4 Ways To Build Better ETF Portfolios

December 16, 2014

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 is by David Garff, president of Walnut Creek, California-based Accuvest Investors.

In April 2014, I attended the Investment Management Consultants Association's annual conference in Boston and came out with a few lessons I thought I'd translate into a portfolio-building context and share with readers of ETF.com.

One of the speakers, author and researcher Dan Heath, talked about a variety of biases that hurt decision-making: narrow framing, confirmation bias, short-term emotion as well as overconfidence. He wasn't specifically talking about investment decision-making, but those biases are classics from behavioral finance.

The session was so good, that I went and bought the book he co-authored, "Decisive: How to Make Better Choices in Life and Work." I highly recommend it. The following is not meant to be a book review, but an application of the main points of the book in building better global portfolios.

The authors teach a four-step process for making better decisions. They used the mnemonic device—"WRAP"—to capture the four steps in the model. Those steps are:

  • Widen your options
  • Reality-test your assumptions
  • Attain distance before deciding
  • Prepare to be wrong

These steps resonated with me, specifically as it relates to how advisors and managers create global portfolios.

Portfolio Creation

In creating equity portfolios, advisors frame their decisions in a variety of ways. Should I buy the market? Should I buy large-caps? What about growth versus value? Should I buy sectors? Should I hire a manager or buy a mutual fund? What about buying individual stocks?

Each layer deeper the advisor goes, the more complex the analysis becomes. It's much easier to say, "I'm going to buy the S&P 500 Index and just forget about it."

Fortunately, ETFs allow advisors and money managers to own very precise segments of the market, in a low-cost, liquid and transparent way. Thus, most investors will do the necessary work in the U.S. market to tilt their portfolios toward a preferred cap size, style or sector.

Widening Options

When it comes to creating global portfolios, many advisors frame the portfolio decision in terms of allocations to U.S. versus international.

Within international, some will go as far as to add emerging markets to the allocation, but that's where the analysis generally stops. This is great example of narrow framing. A wider view might take into consideration an allocation based on geographic regions such as Europe, Latin America, Asia.

Even within Europe, analyzing the relative merits of individual countries—Germany versus France, as an example—can be fruitful. In this case, the antidote to narrow framing is to be more attuned to the nuances of international markets, and not view them as a single opportunity set.

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