Rather than viewing ETFs that short stocks as trading vehicles, advisor using ProShares as long-term hedges to dampen volatility.
Brian Orol is throwing out his old investing playbook.
"We've got to be more opportunistic these days in looking for good investments," said the Raleigh, N.C.-based advisor. "The old adage that he who hesitates is lost has taken on even more significance these days."
It used to be that most of his client assets were put into diversified portfolios of exchange-traded funds. Those positions didn't change much, if at all. "We're at a point of convergence right now in the economy," Orol said. "A lot of significant factors are coming together at once. It's changing the entire environment for the way we think about investments."
Shifting demographics and global economic change is like "standing on a beach where the sand constantly shifts beneath your feet," he added.
The investment environment is morphing so rapidly that "you've got to change the tools you use to accomplish those same long-term goals," said Orol.
As president of Strategic Wealth Group, his research-focused investment shop uses both fundamental analysis of markets as well as considering technical factors.
Even with the rise in volatility in stocks and flux of world markets, Orol says investors need to remain disciplined. "We don't want to move our focus away from long-term planning," he said. "It's important to stick with a strategy and not let the market whipsaw you every time it changes."
To stay focused and to use the market's gyrations to his advantage, Orol says he's turning to a number of unique tools now available.
"There are a number of new ETFs available that allow us more flexibility, both in terms of gaining industry exposure as well as being able to adjust our leverage in the market," he said.
Starting last October, Orol bought shares of UltraShort QQQ ProShares (AMEX: QID). The ETF gives 2-1 short exposure to the tech-dominated NASDAQ-100 index. "It's a great hedging tool. We've kept some of it even as the market came back in March of this year," Orol said.
Unlike some, he sees QID as more of a longer-term investment than a strict trading vehicle. "We're not a market-timing shop. That's not our expertise," Orol said. "But holding an ETF that goes short can really help to minimize volatility in a diversified portfolio."
A good example is this year, he adds. "Our short positions have definitely taken a hit since March when stocks started rallying," Orol said. "But in the past week, QID did well as the NASDAQ fell sharply."
His clients' positions in QID remain slightly above breakeven since he started buying them last year, he says.
"Hedging in a diversified portfolio is almost a necessity these days," Orol said.
In general, only a small portion of his portfolios use ETFs to short the market. "We'll adjust over time the amount of hedging we do," Orol said. "But unless the landscape changes in a material fashion, we'll probably always keep some form of hedging in our strategies."
The firm owns some shares of the UltraShort S&P 500 ProShares Fund (AMEX: SDS) as well. The ETF also provides 200% shorting exposure to an index, in this case, the S&P 500.
Another hedging tool he's used in the past is the UltraShort Oil & Gas ProShares (AMEX: DUG). "We've found mixed results with this ETF," Orol said. "Oil prices change so quickly that it's very difficult to use a double-short fund like this as a good long-term hedge."
Depending on the time horizon and risk tolerance of his clients, Orol will use anywhere from 1-2% of such inverse ETFs in a portfolio.
Orol says he's slowly moving away from ETFs that rely on market-cap-weighted indexes. "It used to be that ETFs were very plain vanilla. Now, there's almost any toppings that you want and you can mix them almost any way you want," he said.
His clients are increasingly being put into ETFs using more quantitative and alternative weighting methodologies these days, Orol observes.
"If you buy an ETF of the S&P 500, you're narrowing your choices into the quantities of the same stocks within the same indexes you can build a portfolio around," Orol said. "We like the flexibility that alternative types of ETFs like those offered by WisdomTree and PowerShares provide in implementing a more tactical strategy. These types of ETFs give us more tools to tailor asset allocation models around each client's particular situation."
One he's using now is the WisdomTree High-Yielding Equity ETF (NYSE: DHS). "We use this to complement and even as a substitute for an S&P 500 market-cap-weighted index fund," Orol said. "Since it's equal-weighted, DHS has many of the same names. But they'll come in different amounts, which allows us to be more creative with building individual portfolios."
Fine-tuning Foreign Markets
He's investing at least 15% of the firm's assets in foreign markets. That can go up to 35% in more growth-oriented portfolios. "Instead of using broader international equity ETFs, we prefer to pinpoint particular places where there appears to be the most opportunity overseas," Orol said.
One of the funds he's using is EWJ. "The Japanese economy is healthier than it has been in years. And they've got major companies well-positioned to expand across the globe," Orol said. "It's a well-established economy that can grow as emerging markets in Asia and China expand."
Another ETF he likes these days is iShares MSCI Hong Kong Index (NYSE: EWH). "It's part of China, but is a very westernized country," Orol said. "So they've got the capitalistic system in place. And since they're part of China, they're really able to tap into a rapidly growing mainland economy."
The firm is avoiding direct exposure to Europe. "We're getting our exposure to Europe through U.S. companies that are doing a lot of business over there," Orol said. "We're just seeing more growth opportunities in non-European markets at this point."