Pockets of Opportunity in Equities

Ben Johnson: Hi, I'm Ben Johnson, director of passive funds research for Morningstar. Today, I'm glad to be joined by Dr. James Breech. Dr. Breech is the president and CEO of Cougar Global Investments, one of the largest ETF portfolio managers, responsible for managing a number of global tactical asset-allocation strategies.

Dr. Breech, thanks for joining me.

James Breech: Thanks, Ben. Nice to be here.

Johnson: If there's one thing we know about investors, it's that they are almost always tantalized by the promise or the appearance of performance. But in the context of the ETF managed-portfolio space, it's really important to more closely scrutinize what is driving performance and how performance is being reported. What should investors and advisors be on the lookout for when they're analyzing ETF portfolio managers?

Breech: We subscribe to GIPS, Global Investment Performance Standards--we are compliant and audited. We have over a 10-year track record. So, naturally we believe that investors should realize that these are actual clients; these are actual decisions that were made and actual accounts being managed. They aren't back-tested, replicated, or hypothetical.

And I can say that pulling the trigger on decisions, it's tough making a decision when you pull all the clients out of the equity markets like in 2008. We lost a lot of clients and they didn't like it when we pulled them out of the equity markets. There are other environments where there's just too much risk, but you make those decisions. It is a quantitative process. But there's also a judgment, and you have to make those decisions.

Johnson: Where are your decisions leading you today? You're running a series of global tactical asset-allocation strategies. Where are you seeing pockets of opportunity in the markets, and where specifically are you putting money to work on behalf of your clients?

Breech: We use a one-year outlook, and we move it forward each month one year. It's based on the U.S. economy, and when we get more growth in the outlook as we do now for the month of April 2014, it's basically 100% growth looking for 96%; 4% is still black swans.

But as we've moved toward this environment, our more aggressive portfolios for the past year have been 100% equities, what we call our MAR 10 and MAR 12 strategies. Our MAR 8, just this month, has gone to 100% equities, which is our typical balance proxy for that kind of client who has a normal balance risk-return trade-off.

Then with our more conservative clients, we've just gone to 85% equities. So, we are very, very overweight equities right now in this environment; 80% of those are in the U.S. across all the mandates, mainly U.S. mid-cap. And we've favored U.S. mid-cap equities for quite a long time. We've been underweight the S&P 500 relative to most people, and we have been slightly overweight S&P small caps relative to most benchmarks.

But for global equities, right now we have Japan, South Korea, Mexico, and Europe, a broad European-equity fund, IEV. Then for the more conservative mandate, the only fixed-income asset class we have less are mortgage-backed securities, 15% as of April.

Johnson: So there are pockets of opportunity out there in the market, and it sounds like that there are number of ETFs that you're using to get access to those opportunities.

Breech: Yes. We model about 30 to 40 ETFs every month, and we're constantly researching new asset classes. For instance, we've been researching like a lot of people have frontier markets for quite a while. We switched last month from Germany and the U.K. into IEV because we wanted exposure to Ireland, we couldn't get it. That wasn't liquid enough, the underlying holdings. And we wanted some exposure to the peripheral Europe and to Scandinavia and to Switzerland, which we couldn't get.

We went to IEV, and it's done very, very well since we added it late last quarter. So we're quite happy with that. MDY has been the star performer, however. The U.S. mid-cap exposure has done quite well for the clients. Its outperformed the S&P 500, which a lot of people aren't aware of because the S&P is always in the news.

Johnson: Dr. Breech, thank you so much for joining me today. It was pleasure to have you here.

Breech: Thanks, Ben.

Johnson: For Morningstar, I'm Ben Johnson.