The puck stops here: Use ETFs as a portfolio’s last line of defence
This
is the third article in a series.
Portfolio
managers can learn from hockey. Previously, we’ve discussed balanced and
aggressive attacks for neutral and positive markets, and the neutral-zone trap as
to defense defend against a potentially hostile markets. This
month, we address the “chip and chase” and the last line of defence,
goaltending.
Low-volatility chip and chase
Playing
the puck deep into the opponent’s end and quickly pursuing it involves risk.
Giving up control may award your opponent with possession. Some risk is
mitigated by the fact that it happens positioning so deep in the
opponents’ end. A low-volatility market is perfect for taking such risks. But
you need good speed and solid fore-checking.
Gordie
Howe and Bobby Hull rarely employed this approach; Jagr, Malkin, and Crosby use
it infrequently. However, the Canuck’s line of Alex Burrows and the Sedin
brothers [DASH] who don’t mind banging bodies in the corners [DASH] are
extremely effective in frustrating and wearing down opponents with their
“cycle”-type offence.
The
“cycle” approach is like identifying uncorrelated asset classes [DASH] some
will do well, while others won’t. Equities, commodities and bonds are three
good examples (see, “Equities, commodities, bonds,” this page). Someone should
always be open for a shot or a pass.
Yet
asset correlations aren’t static. The relationship between stocks, bonds and
commodities will change over time and must be watched carefully, particularly
when volatility is high or rising. Other aspects of the chip and chase are
similar to the 2-1-2 structure described in the first article of this series
(see, “ETF
tips from the rink,” advisor.ca/etf-hockey).
Last line of defence
Recent
market volatility has shown that cash or short-term fixed-income instruments
are occasionally the only safe havens. Diversification simply fails to control
risk during periods of high volatility. In a low-interest-rate environment,
this is an even more painful realization. If investing time horizons are long
[DASH] 10 years or more [DASH] trying to rebalance to a fixed mix may pay off.
For some individual investors, however, there is no guarantee asset-class
returns will approach the long-term averages that underpin their financial
plans in time to skate them back on side. Sometimes, we must rely on that last
line of defence [DASH] goaltending.
Goaltending
has evolved, as have the choices in short-term fixed-income offerings. Today,
most goalies use the “butterfly” technique. They spend lots of time on their
knees with legs splayed outwards to maximize ice-level net coverage. Glove,
blocker and stick skills deflect everything else, making superior mobility and
quickness important. Glenn Hall and Tony Esposito were early proponents. One
risk is the so-called “five hole” between the legs. Like credit or liquidity
risk for a bond fund, this is not normally a concern, but occasionally causes
gnashing of a coach’s teeth.
So
how should we deal with money-market funds in low-interest-rate environments?
Forget about them. iShares Premium Money Market ETF (CMR) has an MER of 0.27%,
compared to major banks’ money-market mutual-fund MERs of about 0.55%, a
bargain if your client has $25,000 or more to park.
However,
it is difficult to justify with annual returns of around 1.0%. Like a
vulnerable goaltender on the blocker side (the Leafs’ Jonas Gustavsson) or on
the glove side (James Reimer or Ben Scrivens), low net-of-fee returns from
money-market funds suggest looking elsewhere for protection and yield
income.
Marty
Brodeur, Tim Thomas and Dominik Hasek have successfully used hybrid goaltending
styles. Likewise, other ETF vehicles can be used effectively as money market
substitutes but with more risk. Short-term fixed-income ETFs are the obvious
first choice, but short-term laddered-fixed-income government and corporate
ETFs, and short-target-maturity ETFs, give advisors even more flexibility (see
“ETF vehicles,” this page).
In
low-volatility environments, diversification helps most. Consider equities,
commodities and bonds. When volatility increases, stronger defence may be
needed. Short-term fixed-income choices, other than money-market, are available
to enhance yield; but watch out as costs become more important considerations.
AER
Table 1
HED:
Equities, commodities, bonds
Broad-based
equities
|
Broad-based
commodities
|
Broad-based
Canadian bonds
|
iShares MSCI World (XWD)
|
iShares
Broad Commodity (CBR)
|
Vanguard
Canadian Aggregate Bond ( VAB)
|
Vanguard MSCI US Broad Market (VUS)
|
|
iShares DEX
Universe (XBB)
|
iShares S&P/TSX Capped Comp. (XIC)
|
|
BMO
Aggregate Bond (ZAG)
|
Table 2
HED: ETF vehicles
Short-term fixed income
|
Symbol
|
Mgt. Expenses
|
Vanguard
Canadian Short-Term Bond
|
VSB
|
0.15%
|
BMO
Short term Federal Bond
|
ZFS
|
0.22%
|
iShares
DEX Short-Term Bond
|
XSB
|
0.25%
|
iShares
DEX Short-Term Corporate
|
XSH
|
0.25%
|
BMO
Short Provincial Bond
|
ZPS
|
0.27%
|
BMO
Short Corporate Bond
|
ZCS
|
0.32%
|
Short-term laddered
|
Symbol
|
Mgt. Expenses
|
iShares
1-to-5 yr Laddered Government
|
CLF
|
0.17%
|
Powershares
1-to-5 yr Laddered Investment Grade Corporate
|
PSB
|
0.25%
|
iShares
1-to-5 yr Laddered Corporate
|
CBO
|
0.28%
|
Short-term target maturity
|
Symbol
|
Mgt. Expenses
|
BMO
2013 Corporate Bond Target Maturity
|
ZXA
|
0.30%
|
RBC
2013 Target Corporate Bond
|
RQA
|
0.30%
|
RBC
2014 Target Corporate Bond
|
RQB
|
0.30%
|
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