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By Andrew Gogerty | 03-21-2013 12:00 PM

A Global View on Credit-Focused ETFs

JAForlines Global's John Forlines III discusses his firm's strategy, the correlations and emerging trends in global credit markets, and the impact of behavioral finance in ETF managed portfolios.

Andrew Gogerty: ETF managed portfolios grew 60% last year as advisors and institutions continue to be drawn to this outsourced asset-allocation model. Hi, I am Andrew Gogerty, ETF managed portfolios strategist here at Morningstar. Managed portfolios in our space that primarily use ETFs as the underlying investment vehicle grew 60% in 2012. Morningstar is now tracking $63 billion in these strategies.

Joining me today for a discussion both on this growth and global investment opportunities is, John Forlines III, chairman and chief investment officer of JAForlines Global, John, thank you for joining me today.

John Forlines III: Thanks for having me, Andrew.

Gogerty: Let's start with the growth of this space first. Obviously advisor education and comfort level is really driving the flows to these strategies, but we're also seeing renewed interest or new interest from small institutions, pensions, and endowments. What comfort level or what is changing in their mind-set that is allowing them to outsource part of their asset allocation to third-party managers, such as, yourself?

Forlines III: I think the short answer to that question is a lot of the institutions that traditionally serve them with products, such as the PIMCOs and the BlackRocks and the Morningstars of the world, have a focus on ETFs now, either they manufacturer them or they sponsor them or do research on them. And that gives comfort to the institutions to say this is a space we need to look at.

Gogerty: How about, let's go right to your strategy, your global tactical allocation strategy. It is very wide-ranging. It can go across the globe and across asset classes. What are some of the key inputs that drive the asset-allocation decisions in your strategy?

Forlines III: We're a little bit different from the traditional quantitative ETF shop, which is how the business started. We are more fundamental in the sense that we emphasize credit systems and credit allocations, as well as liquidity in the system to the assets what we look at. So, for example it's a funny saying, but we say, if you want to know what's going on the equity market, look at the credit markets, if you want to know what's going on the alternatives, look at the credit markets. And for sure with fixed income, you need to look at the credit markets. So, that's sort of how we start, with a fundamental monthly look at our data sets both contracted and proprietary and we take a view on the liquidity and credit health wherever we want to invest and whatever asset class we're going to be in.

Gogerty: Along with credit and looking at credit around the globe, correlations are something that you've talked about in the past and commented on, that they've been changing over the last year. What types of correlation changes are you seeing either within asset classes or between asset classes around the globe?

Forlines III: I think what started the correlations to break down, that is, for everything to be correlated, risk-on, risk-off, really was the crash of 2008 and then the subsequent recovery, which has been sort of manipulated by central banks and governments. Now you're starting to see some underlying strength in some places like the U.S. You are seeing concerted actions that are starting to work in places like Japan, and as a result, some of the subasset classes.

So for example, agency and Treasury bonds versus spread products--they are starting to diverge. Performances are starting to diverge. And you're also starting to see that for the first time in regions, where you've got a Japan, that's vastly outperforming almost any other equity class this year. That hadn't occurred in the last three or four years, either it was risk-on, the S&P went up and MSCI went up or nothing.

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