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CLS: How Smart Investors Remain Disciplined, Will Low Volatility ETFs Be the X-Factor in 2016?


Week in Review
Global equity markets got off  to a rough start in the first week of 2016. The Russell 3000, a measure for the U.S. equity markets,  finished down 6.1% with U.S. large caps outpacing U.S. small caps. International markets were lower; the MSCI EAFE was down 6.1% and the MSCI Emerging Markets fell 6.8%. Regionally, the MSCI Europe was down 6.4%, the MSCI Japan slipped lower 4.6%, and the MSCI All Country Asia Pacific ex Japan  finished down 7.1%. The U.S. fixed income markets were slightly higher as the U.S. 10-year Treasury fell by 14 basis points to yield 2.13%.

Why Smart Investors Remain Disciplined When Others Panic
One of my favorite hedge fund managers, David Tepper, once said, “Those who keep their heads while others are panicking do well.” Now is no different. While markets are off  to a bumpy start for the year, it does not mean investors should panic.

Being a disciplined investor is all about staying true to your investment philosophy, leaving reactionary behavior at the door, and focusing on what matters most – managing risk. News stories such as upheaval in China, speculation about the Federal Reserve (Fed), and volatility in oil prices are all interesting tidbits and trends that capture the minds of many individuals. These stories, however, come and go over time and are just the newest iterations for how risk plays out in the markets. More importantly, market drops are a natural part of investing and tend to translate into the greatest opportunities for investors long-term (specifically buying assets on the cheap when others overreact).

With that said, how has CLS responded to this week’s market movements? As an ETF strategist that builds global, balanced, risk-budgeted ETF portfolios, we continue to do what we do best – monitor and manage our client portfolios to their risk budgets.

Within our risk-budgeting framework, we continue to emphasize our three investment themes for 2016: X-Factor, International Opportunities, and Creative Diversification. Each theme provides ways for us to take advantage of opportunities as they appear, while also staying true to our risk budgets.

  • X-Factor: We will continue to emphasize the use of factor-based ETFs to help manage risk. Factor ETFs are a type of smart beta ETFs that use a rules-based approach to provide exposure to commonly followed risk factors, such as low volatility, quality, value, size, and momentum.
  • International Opportunities: We continue to emphasize a bias to international stocks as valuations and monetary policy actions are providing support to economic growth and investing activity. Despite headwinds in pocket areas of the international markets, we believe a diversified approach can be complemented with targeted regional, country, and sector allocations abroad.
  • Creative Diversification: We continue to be tactical in our fixed-income allocation and biased towards the use of alternatives for additional diversification benefits. We believe these two approaches can help us take advantage of return dispersion in bonds and pare out some risks from other traditional asset classes.

In summary, smart investors tend to be more disciplined than most investors. They design and manage portfolios that account for a whole host of possible outcomes. More importantly, they do not panic when market volatility comes into play – on both the downside and the upside.

Will Low Volatility ETFs Be the X-Factor in 2016?
With the return of volatility to the equity markets, many investors are paying more attention to risk. As investors continue to evaluate global growth, it is likely markets will continue to display higher levels of volatility than what has been observed over the last few years.

As investors think about risk, one thing to keep in mind is not all segments of the market perform the same way. This is especially true in scenarios where investors see modest declines in a short amount of time.

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