Breech: Inside ETF Asset Allocation

January 09, 2014

For top-down asset allocators like Cougar Global, the variety of ETFs keeps getting richer and richer.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features James Breech, president and chief executive officer of Toronto-based Cougar Global Investments.

As a global asset allocator since 1993, Cougar Global from the beginning modeled broad asset classes—EAFE, emerging markets and U.S. equities.

And, as globalization has progressed and as more exchange-traded funds have become available, we have adjusted both our asset allocation analysis and used an increasing number of ETFs to construct our portfolios.

To be clear, Cougar Global models only broad investment-grade, fully liquid asset classes whose behavior we can understand using our “Multiple Economic Scenario Analysis.”

Not that many years ago, we modeled the Russell 3000 as a broad U.S. equity asset class. We’re still dealing with a similar universe of equities, but we’ve made decisions in the years since to look at these markets with a finer-toothed comb and even switch index families.

It’s all a reflection of a deeper ETF market that allows us to do our job better, which is definitely a change for the better in the way we serve our clients.

Changes To U.S Markets

Gradually, we separated U.S. equities into the Russell Top 200 using the iShares Russell Top 200 ETF (IWL | A-100), the Russell midcap via the iShares Russell Mid-Cap ETF (IWR |A-91) and small-caps with the iShares Russell 2000 ETF (IWM | A-80).

Beginning last year, however, we did further research and analysis into index construction and methodology.

By the first quarter of 2013, our research team concluded that the S&P index construction methodology more closely fit our investment criteria—specifically that we wanted our clients to hold profitable companies.

In the first quarter of last year, we shifted to the SPDR S&P 500 ETF (SPY | A-98), the SPDR S&P 400 ETF (MDY | A-82) and the iShares Core S&P Small-Cap ETF (IJR | A-89) for inclusion in our modeling.

More specifically, beginning in March 2013, our models had a clear preference for the S&P 400; consequently, we have been heavily weighted in U.S. midcap equities—ranging from 43 to 57 percent.

Generally, our models are now heavily weighted in U.S. equities. In addition to the S&P 400 Index via—MDY, we have 5 percent in SPY in most investment mandates, and up to 25 percent in IJR, the S&P 600 that covers small-cap equities.

Slicing Up EAFE

As recently as 2007, we continued to model both international developed-market equities (EAFE) and emerging market equities (MSCI emerging markets) using the appropriate ETFs to implement our decisions; namely, the iShares MSCI EAFE ETF (EFA | A-89).

However, a few years ago, we wanted to target our exposures more narrowly, so we split EAFE into its components and started modeling Europe, Japan and the developed Pacific ex-Japan market separately.

 

Crucially, there were ETFs that permitted us to invest in Japan—the iShares MSCI Japan ETF (EWJ | B-96) or developed Pacific via the iShares MSCI Pacific ex Japan ETF (EPP | A-97) or the eurozone using the iShares MSCI EMU ETF (EZU | A-54).

During the past year, we have further targeted countries within Europe. We now model Germany and the U.K. separately—using the iShares MSCI Germany ETF (EWG | A-97) and the iShares MSCI United Kingdom ETF (EWU | B-88). We also model other country asset classes in Europe, but have not yet made an investment in any of them.

Growing Emerging Markets Granularity

Similar to our parsing the developed world outside of the U.S., within emerging markets, we have wanted in the past few years to avoid exposure to emerging Latin America and emerging Europe.

So, we separated emerging markets into the three regions for which ETFs were available.

We started modeling emerging Asia (EEMA | C-94) separately from Emerging Latin America (EEML | C-95) and Emerging Europe, Middle East and Africa (EEME | C-38) through the following funds:

  • iShares MSCI Emerging Markets Asia ETF (EEMA)
  • iShares MSCI Emerging Markets Latin America ETF (EEML)
  • iShares MSCI Emerging Markets EMEA ETF (EEME)

Additionally, we had started modeling specific countries within emerging markets during the second quarter of last year.

So, using the MSCI South Korea Capped Index and the MSCI Mexico Capped Index in our analysis, we began in the third quarter of 2013 investing in both the iShares MSCI South Korea Capped ETF (EWY | B-97) and the iShares MSCI Mexico Capped ETF (EWW | B-94).

Conclusion

The takeaway is that the increasing availability of more finely focused indexes and ETFs has enabled us at Cougar Global to deliver on our goals with increasing precision with the rollout of new more finely focused funds.

And that’s a good thing, because now we have the tools to help investors access global financial markets more completely and effectively than ever before.


Dr. James Breech founded Cougar Global Investments, a Toronto-based money management firm that uses only ETFs in its top-down global asset allocating strategies. He perfected a downside risk management system since founding Cougar in 1993. Contact Cougar Global at 800-387-3779 or [email protected]. Contact Dr. Breech at [email protected].

 

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