when the S&P 500 lost 8.9%, and quickly rebounded; and Sept-Oct 2014, when the S&P 500 lost 7.4% to once again quickly recover. When evaluating tactical ETF Portfolio Strategies, advisors should not just look at the risk / return characteristics, as they also need to dig deeper into the number of false positives that strategy had, and the risk controls the strategy uses to limit the impact of the whipsaw events.

Taxes are another “hidden cost” of owning tactical ETF Portfolio Strategies. To help reduce the costs of implementing these more active strategies, Separately Managed Accounts (SMAs) can be more tax efficient than mutual funds. As we approach year end, some tactical strategies can have large distributions as a result of the whipsaw events, which can be problematic for investors that only recently purchased the mutual fund, received the distribution, but did not enjoy the benefit of the realized capital gains. When implementing SMAs, advisors have better control and more choices. Some SMA/UMA platforms offer a tax overlay strategy to help reduce clients’ taxable gains and can be another value added deliverable of the advisor.

In conclusion, advisors and their clients need a deeper understanding of how to create better outcomes using Smart Beta strategies. If they choose to implement tactical strategies to defend against drawdowns, they need to also understand how to manage the hidden costs. For those that can do this effectively, the outcomes can be dramatically different especially after the next bear market. At IronGate Investment Management, we hope this serves as a friendly reminder that the current 5 1/2 year bull market has benefited from massive government stimulus, and near zero interest rates that have inflated asset prices. With the end of QE, advisors and their clients maybe well served to implement both Smart Beta and tactical ETF Portfolio Strategies that can manage the whipsaw costs, drawdowns, and tax impact now that the Federal Reserve has begun the process of making the U.S. economy stand on its own two feet.

‘Smart Beta’: Bridging Active Vs. Passive | ETF.com etf.com

In a world divided into active and passive camps, ‘smart beta’ is emerging as an interesting middle ground.

(Part 2 of 5) The Need For Managed Volatility: Opportunity is Everywhere, When You Take Control

(Read Part 1 – The Need For Managed Volatility – Systemic Risks)

MARKET RISKS ARE CONSTANTLY CHANGING

As new information flows into the markets buyers and sellers digest the news, and adjust asset prices accordingly.  In “normal markets” the information flow is digested and prices adjust in an orderly manner and within normal volatility ranges.  Price trends can continue as momentum persists.  However, information can also flow much more quickly into the markets during “fast markets”, and asset price changes and volatility ranges  expand…both up and down.

“The premier [market] anomaly is momentum.”                                                                             – Eugene Fama & Kennet French (2007)

Some of the best opportunities are created in fast markets across asset classes.  As the amount and frequency of new information flowing into the market increases price uncertainty can can cause crisis periods when correlations across assets classes crash towards one, and the benefits of diversification disappear when needed the most. For example, tremendous opportunities were created after the three year bear market in U.S. equities 2000-2002, when most risk assets took off for an extraordinary run, gaining more than 100% from 2003-2007.  Opportunities were once again created in March of 2009, after U.S. equities sold off more than 50%, and rebounded nearly 200% as a result of the extra-ordinary actions take by the U.S. Federal Reserve.

Unfortunately, for investors still using diversification alone as their only means to defend against losses (drawdowns), it was difficult to take advantage of the financial crisis since they did not have much cash on hand to buy at the lower prices.  For those investors that stayed invested, and were lucky enough to recover after a tumultuous ride, they could not take advantage of the new opportunities because they were trying to recover the losses caused by the volatility.

For tactical investors the experience was much different, as opportunities were everywhere and they had plenty of cash to deploy when prices corrected.  As upward price momentum began to reemerge, new trends were established, losses were erased more quickly, and new gains were captured.

BEWARE OF THE ADDED COSTS OF TACTICAL

The tactical scenario above sounds simple enough but it can be very difficult to implement without a rules-based process that can adapt to the current environment’s information flow. Compared to static strategies, all tactical strategies have an added cost known as whipsaws (the consistent mis-timing in the purchase and sale of securities).

“When no trend exists, momentum strategies can suffer from whipsaws (the consistent mis-timing in the purchase and sale of securities) and excessive costs from high turnover.  In the worst case scenario, a portfolio might suffer a “death from a thousand paper cuts” before a trend re-emerges.  It is critical, therefore, to employ a process that is as robust as possible to these risks.” (Newfound Research White Paper: “Newfound’s Dynamic Momentum”; www.ThinkNewfound.com).

(For more info, also read: “Managing Whipsaw Risks by Measuring Potential Changes to Tracking Error”, by Newfound Research).

To offset the added cost of whipsaws some strategies add the ability to use leverage to increase the upside capture during the previous uptrend.  This can be very effective at times, but investors have to understand leverage in itself is not free, and when a whipsaw occurs with leverage applied, there can be a triple-whammy effect: 1) the initial loss during the selloff, 2) exacerbated losses due to the leverage, 3) and the opportunity cost of the rebound.

COMBINING DIVERSIFICATION & TACTICAL

History never repeats itself, but it often rhymes.  Investors may want to consider combining diversification and tactical to enjoy the benefits of both risk management techniques. Diversification can be one of the cheapest ways to limit portfolio drawdowns. However, since the benefits of diversification can disappear when needed the most, adding tactical as a second line of defense, to defend against large drawdowns maybe a more prudent strategy than relying on just one technique.

Given the risks of today’s global economy, and the simultaneous balancing act of central banks to deleverage their economies through a devaluation of their currencies, while at the same time propping up asset prices through quantitative easing, investors may be well served to add rules-based strategies that can limit the whipsaw costs of tactical to their diversified portfolios…Opportunity is Everywhere – When You Take Control.

Can BoJ and ECB Easing Offset the Damage From Coming Fed Rate Hikes?

Fed vs BoJ: Who’s bigger?: J.P. Morgan View (video)
http://reut.rs/1vCjDL4

Now that interest rates in many developed countries are near zero, and the powerful cycle of deleveraging a global economy grabs the daily headlines, many private and public sector participants are quickly becoming economic historians, seeking examples of prior deleveragings for potential answers to probable outcomes. The international consulting firm McKinsey & Company has identified 45 episodes of deleveragings around the globe in modern history, providing enough data points to assist in extrapolating potential outcomes for the “great experiment” that many central banking systems have embarked upon. However, unlike the prior 45 episodes, the scale of the current deleveraging cycle is unprecedented, as the developed world works off record levels of debt and deficits.

For investors, the challenges of navigating a multi year deleveraging process will take extra-ordinary time, talent, and strategies. The era of buy-and-hold is long past (ended in 1999), as the era of buy-and-manage is likely to continue for the duration of the unwinding an over leveraged global economy. Opportunities and challenges will likely present themselves fairly often, as the balancing act of deflationary pressures from austerity, write downs, and defaults are countered with inflationary pressures of the printing of money.

Policy makers are challenged with getting the mix right with limited experience and a limited framework of reference. If they don’t go through the proper calculations of how much fiscal and monetary policy is required on a global scale, then it is sure to be a bumpy ride. Historically, there have been “ugly” and “beautiful” deleveragings. When the deflationary and inflationary pressures are managed prudently, and the right mix of each component is applied to keep the scale in balance, a beautiful deleveraging can prevail.

Investment strategies adept at managing risk, without sacrificing long-term returns will be necessary to navigate the choppy waters of ANY deleveraging cycle. The multi speeds of a slower growth global economy coupled with the re-flationary efforts of central bankers set the stage for an exciting investment climate. A climate where institutional and retail investors are “strongly encouraged” to take an increased level of risk as the financially repressive policy of near zero interest rates has the effect of artificially inflating asset values. Central bankers seek to reflate asset values, through the waves of liquidity and quantitative easings. In a world of slower growth, it is important to ride the waves of liquidity and to capture returns when they present themselves. At the same time, it is equally important to protect prior gains from the destructive nature of volatility, as the flow of information increases during potential inflection points, such as the 2012 U.S. Presidential election, or the January 1^st 2013 Fiscal Cliff.

To Learn More, Read The White Paper: “Prosper & Protect in a Deleveraging World – Using Managed Volatility Strategies”

Are Most Liquid Alt Strategies Missing Something?

Michael Boggio 

Managing Director / Chief Investment Strategist

IronGate Investment Management

The rush to get liquid alt strategies to market has lead many of them to be missing something, beta.

Investors don’t want a glorified bond fund that gives them mid-single digit returns and acts as a risk reducer to a portfolio. Investors instead want their liquid alt strategy to capture most of the asset class beta in rising markets, then protect those gains in down markets. This is often referred to as asymmetrical returns.

Deutsche Bank Provides Hard Numbers on Liquid Alts Growth – DailyAlts dailyalts.com

Liquid alts are the fastest growing product group in the asset management industry, and that trend should only strengthen in the coming year. After all, liquid alternatives gained popularity amid the financial crisis.

Noise or Trend?

Since early September 2014 volatility has increased significantly in global equities, and today is no exception, as the major US equity averages have followed small and mid cap equities into negative territory for the year.

But is this just noise, or an important trend reversal? Is it a buy the dip opportunity, or a market top after a 5 year bull market?

The honest answer is, only time will tell. Listening to both sides of the argument is always interesting, and pays the bills for the financial media, but making investment decisions based on the stronger argument does not mean you will be correct.

So how can you sort the noise from the trend to improve your short and long-term investment results? At IronGate we use Newfound Research’s systematic, rule-based process that reacts to the information flow into the market and balances the benefits of diversification with the need to be tactical.

• When the information flow into the markets is slow and the volatility is just noise, the benefits of diversification are usually enough to defend against significant drawdowns.
• However, when the information flow into the markets accelerates too fast, trends are usually broken, the benefits of diversification disappear, and a second line of defense (tactical) is necessary to defend against drawdowns.

The two charts above reveal that the benefits of diversification are still available across multi fixed income, and even commodities. So at this point in time, the global equity market selloff can be considered noise, but only time will tell if a larger trend reversal has occurred.

Since investors measure risk in terms of losses, and not standard deviation, our Risk Managed Core Diversifier strategy can be more in-line with investors’ needs, and can help investors sort through the noise of the markets.

IronGate partnered with Newfound to build the Risk Managed Core Diversifier Index around the other asset classes (satellite assets) that have historically enhanced the returns of core portfolios, but with systematic risk controls to limit drawdowns. As a result, the ETF Portfolio strategy can be used as a single solution for clients’ satellite holdings, and can even be considered a core holding.

To learn more visit: www.ManagedVolatility.com

The Need For Managed Volatility – Systemic Risks

This is the first in a five part series in which we will discuss why a Managed Volatility approach is prudent for investors today. To begin the series of articles let’s start with the macro topic of, Identifying Systemic Risks.

Many investors today are in disbelief about the sustainability of the current bull market. As the market climbs a wall of worry, it is important to understand where the demand is coming from that keeps the market moving higher. With that understanding investors can begin manage the macro risks of the markets more effectively. It may also explain why US equities have outperformed most other asset classes for the last few years.

It is not the purpose of this article to identify all of the systemic risks that could derail the markets, as much as it is to provide an example of a large risk that can be marginalized with a Managed Volatility approach. It is also important to mention that there are several ways to manage volatility, each with their own advantages, disadvantages, and cost structure.

In today’s article, the systemic risk worth exploring is “What Will Happen When Companies Stop Buying Back So Much Stock?”

What Will Happen When Companies Stop Buying Back So Much Stock? businessinsider.com

Corporate stock buybacks have driven stock prices higher over the last several years. These buybacks cannot continue indefinitely…

National Radio Interview – Michael Boggio / Chief Investment Strategist

DISCLOSURESSources: Black Diamond, Newfound Research Performance information represents past performance and does not guarantee future results. Investing involves risk. It is not possible to invest directly in an index. All returns for the Risk Managed Core Diversifier Index are hypothetical and are not based on actual client returns. Prior to 6/16/2013, the index is backtested. Live dollars were first invested in the strategy tracking the index on 8/26/2013. Risk Managed Core Diversifier Composite performance represents live dollars invested in the strategy net of fees. Performance results assume reinvestment of distributions.

NATIONAL RADIO INTERVIEW – CLEAR CHANNEL – YORBA MEDIA (LIVE) Listen to the radio interview (6/20/2014) Click here Michael Boggio Chief Investment Strategist IronGate Investment Management PERFORMANCE & YIELD – PORTFOLIO HOLDINGS – YEAR TO DATE                                                                               Click to Zoom RISK MANAGED CORE DIVERSIFIER (RMCD) To meet investor demand for managed volatility solutions, IronGate has partnered with industry pioneer Newfound Research to offer ETF portfolio strategies. Our Managed Volatility solutions seek to help investors participate in up markets and protect in down markets. The rules-based process diversifies around non-core assets that have historically enhanced returns, but adds a second line of defense behind diversification, as it can tactically raise 100% cash to defend against drawdown.   Newfound has been powering client solutions since 2008. In the last five years, Newfound’s models have been used to drive investment decisions for billions of dollars in assets. RMCD is available as a separately managed account (SMA), and accessible to clients through their financial advisors, institutions, pensions, endowments, and family offices. For firms looking to out-source the portfolio management function, the SMA is currently available at Fidelity Investments.The RMCD index is also available for license to firms looking to in-source the portfolio management function on behalf of their direct clients.  For more information please contact IronGate at (910) 791-1437 or www.ManagedVolatility.com. 10-Year RMCD Index Performance Click to Download the Intelligent Diversification Table IronGate Investment Management   2601 IronGate Drive, Suite 201, Wilmington, NC 28412    ph 910.791.1437   fx 910.796.1959 IronGate Investment Management, LLC is a Registered Investment Advisor.

RMCD – Up Down Capture Chart (10 yr)

(Click for .PDF Version) More Info: RMCD – Fact Sheet RMCD – Presentation

RMCD – UP DOWN CAPTURE CHART (10 YRS)  Simply stated, the Risk Managed Core Diversifier (RMCD) strategy is a single ETF portfolio solution that can enhance returns and limit drawdowns. IronGate partnered with industry leader Newfound Research to provide investors with a risk managed approach to owning risk assets.  We applied Newfound’s proven technology to a wider range of asset classes so investors can tactically take advantage of owning risk assets when they are performing well (momentum). The strategy can also pivot towards lower risk assets, including cash to enhance the returns of a core portfolio, while limiting drawdowns. The RMCD – Up Down Capture Chart (above) illustrates how Newfound’s risk managed approach changes the risk/return characteristics of many asset classes. The RMCD strategy can improve the upside capture by limiting the drawdowns of traditional risk asset classes. Simply, it was designed to help people to invest with confidence again.

RISK MANAGED CORE DIVERSIFIER (RMCD) To meet investor demand for managed volatility solutions, IronGate has partnered with industry pioneer Newfound Research to offer ETF portfolio strategies. Our Managed Volatility solutions seek to help investors participate in up markets and protect in down markets. The rules-based process diversifies around non-core assets that have historically enhanced returns, but adds a second line of defense behind diversification, as it can tactically raise 100% cash to defend against drawdown. Newfound has been powering client solutions since 2008. In the last five years, Newfound’s models have been used to drive investment decisions for billions of dollars in assets. RMCD is available as a separately managed account (SMA), and accessible to clients through their financial advisors, institutions, pensions, endowments, and family offices. For firms looking to out-source the portfolio management function, the SMA is currently available at Fidelity Investments.The RMCD index is also available for license to firms looking to in-source the portfolio management function on behalf of their direct clients.  For more information please contact IronGate at (910) 791-1437 or www.ManagedVolatility.com.

Taxes & Valuations: Fueling Demand For Solutions

Summary

• 77% of Americans will have paid more taxes in 2013.
• Higher tax rates are coinciding with a bottoming and eventual reversal of the interest rate cycle…As investors are embracing tactical asset allocation strategies.
• Why Tactical – Drawdowns.
• The Cost of Managing Drawdowns.
• The key to the current environment is to know when the benefits of trading outweigh the costs of taxes.

77% of Americans will have paid more taxes in 2013 as a result of The American Taxpayer Relief Act of 2012, according to the Tax Policy Center. The increases in top federal income tax rates are fueling demand for solutions that can help investors keep more of what they earned (Chart 1).

Unfortunately for many investors in the upper tax brackets, higher tax rates are coinciding with the bottoming and eventual reversal of the interest rate cycle. In anticipation of rising rates investors are embracing tactical asset allocation to help them capture investment returns. Here lies the conundrum, as some tactical strategies can create tax inefficiency due to short-term capital gains. Therefore, the key to the current environment is to know when the benefits of trading outweigh the costs of taxes.

(Chart 1)

(click to enlarge)

Newfound Research provides the tactical overlay to the Risk Managed Core Diversifier (RMCD) strategy, and is considered a leader in the category of managed volatility strategies. Newfound has published several pieces on the topic of being tactical about trading and taxes. Here is an excerpt from a recent white paper:

“Tactical strategies rely on a variety of methods for selecting assets that should be bought or sold to meet investment objectives. Financial advisors also make similar decisions in client accounts. Considering these decisions in isolation neglects the very real impact of taxes on the overall outcome in after-tax accounts. Each decision to trade must be examined in the context of taxes. Thus, the central question is: When do the benefits from trading outweigh the costs of taxes?”

(Read the full white paper here; Read the summary here)

HIGHER TAXES ARE HERE TO STAY

Unfortunately, the current tax environment is likely to remain elevated for a while given the record amount of national debt, and the debt to GDP (gross domestic product) of the United States. As Washington battles to address the long-term health of the economy higher taxes are certainly an important component to fixing the problem.

(Chart 2)

(click to enlarge)

RULE OF 72, 96 , & 120

Higher taxes rates affect many things, including how investors should plan to accumulate, maintain, and distribute their wealth. It also affects the rules of math. The Rule of 72 is well known as a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest and the powers of compounding.

Two lesser know rules of math are the Rule of 96, and the Rule of 120. These rules take into account the 25% and 39.6% annual tax rates for taxable accounts (chart 3). Essentially, in taxable accounts higher tax bracket investors require more time to double their money.

(Chart 3)

Click to enlarge

 WHY TACTICAL – DRAWDOWNS

Adding bonds to equity portfolios has long stood as a means for reducing equity volatility, and for limiting losses in a diversified portfolio. However, since the bursting of the tech bubble in 2000, traditional diversification can be lacking when volatility rises, leaving portfolios vulnerable to drawdowns (peak-to-trough loss sustained by an investment over a given time frame).

(Chart 4)

Click to enlarge

Traditional diversification can be considered a non-guaranteed insurance policy. However, given the effectiveness since 2000 at limiting drawdowns, the premium is getting more expensive. (For more information see, Newfound Research’s white paper titled, “The Case For Tactical Asset Allocation”).

Below is an excerpt:

One of the unique realities of the last 20 years has been the bull market in U.S. Treasuries due to declining interest rates. This trend has created an environment whereby our risk mitigator was also a tremendous return generator. This made a 60/40 portfolio an incredibly attractive investment profile (Chart 5).

However, this reality was not always the case. Older investors will remember a very different interest rate environment whereby the use of the risk mitigator within the portfolio came with a hefty premium. From 1963 to late 1981, a constant maturity index of 10-year U.S. Treasuries had an annualized LOSS of 3.15%: diversification was certainly not free (Chart 6).

(Chart 5)

Click to enlarge

(Chart 6)

Click to enlarge

 

THE COST OF MANAGING DRAWDOWNS

Investors have been managing drawdowns for decades through different portfolio management techniques. Each technique has its own “implicit performance cost”, for the loss protection. If the loss protection was larger than the implicit performance cost then the tradeoff was worth it. Going forward however, a static allocation to bonds is not likely to be the return generator that it was for the last 20 years, solely because of where we stand today within the interest rate cycle (near zero).

As a result, investors should consider other techniques to manage drawdowns. At IronGate we prefer a momentum model, as it can retain the return structure in normal market conditions, yet protect capital without giving up return potential in bull markets (For more info, see Newfound’s blog post on Drawdowns).

(Chart 7)

Click to enlarge

(Chart 8)

Click to enlarge

 

THE VALUE OF WAITING TO TRADE WHEN CONSIDERING TAXES

Despite the exponential growth of tactical trading strategies since the financial crisis, not enough attention has been given to possible solutions of reducing taxes when allocating to tactical trading strategies. This is particularly important for higher income investors with most of their money in taxable accounts.

In normal markets with low volatility, reducing portfolio turnover is a simple and effective way to increase tax efficiency. It can also reduce whipsaws and therefore, reduce performance drag as the markets slowly grind higher.

In fact, this is our primary method of reducing the tax impact on a portfolio. Newfound’s tactical overlay on the Risk Managed Core Diversifier strategy aims to strike a balance between capitalizing on opportunities for outperformance and turnover/trading frequency. This also reduces transaction costs and can avoid triggering wash sales.

However, in fast markets, as correlations increase, and the benefits of diversification begin to disappear, the risk of sizable drawdowns can increase. In these environments factoring tax impacts into the trading decisions adds additional value. Looking at the cost/benefit of trading now, versus waiting until more favorable tax treatment can significantly increase returns.

“So when do we actually execute our trades given by our tactical strategy? The answer is a resounding: it depends. We must be aware of our different tax lots and sell them efficiently; we must be cognizant of the wash sale rules..And perhaps most importantly, we must understand and be able to quantify the value added by the model’s decision to act immediately” (Nathan Faber – Newfound’s recent blog post “The Value of Waiting To Trade When Considering Taxes”).

 

BALANCING THE BENEFITS OF DIVERSIFICATION WITH THE NEED TO BE TACTICAL

In summary, higher tax rates are likely to remain elevated for some time as the leadership in Washington works to improve the health of the economy and lowers the debt to GDP of the United States. At the same time, near zero interest rates limit the effectiveness of a traditional allocation to bonds which has served investors well as both a risk mitigator and return enhancer to equity portfolios.

As a result, the current tax and valuations environment is fueling investor demand for outcome oriented solutions that can tax efficiently and capture returns in normal markets, yet adapt to fast markets by looking at the cost/benefit of trading now to protect against drawdowns.

The above information was taken from the Managed Volatility Newsletter (6/12/2014)

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Warning to Advisors: Set Proper Expectations

It is paramount that advisors set client and their own expectations properly when allocating to ETF Portfolio Strategies. The appeal of many ETF Portfolio Strategies is their ability to participate up and protect down. HOW strategies accomplish this is very important, yet can be very different. How a strategy protects down is important to understand since hedging a portfolio can add to the “cost” of the strategy. Tactical strategies are prone to whipsaws, and the cost for being tactical is created when a strategy experiences the initial loss, trades out, and then misses the rebound. To offset the potential “costs” of whipsaws, SOME strategies attempt to use leverage to increase the upside capture during longer up trends, and to essentially create a “performance reserve” to offset whipsaws events during short corrections, or trend-less markets. Another hidden cost to tactical strategies are taxes. Excessive trading can create unnecessary short-term capital gains when owned in non-qualified accounts. Balancing the benefits of diversification with the need to be tactical can yield better risk-adjusted, after tax returns for many advisors and their clients.

Warning to Advisors: Set Proper Expectations!!! Have a deeper understanding of the what a ETF Portfolio Strategy can and cannot do, and the types of market environments when a strategy will perform and under-perform. This is just as important in the due diligence process and rests squarely on the shoulders of the ETF Strategist and their ability to communicate the benefits and risks with the advisor.

The Perils of Managed Portfolios (online.barrons.com)

Financial advisors’ use of ETF specialists can provide both benefits and problems. The trouble at Good Harbor Financial and F-Squared Investments.

The Battle For Market Leadership

DISCLOSURESSources: Black Diamond, Newfound Research Performance information represents past performance and does not guarantee future results. Investing involves risk. It is not possible to invest directly in an index. All returns for the Risk Managed Core Diversifier Index are hypothetical and are not based on actual client returns. Prior to 6/16/2013, the index is backtested. Live dollars were first invested in the strategy tracking the index on 8/26/2013. Risk Managed Core Diversifier Composite performance represents live dollars invested in the strategy net of fees. Performance results assume reinvestment of distributions.

_____________________________________________________________________ May 27, 2014 THE BATTLE FOR MARKET LEADERSHIP After a volatile start to 2014, U.S. equity market leadership has been challenged. As a result, new market leaders have begun to emerge and the Risk Managed Core Diversifier (RMCD) strategy has been a beneficiary.  To illustrate the new leadership, Chart 1 examines RMCD’s holdings since the divergence began on March 4th, 2014. Contributing to U.S. equity volatility and the change in market leadership has been the quality of earnings reported in the first quarter as well as forward looking guidance for the rest of the year.  On the backend of earnings season, it can be helpful to look at market fundamentals to gain perspective on which group may have the advantage as the battle for market leadership continues.  Regardless of which short-term leadership group gains the upper hand, balancing the benefits of diversification with the need to be tactical may prove to be the prudent objective, given the five year run in many asset classes.                                    (Chart 1)                                  Click to enlarge RISING DIVIDENDS MATTER The easy money has been made since the market lows of March 2009. Going forward, investors may need to work harder to capture returns and should focus on dividends, valuations, and intelligent diversification. Historically, dividends have been a major contributor to long-term total returns. Chart 2 shows that companies with increasing  dividend payouts have provided greater portfolio stability as they have significantly outperformed the S&P 500, and lesser dividend paying companies since the year 2000.                                    (Chart 2)                                  Click to enlarge VALUATIONS – HAVE Q1 2014 EARNINGS BEEN ENOUGH? Market valuations can be calculated many different ways to gain perspective.  Taking a longer term view of valuations as it relates to the forward price/earnings ratio smoothes out much of the noise and takes into account analysts’ earnings expectations. Chart 3 reveals that at the 1900 level the S&P 500 is ahead of forward looking corporate earnings and therefore, return expectations should be lowered until profits materialize.                                       (Chart 3)                                    Click to enlarge The S&P 500 and the Dow Jones Industrial Average (DJIA) are near all-time high values. Given these record levels, have companies been reporting strong earnings and revenue growth for the first quarter?  Or are optimistic earnings and revenue expectations driving the rally? According to FactSet: With 490 companies in the S&P 500 reporting actual results for Q1 to date, the blended earnings growth rate (combines actual results for companies that have reported and estimated results for companies yet to report) for the S&P 500 is 2.1%, and above the estimate of -1.3% at the end of the quarter (March 31).  The blended revenue growth rate for Q1 2014 is 2.7%, which is above the estimated growth rate of 2.4% at the end of the quarter.   Corporate earnings in the DJIA have not been any better.  In fact, with 24 of the 30 companies reported,  the blended earnings growth rate stands at -3.3%. If this is the final earnings growth rate for the quarter, it will mark the third year-over-year decline in earnings in the past four quarters for the DJIA.  The blended revenue growth rate stands at 0.4%.  If that number is the final growth rate for the quarter, it will mark the seventh straight quarter that revenue growth for the DJIA will finish under 1%.   The answer to the first question is NO.  With Q1 earnings season almost complete, it does not appear that the results are fueling the rally.     Chart 4, illustrates that analysts do expect a significant improvement in earnings growth in the near future for the DJIA.  Over the next four quarters (Q214 – Q115), the estimated earnings growth is projected to be at 5.5%.  Analysts also expect an improvement in revenue growth in the near future.  Over the next four quarters, the estimated revenue growth rate is projected to be at or above 1.8%.   The answer to the second question is YES.  The market is looking ahead at expectations for higher earnings and revenue growth in the future.    Clearly, analysts are optimistic that earnings and revenue growth will rebound for the remainder of 2014.  The markets will likely be watching for any guidance or revisions to expectations going forward to see if these projections are maintained through the rest of the earnings season, and beyond.                                       (Chart 4)                                    Click to enlarge In summary, U.S. equity markets appear to be ahead of corporate earnings and investors are counting on strong economic growth for companies to deliver strong top and bottom line results into 2015.  As a result, investor demand for managed volatility strategies has increased, as there is concern about corporate profits being backend loaded in 2014. At the portfolio level, new market leadership has emerged as investors seek other assets that offer more attractive values.  Investors appear to be focused on companies with rising dividend payouts, as well as other assets that can provide alternative sources of income. After a tremendous five year run in many asset classes capturing future returns may prove to be more difficult. Selectively adding different asset classes in a portfolio is the foundation to intelligent diversification. Balancing the benefits of intelligent diversification with the need to be tactical may prove to be the biggest differentiator as the battle for market leadership is likely to increase market volatility. RISK MANAGED CORE DIVERSIFIER (RMCD) To meet investor demand for managed volatility solutions, IronGate has partnered with industry pioneer Newfound Research to offer ETF portfolio strategies. Our Managed Volatility solutions seek to help investors participate in up markets and protect in down markets. The rules-based process diversifies around non-core assets that have historically enhanced returns, but adds a second line of defense behind diversification, as it can tactically raise 100% cash to defend against drawdown. Newfound has been powering client solutions since 2008. In the last five years, Newfound’s models have been used to drive investment decisions for billions of dollars in assets. RMCD is available as a separately managed account (SMA), and accessible to clients through their financial advisors, institutions, pensions, endowments, and family offices. For firms looking to out-source the portfolio management function, the SMA is currently available at Fidelity Investments. The RMCD index is also available for license to firms looking to in-source the portfolio management function on behalf of their direct clients.  For more information please contact IronGate at (910) 791-1437 or www.ManagedVolatility.com.

Solving The Core Conundrum?

The recent comments by Fed Chair Janet Yellen of keeping interest rates artificially low for another 2 years should have savers yellen’.  Today’s near zero interest rates are causing savers to take uncomfortable credit risk or duration risk to earn a reasonable yield on their “safe money”.

The Core Conundrum

The problem of low yields has coincided with a dramatic change in the composition of the index that is most often used to measure bond performance.  Institutional and individual fixed income investors are dealing with the market realities of yields as the flagship bond benchmark (Barclay Aggregate Bond Index) languishing around 1.9%.  The artificially low yields held down by the Fed has created a chasm between investors’ return targets and the realities of a benchmark with negative real yields.  Bridging this gap, without assuming undue credit or duration risk, requires a shift away from the traditional view of core fixed-income management in favor of a more diversified, multi-sector approach.

Unfortunately, in an environment where the benchmark index has become approximately 75% allocated to low-yielding government and agency securities, maintaining a low tracking error and pursuing total return targets have seemingly become contradictory objectives.

Barclay Agg Index – Not What It Used To Be

Over the past five years, the composition of the Barclays Agg has changed by the massive volume of Treasuries issued in response to the US financial crisis.  According to the Congressional Budget Office this trend should continue to explode.  “The US Treasury debt balance totaled $4.5 trillion in 2007.  By the end of 2012, it had skyrocketed to over $11 trillion. Yet, it is projected to go even higher – hitting $18.9 trillion by 2022.”

As Treasuries climbed from 19% of the core fixed-income universe to 35% over the last five years, the market-capitalization weighted Agg has followed suit.  Treasuries currently comprise 37% of the Agg, and combined with agency debt, total US government-related debt comprises nearly 75% of the index with a weighted-average yield of 1.6%, as of January 31, 2013.

Anchored to a benchmark heavily allocated to sectors yielding negative real rates of return has forced investors to reassess the traditional, benchmark-driven approach to core fixed-income management.

Active Asset Allocation Matters in Today’s Environment

In today’s low yield environment, investors should embrace active management across a global multi-sector fixed income portfolio to generate higher yields AND to control drawdowns.  As the Fed takes it’s foot off the gas of monetary easing, volatility in equities, bonds and interest rates should continue to increase.  Just how fast and how far interest rates move is a key question but extremely difficult to predict.

Given the level of Central Bank intervention across the globe, the US Fed is likely to intervene to help limit market disruptions.  Unfortunately, the blunt instruments of monetary easing and fiscal policy have not proven responsive enough to prevent sharp moves across the interest rate curve.

Defending Portfolios Against Drawdowns

Traditionally active asset allocation has limited the amount of cash a strategy could raise to minimize tracking error from its benchmark.  However, investors have begun to realize that a 60/40 core portfolio may not be enough to limit the amount a portfolio could lose from peek to trough (drawdown).  Especially with the growing amount of US Treasury and Agency exposure to the popular Barclays Agg Index.

Options, futures, long/short, risk parity, and other traditional alternative investments have long been used to reduce correlations of core portfolios.  But the challenge of adding these alternative strategies can come with the added cost of losing upside return capture when the return enhancing asset classes are performing.

As a result investors are plowing assets into strategies that are flexible enough to go to 100% cash, as they are looking for cost effective ways to defend their portfolio’s against drawdowns…while minimizing the added cost of limited upside capture.  Being tactical about tactical can allow investors to participate up and protect down.

Return Enhancers 

Keeping strategic (long-term) allocations to the satellite asset classes may not be the most effective way to enhance the risk adjusted returns of a portfolio.  For example, adding a strategic allocation to Emerging Market equities or even EM bonds over the last few years would have had been difficult for many investors.  However, tactical exposure to these return enhancing asset classes could have avoided much of the pain, and kept the portfolio on track to meet investor objectives.

Some satellite asset classes to consider as return enhancers to a portfolio:

• Emerging market equity
• Emerging market bonds (hedged, unhedged)
• MLPs
• Real estate
• High yield bonds
• Levered loans
• Corporate floating rate notes
• Commodities
  • Energy
  • Agriculture
  • Base metals
  • Gold

By incorporating a single risk-managed solution around the return enhancing asset classes of a core 60/40 portfolio, investors maybe a big step closer in solving the core conundrum.

Other Article / Videos related to this topic:

• Bogle: We need to fix the bond index (Morningstar)
• Yellen’s mind-the-gap goals rule says rates stay low (Bloomberg)
• Retirees, brace yourselves for rising interest rates (CNBC.com)
• The shift toward value continues (BlackRock – Russ Koesterich)
• Diversification is difficult when correlations are rising (BlackRock)

 

Liquid Alts – So much work, so little time

The proliferation of liquid alternative strategies is causing many advisors to take a ridiculous amount of time away from serving their clients.  It has been said, you’ll spend 90% of your time looking at alternatives, and it will make up just 10% of your portfolio.

According to Morningstar the number of mutual funds in the alternative category has exploded from 116 in 2004 to 429 funds as of February 2014; with $22b exploding to $144b over the same time frame. In 2013 alone net inflows into the category were an astonishing $40b.

To help wade through the maze of liquid alternatives, advisors would be better served to examine WHY they are incorporating alternatives in the first place.  Is it as a risk-mitigator?  Is it as a return enhancer? Or, is it both?  With a foundational understanding, advisors can be prepared to incorporate liquid alternatives while maintaining scalability so they can continue to serve their clients.

RISK MITIGATOR?

With near zero interest rates and the prospects of higher interest rates on the horizon, many advisors are preemptively turning to liquid alternatives to anchor the portfolio from equity volatility, and to provide some alternative sources of yield to a portfolio.  The challenge remains, since so many liquid alt strategies are single asset class or strategy specific, how do you know which will be the “hot dot” and the right one to include in your client portfolios.  The answer is you don’t…much like predicting the future return profiles of traditional asset classes its almost impossible.  So diversification can be used to smooth client returns, and to keep clients focused on reaching their goals.

Do multi-alternative strategies provide an advisor diversification benefits?  Maybe, it’s scalable, and defensible in client meetings.  But how much can an advisor really allocate to a liquid alternative portfolio, when the strategy has significantly higher costs, will likely never outperform in up markets, and will most always be a performance drag?  Wouldn’t lower cost, flexible income funds, with allocations to floaters, TIPS, and convertibles be enough in a rising rate environment?

RETURN ENHANCER?

Many clients and advisors turn to liquid alts as return enhancers.  Investors have been conditioned to invest like an institution, as many sales professionals point to the long-term out-performance of the ivy league endowments.  Unfortunately, most advisors don’t have the ivy league resources or the 100 year time horizons of those institutions.  This can leave many advisors to setting high expectations and under-delivering returns.

So many advisors try to pick the hot liquid alternative asset class, or hot manager that happens to be in the sweet spot of the market and currently outperforming albeit with the ability to hedge a portfolio when the market turns.

Here lies the time-trap.  Picking the right liquid alt strategy even some of the time, requires an extraordinary amount of time, diligence, and discipline that most advisors don’t possess.

BOTH RISK MITIGATOR & RETURN ENHANCER?

If the 30 year bond bull market wasn’t over, would there be so many assets flowing into liquid alternative strategies?  If investors hadn’t experience the “Great Recession” when even a diversified portfolio lost more than 30%, would liquid alternatives be where they are today?

Clearly, the demand for liquid alternatives is real and for good reason.  But advisors shouldn’t have to make the trade-off of risk mitigator vs. return enhancer.  If advisors step back and re-examine WHY they are allocating to liquid alts, they would be in a better position to sort through the noise.

The two common investment problems, that many advisors are trying to solve with liquid alts are:

1) Diversification can disappear when needed the most.  In 2008-09, fixed income was not enough to limit drawdowns and many traditional return-enhancers such as emerging market equities, REITs, and commodities all lost more than 60%, exacerbating large core equity market losses during the same period.

2) Non-core exposures (including liquid alts) can significantly underperform core exposures in the short to medium term (ex., 2006, 2008, 2012, & 2013).

For these reasons and more, some advisors are turning to “outcome-oriented solutions” to limit portfolio drawdowns.  These solutions seek to deliver return-enhancement AND risk mitigation while bring scale into advisor practices. These real world solutions, can put the clients’ interest first, and allow advisors to focus their time and attention on serving the client, not navigating the maze of liquid alternatives…Unfortunately, too many of today’s liquid alternative strategies limit their “outcome-oriented solution” to just being a bond fund alternative.

    The perfect storm: Why alts make sense (Investment News)   The modern financial advice industry may have never experienced a time when the case for allocating assets into alternative strategies made perfect sense.  Until now. With the equity market at an all-time high, bond yields hovering near record lows, volatility spiking and global geopolitical risks rising, diversifying into products and strategies designed to hedge risk can mean that clients can sleep soundly at night…

 

Using Momentum to Harvest Value in 2014

Since the March 2009 lows US stocks have rallied over 200%, and valuations are back up near their 20 year P/E highs…making them fairly valued at best, and certainly not cheap (chart 1).

Chart 1

When evaluating securities or broader markets it is important to look at both relative value and absolute value.  On its own, relative value can be interesting but taken together with absolute value it can be compelling, allowing investors to gain increased confidence when choosing where to allocate their dollars.  Once you have identified relative AND absolute value, its becomes a matter of extracting that value…otherwise know as, the investment strategy.  Traditionally, professional value investors buy early and wait for the market to realize that value, often having a catalyst. Unfortunately, this contrarian style does have it’s drawbacks…periods of significant underperformance.  That is why we prefer a Managed Volatility approach that incorporates momentum.

In today’s “what have you done for me lately” society a contrarian investment strategy can be very difficult for average investors to implement, which helps explain why most investors have significantly underperformed the market averages (chart 2).  To make it even more challenging for investors, a year like 2013 occurs when there is a bull market in equities, and a bear market in most everything else (chart 3).

Chart 2

Chart 3

DEVELOPED & EMERGING MARKETS – RELATIVE AND ABSOLUTE VALUE

Examining the relative valuation levels of developed market countries provides a deeper understanding of value, and shows US equities are expensive relative to their own history, and expensive relative to other developed countries (chart 4).  Disciplined investing tells us that when you get outsized returns in a single year like 2013, it is important to ratchet down your return expectations for that asset class for the next several years.  Investors should thank Mr. Market for providing several years of returns in a single year, then have an investment strategy that can rebalance their portfolios toward the areas of the market that are cheap…as it is being realized by the market (momentum).

Chart 4

Charts 5, examines the relative value in emerging markets, but it begins to tell a different story.  The recent selloff in emerging markets has brought several EM country valuations below their own historical average, but it doesn’t necessarily mean they are done falling. Using a forward looking P/E does have its limitations due to earnings volatility, and is why Noble Prizing winning economist Dr. Robert Shiller created the Shiller P/E, which is adjusted using trailing 10-year average, inflation adjusted earnings (chart 6).

Chart 5

The Shiller P/E provides an opportunity to identify absolute value. Chart 6, compares the absolute value of US, International, and Emerging Market equities.  Using it allows investors to conclude that US equity valuation does not support sustained performance; and International and Emerging Market equities are better positioned for long-term returns.

Chart 6

THERE’S ABSOLUTE VALUE IN INFLATION HEDGES

The current low inflationary environment has created significant value in assets that traditionally do well in rising rate environments (chart 7).  Asset classes such as Bank Loans, Emerging Market Bonds, and High Yield Bonds offer the best real yield opportunities.

Chart 7

The trouble for many advisors and their clients, is intelligently allocating to these asset classes before the market moves that direction, and thus the challenge of behavioral finance.  As a liquid alternative, investors should consider momentum based investment strategies, that include these non-core holdings within their investment universe, but have the flexibility to pivot to core exposures to close the performance gap, such as 2013.

FAIL TO PREPARE, PREPARE TO FAIL

May 22, 2013 could have marked the lows in long term interest rates and the end of the 30 year bull market in bonds.  We are entering a new era where interest rates are inevitably heading higher over the long term.  After a very challenging winter where extreme weather dampened economic activity, pent-up consumer demand will likely spur a second quarter rebound in economic growth.  This may push credit spreads even tighter, and as the economy gathers steam over the coarse of the next year or two.

A stronger economy and rising inflation should cause last years underperforming asset classes to do well.  Chart 8, breaks down the non-core assets and their correlation with US inflation.  Investors need to decide how to include them in their portfolios.  Given the structural risks that still face the global economy, we prefer a Managed Volatility approach that uses AVAILABLE diversification as a first line of defense to a portfolio.  Recognizes that the benefits of diversification can disappear when needed the most, and uses being tactical as a second line of defense to limit drawdowns.

Chart 8

Blending Absolute & Relative Return Objectives Into a Single Strategy

The end of the 30 year bull market in bonds has driven many advisors to incorporate alternative investments into their clients’ portfolios, to act as a “bond alternative” and to reduce portfolio volatility. This however presents many challenges for advisors and their clients.

The investment industry has been happy to respond with a flood of new mutual funds that are watered down versions of hedge funds so they can operate inside the limits of a 40 Act mutual fund structure. If an advisor is lucky, the net result for many of these products will be the desired outcome…a bond alternative.

What if the desired outcome were different? What if an outcome-oriented solution were not a bond alternative, but to blend absolute and relative return objectives into a single strategy? Could the result be different, than a bond fund in a bond bull market?

These questions were presented by IronGate Investment Management to Newfound Research over a year ago. Newfound, a pioneer in “Outcome-Oriented Solutions”, began the process by refining the questions, to solve two important investor problems:

* Problem #1: Non-core exposures can underperform core exposures significantly, in the short and medium term (2003, 2006, 2009, 2012, 2013).

* Problem #2: Diversification can disappear when needed the most. In 2008-09, emerging market equities, REITs, and commodities all lost more than 60%, exacerbating large core equity market losses during the same period.

The result was the Risk Managed Core Diversifier index, a single strategy that seeks to adapt to the current environment (bull or bear), and the risk factors that drive asset class return profiles (economic growth, inflation, & correlations).

A global multi-asset investment universe of liquid ETFs provides access to very cheap beta, without having to delve into the foggy world of derivatives, leverage, shorting, performance fees, black boxes, lock up periods, or transparency. Newfound Research was able to apply their core quantitative process to a broader set of risk assets to balance the risk/return trade-off of diversification with the need to be tactical.

To learn more, click The Risk Managed Core Diversifier Index

To learn more about “Outcome-Oriented Solutions” and blending absolute and relative return objectives visit:  www.ManagedVolatility.com

Solving the alternatives riddle

investmentnews.com

Alternative investments have never been as readily available to financial advisers as they are today. But for many, implementing the strategies in a portfolio may seem as daunting as solving a Rubik’s Cube that has been deep fried in secret sauce. In…

Smart Beta vs. Intelligent Diversification

Click here for Intelligent Diversification – Periodic Table

Smart Beta is receiving a lot of media attention and asset flow these days. But what about “Intelligent Diversification”?

If smart beta strategies are alternatives to market-cap weightings, then what do you call strategies that seek to maintain diversification benefits when correlations are rising…”Intelligent Diversification”?

As the BlackRock article below points out, diversification is difficult when correlations are rising. This is especially true for non-core exposures as advisors are sold them under the notion that they have a low correlation to core exposures.

The problem is that every asset class has changing correlations, including alternatives. In fast markets (or crisis periods) correlations often move towards one, and diversification can disappear. At IronGate we believe diversification is a good first line of defense, but it has its limits, and balance the need to be tactical by aggressively raising cash.

Now that the 30 year bond bull market has been officially pronounced dead, advisors need to be more vigilant about managing portfolio risk. Gone are the days when an advisor can simply add core fixed income to a US equity portfolio and maintain diversification (as the BlackRock article clearly points out).

As advisors add more complex alternative strategies to their clients’ portfolios, it is even more important to measure the portfolios’ effectiveness in maintaining diversification. For many advisors, it would be more effective to have a single solution to serve as a core-diversifier so they can focus on serving their clients and growing their business.

To learn more, click: http://www.ManagedVolatility.com

Diversification is Difficult When Correlations are Rising: Alternative Investments Education Center: Tools: Financial Professionals: BlackRock

www2.blackrock.com

Rob Arnott’s compelling case for GTAA in 2014 & beyond

Thank you Rob, for making such a compelling argument for GTAA (Global Tactical Asset Allocation) strategies. Research Affiliates has an interesting solution, but there are others investors should consider as a supplement and for strategy diversification.

The Risk Managed Core Diversifier (RMCD) strategy index is one alternative to Mr. Arnott’s Pimco offering. RMCD is a unique “outcome-oriented solution” that aims to solve two investment problems:

1) Non-core exposures can underperform core exposures significantly in the short and medium term (i.e. 2006, 2008, 2012, & 2013).

2) Diversification can disappear when needed the most. In 2008-2009, emerging market equities, REITs, and commodities all lost more than 60%, exacerbating large core equity market losses during the same period.

For more info, visit: http://www.ManagedVolatility.com

Rob Arnott: Q4 2013 Quarterly Update (brainshark.com)

MULTIMEDIA: The past year was an interesting one for investors: Mainstream developed-market stocks did well, while all other asset classes were shunned.  Where are the opportunities today?

Who Should Investors Believe? (Part 2)

(See Part 1) After a 30% move in US equities in 2013, and a powerful move off the March 2009 lows (Nasdaq +221%; S&P 500 +164%) investors are confused by today’s markets, the headlines, as they fear another major correction.

Long term bull markets are born after major corrections, a bottoming phase, and with a lot of uncertainty. The high levels of cash on the sidelines and the uncertainty of bonds in a rising interest rate environment can be the fuel that equities and other risk assets need to continue their march higher.

Unfortunately, behavioral finance and predictive models are prone to mistakes especially as the markets climb a wall of worry. What makes today’s environment different than 1982 (the last birth of a longterm bull market) is the level of interest rates. From 1982-2000, falling rates provided a tail wind for bond and equity investors. Additionally, portfolio managers enjoyed rising bond prices for the part of the portfolio that they counted on to diversification.

Today, with interest rates near zero, bonds no longer have a tail wind. In fact they provide a head wind, causing choppy waters, and increased volatility in bonds. Although bonds can still be a good diversifier to an equity portfolio when equity volatility strikes, investors need to look for “bond alternatives” for income AND for growth.

For more info visit, http://www.ManagedVolatility.com

Historic bull market only in ‘middle innings’: JPM (CNBC.com)                      There are many reasons the stock market could advance double-digits again in 2014 and in years to come, JPMorgan Chief U.S. Equity Strategist Tom Lee told CNBC on Wednesday, a day after the Dow Jones Industrial Average and S&P 500 Index each…

Who Should Investors Believe? (Part 1)

After a 30% move in US equities in 2013, and a powerful move off the March 2009 lows (Nasdaq +221%; S&P 500 +164%) investors are confused by today’s markets, the headlines, as they fear another major correction.

With commencement of the Fed taper the markets will need to stand on its own fundamentals. Even leading economists (Summers, Krugman) warn of being trapped by “secular stagnation”, which causes many professional and individual investors to question if the run on equities can continue…as a result many are under weight risk assets.

Emotional investing, and predictive investment models are prone to mistakes. Whether its behavioral finance or faulty forecasts the only way to capture market returns is a strategic asset allocation that exposes the investor to maximum drawdowns of the asset classes. The lesson learned from the last 13 years is that the benefits of diversification can disappear during fast markets as correlations rise and even quality assets fall.

“Smart diversification” recognizes that diversification is a good first line of defense to managing volatility, but also balances the need to be tactical as a second line of defense to a portfolio. Successfully executing a smart diversification strategy requires a reactive investment process, instead of a predictive process, as markets can remain irrational longer than investors can remain solvent.

To learn more visit, http://www.ManagedVolatility.com

US economy may be stuck in a slow lane for long run (CNBC.com)

Tim Boyle | Bloomberg | Getty Image Job seekers fill out applications at a job fair for concession employment opportunities in International terminal at O’Hare International Airport…

Why Tactical – 60/40 in a Rising Rate Environment

A very useful 1-Pager, that puts the last extended rising rate environment into perspective…and makes a compelling argument for being tactical.

Why Tactical – 60/40 in a Rising Rate Environment managedvolatility.com

The 60/40 portfolio has served investors well over the last 30 years — but how will it serve investors if interest rates begin to rise for decades on end?

Prosper in a Deleveraging World

In the video below IMF Managing Director Christine Lagarde does an excellent job of laying a framework to “reset” the global financial system. The unbalance growth of the world economy is creating simultaneous inflationary and deflationary pressures that need to be balanced to achieve a “beautiful deleveraging.” 

Six years post crisis, the efforts of the world’s central banks to reflate their individual economies has unbalanced growth, but it has at least stabilized. Now more than ever nations need to coordinate their efforts as the Fed continues to taper its monetary easing. The ripple effect of the tapering has required global financial markets to begin to stand on their own fundamentals. Unfortunately, the process of moving from unprecedented central bank intervention to sound global economic growth will take years more, and will include periods of extreme volatility across asset classes.

If world history can serve as a guide, deleveraging cycles can take decades to unwind. Prospering through the current cycle will require additional risk management techniques. Two of the most cost effective techniques are diversification and Dynamic Risk Balancing. Since the benefits of diversification can disappear when need the most, tail-risk management is also important.

To learn more, read the white paper: “Prosper in a Deleveraging World: Using Managed Volatility Strategies”

VIDEO: Lagarde Sees Complacency Risk as Growth Unbalanced  bloomberg.com

International Monetary Fund Managing Director Christine Lagarde talks about the outlook for the global economy. She speaks with Bloomberg Television’s Francine Lacqua at the World Economic Forum’s annual meeting in Davos, Switzerland. (Source: Bloomberg)

WebEx Replay (Part 2) – Managed Volatility: Under the Hood

Click here to watch the WebEx replay:

“Looking Under the hood of the Risk Managed Core Diversifier Index” 
Special Guest, Corey Hoffstein – CIO Newfound Research 

The decision engine is ‘Powered by Newfound’ 
Who is Newfound Research? 

Understanding what to own & how much to own using: 
Absolute Exposure Model 
Relative Exposure Model 

Who should attend: 
RIAs, Family Offices, CIOs, Institutions, Insurance Companies, Pensions, Endowments, Consultants, Financial Advisors 

Host: Michael Boggio / Corey Hoffstein 
Sponsor: IronGate Investment Management 
Duration: 40 minutes 

FOR MORE INFORMATION, VISIT OUR WEBSITE: http://www.ManagedVolatility.com

WebEx Replay (Part 1) – Managed Volatility: An Introduction

Click here to watch the WebEx Replay:

MANAGING VOLATILITY IN CLIENT PORTFOLIOS

* What are Managed Volatility strategies?
* Why are ETF Portfolio Strategies HOT?
* How do I “intelligently diversify” my clients?
* How can I participate up & protect down?
* Is the Risk Managed Core Diversifier right for my clients?

WHO SHOULD ATTEND:
RIAs, Advisors, Institutions, Insurance Companies, Pension Funds, Family Offices, Broker Dealers

Host: Michael Boggio – Chief Investment Strategist
Sponsor: IronGate Investment Management
Duration: 30 minutes

2014 – The Fed & Bubble Risk – Volatility Needs Guardrails

Yesterday’s (1/8/14) WSJ article regarding the Fed watching for asset bubbles should be taken as a yellow flag that company earnings will need to catch up to the 2013 multiple expansion. Coupled with the beginning of Fed tapering, the economy and equities will be required to stand more on their own fundamentals. 

Many consider May of 2013 to have been a trial ballon for the Fed to see how the markets would react to tapering. Regardless, given the bond markets reaction to the whisper of tapering we should expect rates to continue their move higher, and thus increased volatility in 2014. But the question remains, how fast will rates rise and will that benefit equities, given last years multiple expansion, and given the scheduled reduction in stimulus?

Historically, diversification has proven to be is a good first line of defense in portfolio management, during periods of heightened volatility. But recent history has also reminded us that in fast markets, correlations move toward one, and the benefits of diversification can disappear. Therefore, additional layers of risk management need to added for drawdown protection.

Different types of drawdown protection have varying costs to hedge a portfolio. In our opinion diversification and being tactical can provide the most cost effective drawdown protection available.

To learn read the white paper:  Intro to Managed Volatility Strategies: Why Now, Who Benefits, Who Doesn’t & How Do They Work?

Fed Minutes: Bubble Risks Drawing Attention – WSJ.com online.wsj.com

Minutes of the Federal Reserve’s December policy meeting showed most officials supporting a pullback in the central bank’s bond-buying program.

Be Tactical…The Market is Always Right

At the start of the new year, everyone wants to release their 2014 predictions for the “I told you so” moment at year end. If they are wrong – no one has a crystal ball; but if they’re right – then open the doors assets should flow in. Pardon my sarcasm, but the games that asset managers and the media play are often nebulous at best due to the lack of accountability.

The attached video clip mentions GMO that suggests a 20% allocation to emerging markets due to their 7 year asset class forecast. While their analysis is rooted in thoughtful research, this type of investment model is still predictive in nature, and highly dependent on the accuracy of the forecast. In full disclosure, I often read Jeremy Grantham and have great respect for him and his firm but I prefer reactive models for investing.

Reactive models are not biased by forecasts, can adapt to the flow of information more quickly, can sort through the noise of the markets and its headlines, and can help remove the emotions from investing.

Most importantly, reactive models can be useful in determining how much to invest in emerging markets. In a year like 2013 when emerging market equities underperformed US equities by 35%, setting a fixed allocation to emerging markets is difficult for both professional and individual investors, especially if the allocation is sizable.

If the goal is to build a globally diversified portfolio across asset classes, then the allocation decision to emerging market equities becomes more complex as you add more asset and sub-asset classes.

As mentioned above non-core exposures, such as emerging markets, can underperform significantly, and 2013 was a prime example. To solve for this problem we prefer investment models that can pivot, toward core-holdings, such as US equities. For this reason and more, reactive models can be more tactical in their allocation weighting to emerging markets. In other words, you don’t have to decide how much EM, let the market and the (reactive) model tell you. You just need to courage to listen.

For more information visit: http://www.ManagedVolatility.com

Video – Emerging Markets: How Much to Invest? – WSJ.com  live.wsj.com

Ben Levisohn explains how much of your portfolio should be allocated to young economies.

Solving for Sequence of Returns – Outside of Annuities

Advisors have been educated about the Sequence of Returns for years by legions of wholesalers passing through their offices, with different annuity products.

Common practice for many financial planners has been to place 30% of client assets into annuities for guaranteed growth of their income, before turning the annuity on for lifetime income.

But what about the other 70% of client portfolios?

Given near zero interest rates, and the prospects of a rising rate environment bonds do not offer the safety they did for the past 30 years. How can advisors solve for the Sequence of Returns, outside of annuities, for the majority of their clients assets?

To learn more, visit: http://www.ManagedVolatility.com
or Click the link to read the 1-Pager: Drawdowns & Withdrawals

Managed Volatility – Drawdowns & Withdrawals managedvolatility.com

Check out http://managedvolatility.com!

VIDEO: Some will recommend anything to achieve diversification

In the video below…At the Charles Schwab IMPACT 2013 Conference Dorothy Weaver’s comments sound outrageous, using alternative investments in place of bonds in a portfolio. But after reflecting on the desired outcome, and with embedded risk controls around risk assets, it makes sense.

There remain two problems with adding alternatives in place of bonds:

1) Non-core exposures (such as alternatives) can underperform core exposures significantly in the short and medium term (2003, 2006, 2009, 2012, & 2013).

2) Diversification can disappear when needed the most. In 2008-09, many alternative investments lost more than 30%, eliminating any diversification benefits.

An outcome-oriented solution that aims to solve these problems could be MUCH more useful in finding bond alternatives.

To learn more, visit: http://www.ManagedVolatility.com

IMPACT 2013: Using alternative investments in place of bonds in a portfolio investmentnews.com

Dorothy Weaver of Collins Capital on how alternatives can fill a role previously held by bonds thanks to their ability to dampen volatility, differentiate returns and provide diversification. Exclusive coverage of Charles Schwab’s IMPACT 2013…

What is outcome-oriented investing?

Investors need solutions, not benchmarks.  Our strategies focus on solving real problems like capital protection, income generation and access to diversifying factors.

The IronGate Risk Managed Core Diversifier aims to solve these problems for investors:

• Problem #1: Non-core exposures can underperform core holding significantly in the short to medium term (i.e. 2003, 2006, 2009, 2012, & 2013).
• Problem #2:  Diversification can disappear when needed the most.  In 2008-2009, emerging market equities, REITs, and commodities all lost more than 60%, exacerbating large core equity market losses during the same period.

To learn more, visit: http://www.ManagedVolatility.com