Many ETFs offer “liquid alternatives” of various kinds, but very few have provided meaningful returns that are uncorrelated with the stock market, which is the whole point of investing in alternatives. IQ Merger Arbitrage Index ETF (MNA) is an exception. MNA offers investors a relatively low-cost passively-managed fund that systematically harvests the merger arbitrage risk premium. The fund has had a low correlation with the S&P 500, low volatility, and an impressive return history. It was just named “Alternative ETF of the Year” at the 2019 Mutual Fund and ETF Industry Awards.
Many investors try to fill in all nine of the “style boxes:” growth, core, and value along the style axis; large, mid, and small along the size axis. Unfortunately, all nine boxes have a very high correlation to each other. Their shared U.S. stock market risk means that they will all fall together. To obtain meaningful diversification requires allocating to equity asset classes with much lower correlations to U.S. stocks, including real estate and international stocks.
Nearly all portfolios are dominated by stock risk. For example, in a 60/40 stock/bond portfolio, stocks typically account for well over 90% of the risk. Therefore, in seeking to reduce overall portfolio risk, it is much more important to diversify stock risk than bond risk. Bonds currently have a low correlation with stocks, and so do a good job of diversifying stocks, but bonds also currently have low expected return.
The presence of many individual country ETFs (exchange-traded funds) and CEFs (closed-end funds) makes country-targeted investing easy. It can also be profitable. This article will highlight several characteristics that have provided consistent risk-adjusted excess return, including value-, quality-, and sentiment-related factors.
Vanguard’s target date funds include a meaningful allocation to international bonds despite their ridiculously low (or in many cases negative!) yields. Their rationale is based on the premise that global capital markets are efficient and asset prices provide a fair return that reflects their risks. This assumption is so firmly embedded in the Vanguard DNA that they are apparently unable to adjust to the compelling evidence that many international bonds are artificially overpriced and should be avoided.
The presence of many sector and industry ETFs makes industry-targeted investing convenient and inexpensive. It can also be profitable. This article will highlight several characteristics that have provided consistent risk-adjusted excess return, including value-, momentum-, quality-, and sentiment-related factors.
The dots are coming! The Fed is scheduled to release its famous “dot plot” of forecasts of various key economic figures, including the Fed funds rate, tomorrow (Wednesday, March 20th). The reaction of the Fed funds futures market may portend the stock market’s reaction in the days ahead. In this article, we examine the interest rate changes implied by the 6-month Fed funds futures contract as a potential stock market allocation indicator.
Most of the return from a diversified portfolio is derived from stock market exposure. If an investor can increase or decrease exposure to the stock market at the right time, he or she can avoid much downside loss and gain much upside return. There is more reason to believe that asset classes are inefficiently priced relative to each other than that individual assets are mispriced within asset classes. If that is true, then tactical asset allocation, if done well, can be extremely beneficial.
Measuring risk is the first step in controlling risk. In a diversified portfolio, most risk is systematic risk, since a lot of the non-systematic risk is diversified away. Systematic risk is explained by one or more risk factors such as stock market risk or interest rate risk. My research suggests that four risk factors will capture most of the risk in most portfolios.
Real estate is a huge part of the global capital market, but most portfolios have little exposure. Many investors have an undiversified investment in residential real estate by owning a home, but REITs provide a convenient way of gaining broad exposure to many types of commercial real estate. They also help diversify a portfolio’s stock market risk.