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 Mike Venuto, co-founder and chief investment officer of New York-based Toroso Investments.
November 2016 was a confusing month for most investors. The U.S. equity markets experienced a high-beta rally, which culminated in returns for the S&P 500 of more than 3.5%.
That said, most investors endured very different returns due to intelligent diversification. The table below shows the returns for diversified asset classes in November 2016:
|Asset Class ETFs||Nov 2016|
|iShares MSCI EAFE||-1.99|
|iShares MSCI Emerging Markets||-4.67|
|iShares Core US Aggregate Bond||-2.38|
|iShares 20+ Year Treasury Bond||-7.70|
|VanEck Vectors AMT-Free Interm Muni ETF||-4.97|
|SPDR Gold Shares||-7.41|
|S&P 500 TR USD||3.70|
Clearly this is an anomaly and will correct over time. Diversification in the long run is usually the right approach, but short-term market reactions can catch even the most astute investor off-guard.
Perhaps the most shocking surprise to most investors came from the losses in fixed-income ETFs. Due to lack of yield, most investors have used fixed income to mitigate volatility, and in the month of November, the exact opposite happened.
So this highlights a concern I discussed in previous research: Do fixed-income ETFs really behave like bonds?
In 2015, I wrote a piece on concerns with fixed-income ETFs and the concept of income barbells.
The main concern identified in my research, in summary, is that although ETFs have democratized access to fixed income, the traditional indexes negate the two most important covenants of a bond:
- Consistent Coupon/Yield
Even worse, these products, as evidenced by the November 2016 performance, are still subject to duration risk.
Income Barbell Solution
A solution I have employed for many years is the income barbell, which can produce consistent yield and can mitigate volatility. The example in our original research was to simply combine 50% PowerShares CEF Income Composite Portfolio (PCEF) with 50% Guggenheim Enhanced Short Duration ETF (GSY) to generate a consistent yield of about 5%. Below are some examples of the recent performance of this simple model:
|Income Solutions||YTD||November||3 Years Annualized||5 Years Annualized|
|iShares Core US Aggregate Bond||2.43||-2.38||2.76||2.34|
|iShares 20+ Year Treasury Bond||1.95||-7.70||7.78||3.26|
|VanEck Vectors AMT-Free Interm Muni ETF||-1.84||-4.97||3.34||3.11|
|50/50 PCEF/GSY Barbell||6.25||-0.15||3.34||4.23|
Source: Morningstar Direct