One of the newest ETFs on the market is built around the idea that you can have your risk assets and eat your cake too in troubled times. The Armor US Equity Index ETF (ARMR), designed by Armor Indexes and brought to market by Exchange Traded Concepts, offers access to U.S. equities through various sector ETFs. The fund of funds also tackles downside risk in a sector strategy that can find itself fully tied to Treasuries. Armor Index founder Jim Colquitt explains how this quant strategy fits the bill in turbulent times such as these.
ETF.com: ARMR tracks an index that’s built around a metric you call the “market performance indicator” or MPI. How does that compare to price momentum?
Jim Colquitt: Effectively, we’re attempting to give investors exposure to the U.S. equity market, but to do so with downside protection built into the ETF.
We do that not by looking at U.S. equity as a whole, but through the lens of the 11 major sectors—energy, financials, health care, etc. At the end of every month, we run our MPI to help us understand what sectors we’re going to be involved in for the next one month. Every month it’s a different answer.
The MPI is the secret sauce. It works out based on moving averages. It’s a systematic, quantitative-based strategy where we don’t allow for human qualitative decision-making.
In my 20 years of experience, I’ve learned that, more often than not, when it comes to investing, there are way too many decisions that are made based solely on fear or greed. And that ultimately leads to poor investment decisions.
ETF.com: This ETF is meant to offer downside protection. How is that achieved? Is part of that protection coming from the fact that you equal-weight the sector ETFs?
Colquitt: Because of the equal weights, you end up getting over-weights in sectors that are oftentimes smaller. A perfect example is February. We had no exposure in February to energy or materials. Energy was by far the worst sector of the month. So, it served us very well not to have any exposure to energy.
By being overweight—relative to the market cap S&P 500—some of these smaller, more defensive-type sectors, end up being slightly overweight to utilities, which tend to hold up better when you have fear in the market. That’s part of the process as well.
But again, going back to the methodology, we’re looking at moving averages to make our decisions. And you end up eliminating the sectors that are trending poorly. When we see something that’s starting to lose, we cut our losses and then move out of it altogether.
As I developed this product, I went back and said, “Let me look at moving averages that are based on daily prices, weekly prices, monthly prices, quarterly prices, annual prices. And then let’s look at every variety of different moving averages, from two days to multiple hundreds of days of moving averages.”
When you do that, there is an answer that turns out to be the best for having lower volatility and better long-term results.
ETF.com: The prospectus for ARMR says you can shift into Treasuries, and you don’t have limitations on how many sectors you can exclude at a time. Does that mean that in some kind of apocalyptic scenario, we could expect ARMR to be 100% allocated to Treasuries?
Colquitt: Yes. I'm glad you brought that up. As you travel through time, and we start to experience a market correction, or a bear market, or even a recession, at some point you're going to get to the end of the month, and the MPI is going to say that you should be involved in no sectors for the next one month.
When that happens—and it’s happened on a number of different occasions—the product then moves to 100% Treasuries. In that case, buy seven- to ten-year Treasuries. The idea is that we shift out of the asset class that’s falling, and we move into an asset class that provides us with safety and liquidity, and oftentimes, appreciates in value in that type of a scenario.
ETF.com: Could you have, at any point, a mix of sectors and Treasuries?
Colquitt: No. It’s all or nothing.
ETF.com: ARMR is an equity fund that can also, occasionally, be a Treasury portfolio. How do you pitch it to advisors? What’s the best implementation for this ETF?
Colquitt: We tell RIAs and financial advisors that this should be a complement to an existing U.S. equity exposure. I’d suggest that this product become, say, 20% of the overall equity exposure.
We’re giving you exposure to the U.S. equity market with built-in downside protection. You can legitimately say to your client, “Look, I know this is scary right now. But you can rest assured, knowing that we have a portion of your assets protected on the downside.”
ETF.com: Why the choice to use all Vanguard ETFs for sectors instead of the super liquid Sector SPDRs, given this fund gets in and out of these positions every month?\
Colquitt: I wanted a good mix of necessary liquidity and low price. The SPDRs are a little bit more expensive than Vanguard. Now, I will also say that the prospectus is written in such a way that we don’t have to always use Vanguard products. If we were to wake up tomorrow and SPDR moves their expense ratio down, we can use them. And we would likely do that. It’s what’s giving us the best bang for our buck with regard to liquidity and price.
Contact Cinthia Murphy at [email protected]