Wed, 17 Jul 2013
With lower expected equity returns for the remainder of the year but the thirst for yield still prevalent, investors should consider dollar-cost averaging in and out of positions, says Sage Advisory's Anthony Parish.
Andrew Gogerty: Hello. We're here at the annual Morningstar Investment Conference. Joining me today for an update on the current market environment and some key takeaways for market allocations is Anthony Parish, director of portfolio and research at Sage Advisory.
Anthony, thank you for joining me today.
Anthony Parish: Thank you.
Gogerty: So, Sage has a very long and successful history doing institutional fixed-income portfolios. What are the takeaways or what does that body of work help influence when you're building ETF managed portfolios for use by advisors?
Parish: Well, Sage started in the mid-1990s as an institutional fixed-income manager. We began managing ETFs in the late '90s, and that without a doubt drives our investment management process. We look at the investment markets and then take a very measured approach to allocating risk. We basically ask ourselves: "Are we being adequately compensated to take the risk?" And if not, it's not in our portfolio. If we're not sure, we err on the side of conservatism.
We sometimes refer to ourselves as positively pessimistic, and that has implications for our portfolios. It means that, when we have a roaring bull market and it's starting to get frothy, Sage will tend to reduce its risk allocations in the portfolios. That means, we may underperform at the top of a bull market, but we will also tend to be much better-positioned for when the risk appetite in the market turns.
Gogerty: Let's go into some of those allocations. Obviously, the panel that you're on here at the Morningstar Investment Conference talked a lot about the recent market volatility, and does that mean that things have changed or does it not? And you had mentioned that, ironically, over the last six months not very much has materially changed. I wonder if we could expand on that. What did you mean by "it's the same," and what are you seeing that's different even if only on the margin?
Parish: I think if we look at what's driving the capital markets, most of the things that were driving the markets at the beginning of the year are still the major drivers of the market at this point half way through the year. For instance, we have very sluggish global GDP growth. We have tame inflation. We have yield curves that are relatively flat, and credit spreads that are relatively tight by historical standards.
And of course, we also have unprecedented stimulus coming from the global central banks. All of those things were in place and continue to be in place now. At the margin, some things have changed. For instance, we've had a big runup in the stock markets globally this year, and so by definition the return potential for the second half of the year is somewhat more compressed than it was at the beginning of year.
The other thing that's changed that I think is possibly the most important change is what has gone on with the perception of central-bank activities. For instance, there is much more talk now about the Fed tapering its asset-purchase program. However, we also have the Bank of Japan having stepped in and announced massive stimulus, by order of magnitude greater for the Japanese economy than what the Fed is doing to the U.S. economy because of the relative size of the economies. So ironically, even though the markets have a perception that at the end of the year we may have less stimulus than we had at the beginning of the year, the truth is we're likely to have more.
Gogerty: Let's talk about what that means in actuality for a portfolio? Because for a lot of advisors, working with their clients isn't just a relative game, it's an outcome that they're trying to reach, a financial outcome, and Sage has built outcome solutions for advisors from pure equity portfolios all the way to multiasset income. What have been some of the changes in the first half of the year that you've made in those portfolios? We don't have to go through every one, but what have been some asset-class changes that have had driven your returns this year?
Parish: Well, in the first part of the year, certainly throughout the first quarter and into the second quarter we carried an overweighting to equities in our balanced portfolios, overweighting equities relative to fixed income. We also had some positions in commodities and in gold at the beginning of the year that we no longer have.
Somewhere in the second quarter, our risk monitors and risk models began to tilt southward, and we thought it was prudent to take a somewhat more conservative posture in our portfolios. We still believe that the risk-on environment will prevail, but we wanted to take off some of the risk that we had at the margins. So, we reduced our equity allocations to neutral. We exited our positions in commodities, and we got somewhat more conservative in the durations of our fixed-income portfolios.
Now recently, after the month of May which was incredibly volatile--I mean the core bond market just got creamed with the volatility of interest rates--that opened up some new opportunities. For instance, we believe that the market's perception that the Fed may taper its asset-purchase program caused mortgages to heavily sell-off, and we believe that created some relative value opportunities.
We also saw that high-yield corporate debt really got punished. And though we had liked high-yield corporate debt, we hadn't owned it prior to recently. We recently opened the position in high-yield corporate debt because we believe that this is a relatively benign economic environment, corporate balance sheets and fundamentals are very strong, and the global thirst for yield would continue. And all those things make for a very good case for a high yield.
Gogerty: Going in and maybe stepping more into the advisor shoe, what would be some of the advice or the key points that you would have advisors focus on because obviously a lot of advisors are still building their own portfolios, building at multiasset, using ETFs? What would be one or the two key factors, whether they are market technicals or economic data that you would be watching in the second half of this year? What would be some of the key points? We've obviously talked about Japan, and rates, and the Fed and quantitative easing. Is there anything else that would be a good point to focus on as an individual, but also in the context of a broader portfolio?
Parish: Well, at Sage, we don't rely on any one type of analysis to make our decisions. We use what we call a weighted-evidence approach. And that broadly means, we look at macroeconomic analysis, we look at fundamental analysis, we look at relative value analysis, and we look at technical analysis. And each of the categories that we're looking at will give us positive or negative scores in each of those categories. Then the highest scores tend to end up in our portfolios. I think that with the global equity markets having had a significant runup this year and fixed income having gone through a lot of volatility, relative values are a very important way to look at the world.
So, investors shouldn't be afraid to exit positions that have had significant runups. By definition, the more they run, the less attractive they become on a relative-value perspective. So, I would urge investors to set targets within their expected range, both on the upside and on the downside. And if their positions hit those targets and they have become relatively less attractive than others, don't be afraid to exit and move into other areas of the market that have underperformed over the short term, but may have better potential to outperform in the future.
Gogerty: It sounds like even with the volatility, the concept of rebalancing back to your target allocation is still valid
Gogerty: And it almost ensures that you don't get too far astray on missing that relative-value recorrection that the rebalancing enforces some discipline in the portfolio.
Parish: You're absolutely right, absolutely. Rebalancing is very important, and if investors are not sure to what extent they should be rebalancing, I always advocate dollar-cost averaging in or out of positions. That way you're able to take advantage and participate if there is some upside movement and you're not fully exposed if there is some downside.
Gogerty: Great. Thank you very much for your time at this year's conference.
Parish: Thank you.
Gogerty: This has been Andrew Gogerty with Anthony Parish from Sage Advisory. Thank you for joining us.