Ex-Stock Strategist Preparing For Rebound In Stocks

February 09, 2009

Manager says that investors who've remained disciplined in the past 18 months deserve to get the most out of an inevitable rebound in stocks. 

 

Mark Armbruster doesn't consider himself a market timer.

Still, he's getting his high net worth and institutional investors ready for a turnaround in stock markets around the world.

"Nobody knows when the market's going to come back. But all of my clients suffered from the downturn. Now that they've remained disciplined by sticking with their long-term investment plan, they deserve to be positioned to fully take advantage of a recovery once it occurs," said the Pittsford, N.Y.-based adviser and portfolio manager.

Stock valuations are extremely low, he adds. "If you look at price-to-trailing 10-year earnings, U.S. equities are as low as they've been since 1991," said Armbruster. "When I think where we were in November, bonds weren't safe and money market funds were breaking the buck. It was a really nasty situation."

Today, domestic stock markets are selling at about the same levels, he notes. "But the fundamentals have improved. The economy certainly isn't doing well, but there's definitely a sense of stability in the stock markets that we weren't seeing just a few months ago," said Armbruster.

As a result, he's making sure investors aren't letting their long-term asset allocations to stocks slip. "We're actively rebalancing right now," said Armbruster.

'Mosaic' Approach 

His U.S. stock allocation plans are targeting the Wilshire 5000 index, which takes a total stock market approach. "Then we layer on exposure to different markets," said Armbruster. "We do that using a mix of exchange-traded funds and mutual funds from Vanguard and Dimensional Fund Advisors. It's a sort of mosaic approach that's not strictly ETFs or mutual funds, but a combination of the two."

He starts with adding a small-cap stock bias and a value-style slant to overall portfolios. For those funds he prefers the iShares S&P SmallCap 600 Index (NYSE: IJR) and the DFA U.S. Micro Cap Fund (DFSCX). "There's not a lot of overlap between the two," he said. "IJR has bigger small-cap stocks than the micro cap fund. So I'm trying to cover the entire market, but push a portfolio's return profile down the market-cap spectrum."

But he's also a big believer in tilting toward value-styled stocks. "Historically, the value premium has been about three times bigger than the size premium," said Armbruster. "That means if you put 10% of your portfolio into small-cap stocks and 10% into value stocks, the expected return from the value fund would be three times greater over time."

He doesn't mix and match along those lines, however. "I don't use small-cap funds to gain a big value advantage," said Armbruster. "Our client portfolios only use large-cap value to overweight exposure to value-styled stocks."

While IJR and DFSCX do hold some small-cap value names, they also own growth stocks. "They're more core holdings in the small-cap part of the market," said Armbruster.

To keep expenses down, he prefers to slant overall style exposure to DFA U.S. Large Cap Value Fund (DFLVX). "That's the reason why we like to use large-cap value funds instead of smaller-cap funds to overweight our portfolios towards value," said Armbruster.

For blended large-cap-styled domestic stocks, he prefers to use SPDRs (NYSE: SPY). And for mid-cap exposure, he'll add some of the iShares S&P MidCap 400 Index (NYSE: IJH).

 

"I like to do my own number crunching and analysis," said Armbruster. "As a result, I like to use small-, mid- and large-cap funds to create my own profile to stock markets."

The former strategist at Smith Barney's equities research group became an independent portfolio adviser nearly a decade ago. "I enjoy doing research and my dad and uncle were advisers and investment managers," said the 36-year-old Armbruster. "So it's something I've grown up with. I enjoy studying all of the latest research and academic journals."

But he doesn't just focus on U.S. stock funds. "Internationally, we try to cover the whole market as we do in the U.S.," said Armbruster. "We take a total market approach using three core funds."

For developed large-cap non-U.S. markets, he uses the iShares MSCI EAFE Index (NYSE: EFA). Then, he'll typically add two DFA funds for small-cap international and emerging markets exposure.

Armbruster also breaks out real estate investment trusts as a separate asset class. On the domestic side, he uses the Vanguard REIT Index ETF (NYSE: VNQ) or the SPDR DJ Wilshire REIT ETF (NYSE: RWR). For foreign REIT exposure, Armbruster likes the SPDR DJ Wilshire International Real Estate ETF (NYSE: RWX).

"Over long periods of time, the expected return on REITs is about the same as the stock market. And the standard deviation, which is a measure of volatility, has been about the same as large-cap stocks. But the correlation of returns has been fairly low," said Armbruster.

REITs Need Patience? 

He added: "Is this the right time to be invested in REITs? Probably not. But the long-term diversification benefits of adding REITs to a portfolio is tremendous. So I'm willing to be patient with this asset class—and, oh yes, they're yielding around 8% right now."

For core accounts, he hasn't gotten involved with currencies or commodities yet, says Armbruster. "From a theoretical standpoint, it makes a lot of sense. You can get higher risk-adjusted returns for your portfolio using ETFs that provide exposure to those different asset classes," he said.

But he finds that most investors don't have an appetite for "what they perceive as overly risky asset classes," added Armbruster.

With some clients, however, he does pitch the PowerShares DB G10 Currency Harvest (NYSE: DBV) and the exchange-traded note iPath Dow Jones-AIG Commodity Index (NYSE: DJP).

On the bonds side, Armbruster is slowing diversifying from the Vanguard Total Bond Market Index Fund (VBTLX) and the Vanguard Inflation-Protected Securities Fund (VAIPX). He's also adding a third type of fixed income through the Vanguard Intermediate-Term Investment-Grade Bond Fund (VFIDX).

"Treasuries are a significant component of the Total Bond Market Fund. But we can get significantly greater yields through corporate bond issues. And VFIDX is widely diversified, so if there are some defaults, it won't hammer this fund," said Armbruster. "And while risks might appear greater by diversifying around 10-15% of our bond allocations into corporates from VBTLX, it actually should lower the overall portfolio's risk profile."

 

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