ETF Picks From A Tactical Manager

April 27, 2017

Sage Advisory is one of the best-known asset managers in the ETF space, commanding $12 billion in assets today. The Austin, Texas, firm, known for its tactical expertise, takes a more activelike approach to investing. Robert Williams, managing director, gives us a rundown of where the firm sees the most opportunities this year, and what they’ve gotten wrong.

ETF.com: I was recently told that, in this environment, investors don't really want to hear about being tactical. Is there a negative perception about tactical investing, or are there times when tactical investing makes more sense than others?

Rob Williams: It's more about the environment, I’d say. Tactical for us means shorter time horizon, being more active, being able to take advantage of dislocations, volatility, things where big relative value opportunities emerge.

But we've just been treated to a really nice environment. We've had a pretty good bull market for years now, so it makes strategic look very good, like you don't need to put a lot of effort into this. Investors become complacent and say, “Why do I need tactical? I'll just put money in an index fund and leave it alone.”

But we've been in a nine-year cycle here, and volatility's been very low, so it might be a good time for investors to start pairing some strategic assets with some tactical approaches.

For example, we've been positioned overweight international and Europe for a while; it ran behind the U.S. in the beginning of the year. Now as some of the political clouds start to become a little clearer over there, there’s opportunity. We’re now outperforming by a good deal.

ETF.com: Do you expect this outperformance in international stocks to continue this year?

Williams: One of our core views going into the year was that you should have higher levels of international exposure. You've had U.S. outperformance, and it's been going on for a long time. Our growth came a little bit quicker. Our Fed was a little more aggressive, so things came back a bit better here, but they discounted the other markets around the world. That's changing now.

If you look at the data, this is the first time in many years we've seen a synchronized recovery in China, Europe, the U.S. and Japan. For the first time, you see earnings recovery in emerging markets and Europe, and some of the data looks better overseas.

What's been holding it back is the political risk. If some of that clears up, international markets are cheap. It's the biggest opportunity we saw going into the year—to overweight international, specifically Europe.

 

ETF.com: What’s the biggest risk in that trade?

Williams: There’s a lot of political risk, and it’s the political risk that's been discounting that market. That’s definitely been the main risk.

People realize it's been attractive for a while from a relative value standpoint, but you can't invest just based on relative value. You've got to see some recovery in fundamentals, and you're starting to get that, too.

ETF.com: What ETFs do you like for this space?

Williams: Broad with the iShares MSCI EAFE ETF (EFA), and core with the iShares Core MSCI EAFE ETF (IEFA), because it's cheaper and it's essentially the same index. We also like the eurozone iShares MSCI Eurozone ETF (EZU), which is more focused on the core eurozone excluding the U.K. That way we can carve out some of that Brexit risk.

We also like the Vanguard FTSE Emerging Markets ETF (VWO) or the iShares MSCI Emerging Markets ETF (EEM) for broad emerging markets exposure.

ETF.com: In fixed income, where are the opportunities? Do you like the iShares Core U.S. Aggregate Bond ETF (AGG)?

Williams: We're an active ETF manager, and we're also an active institutional fixed manager. We've always believed you can do better than the benchmark. Just sitting in AGG is not taking advantage of your interest rate call or how you want to be on the curve or getting excess yield.

And the duration in the AGG is as high as it's been in 20 years, so you've got extra interest rate risk and you've got about a third of the yield you've gotten about a decade ago. When rates start going up, you've got more sensitivity and less yield cushion. Of anywhere to not be indexing, it's the fixed-income markets.

Going into this year, a lot of people were saying the Fed's going to get more aggressive, that rates are going to rise sharply. Shorten duration—we were not in that camp. We think rates are still going to stay low in the first half, so let's stay close to your benchmark in duration, but out-yield it with things like credit, short-duration high yield. We did that with emerging market debt earlier in the year.

There have been big dislocations after Trump was elected. Preferred stocks, for example, gave back their full year's return in about two weeks because of that spike in interest rates. We saw that as a great relative value opportunity. We stepped in and bought preferreds back in November or December of last year. That's been good. The key has been to not bank on rates spiking higher.

 

ETF.com: Investment-grade corporates haven't done much. Is that a segment that's not offering a whole lot?

Williams: They out-yield Treasuries by a good deal. But you have to balance the overall portfolio. It's not just where you want to be, it's what kind of yield and duration you want the whole portfolio to have.

If I looked at the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), it’s up about 2.5% this year, and the AGG is up less than 2%. Part of that's because it's had a little longer duration. But if you're out-yielding and rates are range-bound, you're just kind of clipping coupon as the year goes along. That's kind of what you want to do right now. There’s a little bit of outperformance there.

ETF.com: What's investors’ biggest concern about fixed income these days?

Williams: The biggest concern for many years is obviously the rate risk. People keep assuming every year that rates are going to go up. We’ve been having this conversation since back in 2010, every year. This year, we started with that fear after Trump was elected and rates spiked, and off to the races we were.

People are always a little confused about the direction of rates and how far they're going to go. So we try to preach the importance of looking at the big picture and the big influences. You should be out-yielding right now and not worried too much about the rate risk.

ETF.com: What ETFs do you like, and what positions did you get out of this year?

Williams: We started with the international overweight. We've done some tweaks on the fixed-income side. We were a little more aggressive early in the year with emerging market debt with the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY)—we got out of that ahead of the first Fed meeting in case they were a little more hawkish on rates. We also got rid of bank loans recently because a lot of flows have gone into that. We wanted to get more yield, so we moved into regular corporates. We moved it into short high yield.

So we've made tweaks, but nothing major. We were positioned in the major parts of the market that we wanted to be going into the year, which was full allocation to EM, overweight international, overweight Europe, mostly a large and midcap bias. We’re staying away from small-caps—they’re overvalued.

The bias we've gotten wrong this year is the value bias. We thought we wanted to be in banks, in energy, in the value sectors. But rates have been even a little lower than we thought they would be. They kind of tailed down, so the value sectors haven't done as well this year.

But this has been a risky market to be defensive. For the first time, you have a synchronized global recovery.

Contact Cinthia Murphy at [email protected]

 

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