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 John Davi, chief executive officer and chief investment officer of Astoria Portfolio Advisors in New York City.
First, let’s address the recent FOMC announcement, which always brings a healthy amount of debate.
The Fed told us that inflation was softer while economic growth was stronger. It has more conviction in its near-term policy path, while it lowered the long-run neutral rate.
From a big-picture standpoint, the Fed still remains very accommodative, and the same goes for other central banks globally. We still have an upswing in the global earnings cycle that supports international equities whose margin of safety is higher compared to U.S. stocks. Lastly, with the Fed lowering the neutral rate, income strategies should continue to remain in vogue.
Astoria Portfolio Advisors believes the following offer an attractive risk reward: international equities, U.S. small-caps and U.S. cyclicals. And for income strategies, we believe that preferreds, senior loans, emerging market debt, munis and master limited partnerships are attractive.
Let’s walk through a few select ideas.
We remain constructive on EM equities given the weaker dollar, lower rates and cheaper valuations.
- For our emerging market equities, Astoria is using the iShares Core MSCI Emerging Markets ETF (IEMG) which includes large-, mid- and small-caps in the emerging market complex, as well as the WisdomTree India Earnings Fund (EPI). EM small-cap stocks have a lower beta and lower volatility compared to EM large-caps (see below), which makes it attractive from a portfolio construction standpoint. This is contrary to the U.S. equity marketplace, where small-caps historically have had higher betas and higher volatilities compared to large-caps.
Sources: Bloomberg, Astoria Portfolio Advisors LLC
- We are secular bulls on India, and previously highlighted why (read here).
- For our international equities, we are using the iShares MSCI ACWI ex U.S. ETF (ACWX), the Deutsche X-trackers MSCI EAFE Hedged ETF (DBEF), the WisdomTree Japan Hedged Equity Fund (DXJ) and the WisdomTree Japan Hedged Quality Dividend Growth Fund (JHDG).
International small-caps have important portfolio diversification benefits.
- How many research reports do you read on international small-caps?
- In an environment of increased global growth, muted inflation, and with an upswing in the global earnings cycle, international small-caps are attractive.
- Compared to large-caps, international small-caps: (1) have lower correlations; (2) are pure-plays on local economies around the world; (3) have varying factor (see charts below) and sector exposures; and (4) have important diversification benefits within a global equity portfolio.
- International small-caps historically have had a value bias (positive bias to book to price) but higher earnings variability.
Source: MSCI Barra. Based on MSCI Barra’s GEMLT average active factor exposures from December 1998 to June 2017
- For our international small-caps, we are using the WisdomTree Europe SmallCap Dividend Fund (DFE), the SPDR S&P Emerging Markets Small Cap ETF (EWX), the Schwab International Small-Cap Equity ETF (SCHC) and the iShares MSCI EAFE Small-Cap ETF (SCZ).
We have a smaller-cap value/cyclical bias for our U.S. equity exposures.
- While we are underweight the U.S. given our global macroeconomic framework, we own the Vanguard Total Stock Market (VTI) for our U.S. large-cap exposure.
- We own the Schwab U.S. Small-Cap ETF (SCHA), as the disconnect between small-caps and the broader market got too stretched this summer.
- We are also using the PowerShares KBW Bank Portfolio (KBWB) and the Energy Select Sector SPDR Fund (XLE) given our constructive view on U.S. cyclicals and value stocks.
We value income strategies as they help reduce our portfolio risk.
- Astoria’s Multi-Asset Risk Allocation portfolio contains an income sleeve. The total current dividend yield for our model is approximately 3.0%.
- Can there be any value in fixed income after seeing $2 trillion of inflows since 2007? It’s not easy to find value, but we would note the following:
- When factoring in the yield relative to the risk you are taking, preferreds are attractive. The iShares U.S. Preferred Stock (PFF) yields 5.67%, and its median 30-day realized volatility over the past five years is 4.5%.
- PFF fits our constructive view on U.S. large-cap banks, which make up 40% of the ETF. PFF yields 5.67%, and 33% of its bonds are rated AAA. It has a duration of 3.6.
- The iShares JP Morgan USD Emerging Markets Bond (EMB), the VanEck Vectors High Yield Municipal Index (HYD), the PowerShares Senior Loan Portfolio (BKLN), the SPDR Blackstone / GSO Senior Loan ETF (SRLN) and the Alerian MLP (AMLP) are other income components of our model.
At the time of writing, Astoria Portfolio Advisors owned positions in IEMG, EPI, ACWX, DBEF, DXJ, JHDG, DFE, EWX, SCHC, SCZ, VTI, SCHA, KBWB, XLE, PFF, EMB, HYD, BKLN, SRLN, AMLP. You can reach John Davi at [email protected]. For a list of relevant disclosures, please click here.