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By Andrew Gogerty | 06-14-2013 12:00 PM

When to Rebalance in a Risk-On Environment

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.

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