Active Asset Allocation Strategies Using ETFs
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Transcript of Active Asset Allocation Strategies Using ETFs
Active Asset Allocation Strategies Using ETFs
Marvin Appel, MD, PhDCEO, Appel Asset Management Corp.
Great Neck, [email protected]
Outline• Update relative strength strategies from my
2005 presentation to QWAFAFEW– Growth vs value– SPX vs EAFE—extended to include emerging
markets
• Covered call writing– Not all ETFs are created equal.
Concept of relative strength• Divide index1 by index2.
These indexes may reflect price or total return.
• Rising ratio means index1 (numerator) is stronger.
• Falling ratio means index2 (denominator) is stronger.
• Relative strength leadership does not tell you whether either or both indexes are showing profits or losses.
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index 1
index 2
time period
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Index 1 divided by index 2
Rising = index 1 strongerFalling = index 2 stronger
Index 2 peak relative strength
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index 1
index 2
ideal switch
time period
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model in index 1
model in index 2
Index 1 divided by index 2
Rising = index 1 strongerFalling = index 2 stronger
Index 2 peak relative strength
Hypothetical ideal relative strength switching model
Recognizing new trends in relative strength
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40% drop
Growth versus value model
• Select value and growth benchmarks for either large or small caps (eg: Russell 2000 value and growth indexes)
• Calculate the monthly total return indexes and find the ratio as of the last day of each month.
• Look for 10% reversals in the ratio to define new long term trends.
Trend-following strategy: large-cap value versus large-cap growth
Source: Mutual Fund Expert as of 5/31/2010
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1000
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Russell 1000 Value Index: 12%/year, 56% drawdown
Russell 1000 Growth Index: 10.2%/year, 62% drawdown
Switching strategy: 12.9%/year, 50% drawdown
Russell 1000 Indexes and switching strategy, 1979-2010
(total returns)
History of value/growth model signals for large cap (Russell 1000) Indexes
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1/31/79 7/23/84 1/13/90 7/6/95 12/26/00 6/18/06
Model in value
Model in growth
Russell 1000 Value / Growth Rising = value strongerFalling = growth stronger
Trend-following strategy: small-cap value versus small-cap growth
Source: Mutual Fund Expert as of 5/31/2010
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/07
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Russell 2000 Value Index: 13.5%/year, 55% drawdownRussell 2000 Growth Index: 8.9%/year, 63% drawdownSwitching strategy: 14.3%/year, 58% drawdown
Russell 2000 Indexes and switching strategy, 1979-2010
(total returns)
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1/31/79 7/23/84 1/13/90 7/6/95 12/26/00 6/18/06
Model in value
Model in growth
Russell 2000 Value / GrowthRising = value strongerFalling = growth stronger
History of value/growth model signals for small-cap (Russell 2000) Indexes
Foreign (developed country) versus U.S. stock model
• Use MSCI EAFE as the benchmark for foreign stocks and S&P 500 as the U.S. benchmark.
• Calculate the ratio of EAFE / S&P 500 (price-only data) on the last day of each month.
• A new trend is defined by a 15% reversal in relative strength.
MSCI U.S. versus EAFE
75.000
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Dec
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196
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01, 1
972
Feb
01, 1
974
Mar
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01, 1
982
Jul 0
1, 1
984
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01, 1
988
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02, 1
995
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02, 1
997
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02, 2
005
Jul 0
2, 2
007
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MSCI EAFE: 9.8%/year, 56% drawdownMSCI US: 9.4%/year, 51% drawdownSwitching model: 10.4%/year, 58% drawdown
Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)
History of EAFE / U.S. switch model
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Model in foreign stocksModel in U.S. stocks
Rising = foreign stocks stronger
Falling = U.S. stocks stronger
A Quarterly Asset Allocation Strategy for Foreign-Equity ETFs
FT Press 2008
Three distinct areas of the world’s stock markets
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MSCI Europe total return
MSCI Emerging Markets total return
MSCI Japan total return
1994-2001EM weak,Japan weak,Europe strong
Through 1989,Japan strong
2002-2007EM strong
Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)
Quarterly rotation among broad areas of the foreign stock market
• Evaluate MSCI gross total return, US Dollar indexes at the end of each quarter for Japan, Emerging Markets and Europe
• Whichever area was strongest in the prior quarter should be held in the current quarter.
• Can use ETF data instead:– EWJ for Japan– EEM or VWO for emerging markets– IEV for Europe
Europe / Japan / Emerging Mkts
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MSCI Europe: 8.4%/year, 54% drawdown
MSCI Japan: -1.4%/year, 61% drawdown
MSCI Emerging markets: 12.4%/year, 53% drawdownQuarterly switching model: 11.9%/year, 50% drawdown
Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)
Covered call writing• In return for a fixed payment up front, you agree to forego profits but bear
losses that may occur within a limited period of time on a stock or ETF.
• Example: I will accept 1.2% to forego all profits and bear all losses in the S&P 500 SPDR (SPY) between now and March 19, 2010 (12 trading days).
– The maximum possible gain is the 1.2% of risk capital– Losses can be as large as the amount by which the S&P 500 SPDR (SPY) can fall between now
and March 19.– But any loss will be mitigated by the 1.2% I collected. (So if the market falls 5%, my loss on
the covered call position will be 3.8%.)
• Not a “conservative” strategy• Good strategy for flat or slowly rising markets, like the second year of bull
markets.• Important to choose the right ETFs or stocks• It has been possible historically to achieve a significant risk reduction without loss
of profitability• Need to watch transaction costs
Covered call position• Buy 100 shares of
stock and sell one option on the stock.
• Gain is likely to occur, but is limited.
• Losses are relatively unlimited, but in a losing month writing a covered call always reduces losses compared to owning the shares alone.
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Profi
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ositi
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Share Price at Expiration
Profit / loss on covered call position
Profit / loss on ETF alone
Buy stock at $90Sell covered call at $2
Covered call writing: S&P 500
Sources: www.cboe.com, Investors FastTrack
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S&P 500 total return (8.9%/year)
S&P 500 Buy-Write Index (BXM, 9.4%/year)
BXM dd: -33%S&P dd: -47%
BXM dd: -40%S&P dd: -55%
Covered call writing: Dow Jones Industrial Average
Sources: www.cboe.com, Investors FastTrack
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240DJIA total return (4.2%/year)
DJIA Buy-Write (BXD, 4.8%/year)
DJIA dd: -52%BXD dd: -36%
DJIA dd: -35%BXD dd: -30%
Covered call writing: NDX
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NDX total return (10.3%/year)
NDX buy-write (BXN, 7.5%/year)
NDX dd: -83%BXN dd: -57%
NDX dd: -54%BXN dd: -45%
Sources: www.cboe.com, Investors FastTrack
Covered call writing: Russell 2000
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190 Russell 2000 total return (4.4%/year)
Russell 2000 Buy-Write (BXR, 3.3%/year)
Ru2000 dd: -59%BXR dd: -51%
Ru2000 dd: -37%BXR dd: -29%
Sources: www.cboe.com, Investors FastTrack
Shorter-term ETF relative strength rankings and trading strategies are reported in my newsletter, Systems and Forecasts (www.systemsandforecasts.com)