"In early 2005, we started bumping up emerging markets allocations from around 4%," said Smith. "But emerging markets got up to about 12% of world markets based on capitalization levels at the beginning of this year. The year before, it was close to 7%."
He added: "We'll be evaluating that asset class again at year-end to see if it needs more adjusting based on global capitalization rates, correlations and valuations."
Smith is also putting his clients into the Northern Global Real Estate Index Fund (NGREX). On average, client portfolios will have about 5% of its stock assets in that fund, according to Smith.
"It's just a straight index mutual fund," he added. "It came out about two years ago and was the first passively managed index fund that provided exposure to global REITs. It holds both U.S. and international real estate companies."
Finally on the equity side, Smith puts about 5% of an average client's assets into the iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG). "We like the exchange-traded notes in the commodities area," he said. "But until there's a ruling that changes the tax structure of commodities ETNs, we're sticking to the ETFs. And we also don't want to take on the credit risks with ETNs right now."
Rebalancing Rather Than Pooling
Empirical is rebalancing client assets into both stocks and commodities now. "But we're not big fans of buying into big pools of gold or metals. We don't focus on any one sector—we want exposure to a broad range of commodities," said Smith.
And the GSG's index weights commodities based on global production, he adds, "which is the most straightforward and pure weighting methodology among commodities ETFs and ETNs."
Empirical rebalances portfolios based on a banding system. If an asset class shifts anywhere from 10% to 25% off its target allocation, then Smith and his team will consider making changes. Each asset class and fund is given different bands within a portfolio, he says.
"We're not market timers. But we review valuations for every asset class. So we do make adjustments, but it's not based on macroeconomics. It's based on changing correlations and valuations of different asset classes over longer periods of time," said Smith.
For bonds, Empirical focuses on constructing portfolios that are as noncorrelated to stocks with as little risk as possible. "We keep it very simple using shorter-term durations and very high-quality funds," said Smith.
Empirical has four basic ETFs it includes in client portfolios. Those include the iShares Lehman 1-3 Year Treasury Bond Index (NYSEArca: SHY) and the iShares 3-7 Year Treasury Bond Index (NYSEArca: IEI). The other two are the iShares 1-3 Year Credit Bond Index (NYSEArca: CSJ) and the iShares TIPS Bond Index (NYSEArca: TIP).
The firm's investment policy committee has just changed allocations within fixed income because of narrowing spreads between TIPs and nominal Treasuries, says Smith.
It's now allocating about 30% into TIPs, up from 20% a month ago. Targets for the other three are: SHY (20%); IEI (15%) and CSJ (35%).
"We want the average duration of portfolios to be around five years or less. If you have a greater number of longer-termed bonds in a portfolio, correlations with stocks go up. And the longer the maturity of bonds, the greater the interest rate risks. So we find that five years or less poses the best risk-reward profile," said Smith.
-- This article was submitted by IndexUniverse.com's Murray Coleman.