Kotok: Sticking With 5 Fave ETFs In 2014

January 10, 2014

Cumberland, for now, is sticking with its five ‘core’ equity ETFs in 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 features David Kotok, chairman and chief investment officer of Sarasota, Fla.-based Cumberland Advisors.

As 2014 commences, we are looking forward and also looking back by examining our ETF strategy.

Last year was a dramatic stock market year, and everyone in the market knows it. What’s perhaps less clear to some investors is the way forward, and that’s why I want to say a few words about our “core” strategy.

For the record, we remain fully invested in the U.S. stock market using the same five main ETFs from last year—each of which outperformed—yes, outperformed—the SPDR S&P 500 ETF’s (SPY | A-98) impressive 30 percent-plus rise last year.

For the record, those five ETFs are:

Before moving on, let’s look back for a moment at 2013.

Those who retreated to the sidelines are kicking themselves for missing out on stellar returns. Stock portfolios that were invested in 2013 and that maintained their positions and diversified distributions rose about 30 percent.

Investors achieved this without needing to pick single “hot” stocks and without having to concentrate risk.

At Cumberland Advisors, we only use ETFs in the management of stock portfolios worldwide.

In the U.S., we have a basic core position that selects broad-based ETFs. We add satellite positions in sectors and specific industries.

Cumberland’s Core ETFs

At the end of 2013, Cumberland’s core position comprised the five ETFs mentioned above.

Those five ETFs expose the portfolio to approximately 3,000 different stocks in a weighting system that is derived from the contents of the ETFs. In 2013, those weights changed as occasional substitutions were made in the ETF portfolios’ core section. We won’t elaborate on the details of those changes since this is a proprietary technique.

In January 2014, the five different ETFs in our ETF core portfolio ranged in weight from a high of 30 percent to a low of 10 percent. While our portfolio composition and weights varied through last year, our main objective for this core investment style is to offer a low turnover with very broad diversification.

Looking at returns of the five ETFs more closely, the PowerShares Dynamic Market Portfolio (PWC | B-60) produced a 41 percent total return in 2013, and outperformed SPY by about 9 percentage points.

The next two ETFs, the Guggenheim S&P 500 Equal Weight ETF (RSP | A-71) and the iShares Russell 2000 Growth ETF (IWO | A-84), are each larger positions, and both also outperformed SPY last year, by 3 percentage points and 11 percentage points, respectively.

Our last two positions, the Guggenheim S&P 500 Pure Value ETF (RPV | A-49) and the RevenueShares Small Cap ETF (RWJ | C-75), are assigned smaller weights in our model. Each outperformed the benchmark SPY last year—RPV by 15 percentage points and RWJ by 13 percentage points.

We start the year with these proven and promising core positions, but they may change at any time.

Looking Ahead

The point is, transition is ahead in 2014.

The new year starts out with the same low interest rates at the short end of the yield curve as we saw in January 2013. The bond market is already up in terms of longer-term interest rates. The yield curve is steepening, which suggests economic growth rates will be improving.

Not least, the Federal Reserve has finally commenced “tapering.”

The bond market seems to be ignoring the current low-inflation statistics. In a longer-run scheme, bonds are negatively impacted by inflation that erodes the real value of the bond’s payment stream.



Either the current bond market is anticipating a rise in inflation, or bond investors are shunning the bond market for the stock market and may be making a mistake in doing so.

We think that is the case with tax-free municipal bonds: They still remain cheap. We do not own intermediate Treasury notes. They are not cheap.

Back to the U.S. stock market: On the heels of 2013, 2014 is unlikely to see such stellar gains. Stocks cannot go up 30 percent per year for years and years. It simply does not happen.

Stock market history shows that after surges similar to the one in 2013, the subsequent year usually has a positive result.

We expect that to be the case in 2014, and for several reasons: The economy will continue to recover at a measured pace; inflation will continue to be subdued; interest rates in the shorter- term maturities will remain very low; and bond interest rates will not immediately spike significantly higher than present levels.

The current 30-year Treasury bond yield is about 4 percent and the 10-year is about 3 percent; high-grade muni yield remains over 4 percent, while a money market fund still pays next to zero percent.

Bonds can hold at near-present levels during 2014, but they are not yielding enough to steal the show from the stock market.

Thus the mix could lead to a positive stock market return in the high single digits for 2014.

That would put a 2014 year-end close on the S&P 500 at 1950 or so. At the moment, such a result is possible. But there are risks, and the outlook could easily deteriorate.

Politics tops the risk list.

D.C. Dysfunctionality

This year is an election year in the United States. The Republicans have a narrow majority in the House of Representatives, and the Democrats have a narrowing majority in the U.S. Senate.

As a country, we have a dysfunctional and divided government.

Both houses of Congress are in for a massive fight. Incumbents face primary threats from the extremes of their respective parties. Neither party nor chamber wants to be blamed for something going wrong. Each seeks power while being risk-averse when it comes to blame.

Despite the sharp divisions, since blame avoidance is now the word in Washington, political risk in the U.S. due to some policy impasse has apparently eased. But that also means the penalty for failure is very high.

Markets seem to be pricing in a docile political environment, one unperturbed by a government shutdown, a debt-ceiling fight or an external shock from some geopolitical event—North Korea? Iran?—or some other politically induced catastrophe.

Such an assumption of sustained calm and stability sometimes flies in the face of history.

The world is still a dangerous place. Washington, D.C., is still a dangerous city from the perspective of the rest of us Americans, who have to put up with the shenanigans of the people we elect to govern us. Risk in the political arena, I’ll repeat, remains high in 2014.

Looking back, we just had a terrific year. As of Jan. 1, 2014, we remain nearly fully invested in our U.S. ETF-managed portfolios.

But we must look forward with caution and navigate the year’s opportunities with a close eye on winds, weather and the seaworthiness of our investment strategy.

Cumberland Advisors is a registered investment advisor based in Sarasota, Fla. Founded in 1973, the firm has clients all around the U.S. and several foreign countries. It manages about $2.2 billion of fixed income and runs separately managed equity accounts built solely of ETFs. Contact Cumberland at 800-257-7013 or at www.cumber.com/.

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