Bull Or Bear, Focus On Asset Allocations

August 19, 2014

Keep Cash At Bay

Risk, as defined within our firm, hasn’t presented a material opportunity to raise cash in our portfolios this year. Our investment models continue to identify broad asset class momentum around the globe using our dynamic, volatility-adjusted momentum philosophy.

Within U.S. equities, we continue to see broad strength across sectors, and vertically from large- to small-cap. Our models have kept our domestic and global sector strategies fully invested throughout the year. Our models are telling us that the 5-10 percent drawdowns seen in the U.S. market at certain times earlier this year are a healthy consolidation in our opinion, rather than the emergence of a new momentum trend.

A Liquid Alternative Addition

We recently added the PowerShares Multi-Strategy Alternative Portfolio (LALT) to our U.S. Equity Dynamic Long/Short strategy. This ETF tracks a Morgan Stanley multistrategy index and aims to capture nontraditional risk premia across equities, interest rates, currencies and volatility markets.

The fund allows us to incorporate previously unavailable, institutional asset-class strategies into our managed account portfolio, and complements the existing alternative long and short exposures.

This exposure, combined with a number of Quantshares ETFs that our U.S. Equity Dynamic Long/Short strategy uses delivers a diversified return stream that can complement existing core holdings using long and long/short U.S. equity exposures.

Among the QuantShares ETFs in the strategy are:

Reminder On ETF Liquidity

I’d be remiss if I didn’t stress that many of the ETFs mentioned above, particularly the QuantShares funds, have a combination of low assets and low average daily trading volume (ADV) of the actual ETF shares.

But remember that while the volume of traded ETF shares may be low, it’s the liquidity and volume of the underlying stocks that determines how closely the ETF will track its net asset value, and provide market makers the opportunity to offer tighter spreads to market participants.

More specifically, stocks in these portfolios are from the broad U.S. market where the liquidity is deep and broad. For example, the anti-beta ETF BTAL has approximately 85 percent of its assets invested in large- and midcap stocks. That type of exposure along with the creation/redemption process gave us confidence that these ETFs can support material growth in assets.

The bottom line is this: Take a holistic view of ETF liquidity by examining the underlying holdings, not simply the number of shares of the ETF that are traded every day.

A good rule of thumb is that you can normally trade up to 10 percent of the ADV of the underlying holdings of an ETF before you see market impact issues. That level is oftentimes far larger than the ADV of the ETF shares.

Newfound Research LLC is a Boston-based quantitative asset management firm focused on rules-based, outcome-oriented investment strategies. Newfound specializes in tactical asset allocation and risk management solutions. Founded in August 2008, Newfound offers a full suite of tactical ETF managed portfolios covering global equity, U.S. small-cap equity, multi-asset income, fixed-income and liquid alternative asset classes. For more information about Newfound Research LLC, call us at 617-531-9773, visit us at www.thinknewfound.com or email us at [email protected]. For a list of relevant disclosures, click here.

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