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.