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This Week’s Sizemore Insights: The Tactical ETF Portfolio; What’s Working and What’s Not

Charles Sizemore
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With just a month and a half until the end of 2014, I wanted to dig into the holdings of my Tactical ETF portfolio and review which positions are working for us…and which aren’t.

This has been a tricky year.  Going into 2014, I expected European and emerging market equities to vastly outperform U.S. equities based on their cheaper valuations and based on my belief that sentiment toward these sectors had reached an extreme level of bearishness that was likely to reverse.

Well. for a long stretch of 2014, my thesis appeared to be right.  European and emerging market indices broadly outperformed the S&P 500 from early February through late summer.  But after taking a tumble in September and October, European and emerging market equities have massively underperformed U.S. equities, and we’re now sitting on modest losses for the year.  Through November 12, the Tactical ETF portfolio had returned (0.8%) after all fees and expenses vs. a total year-to-date return of 8.9% for the S&P 500 [Note: Performance data tracked by Covestor; past performance is no guarantee of future results].

My Tactical ETF portfolio is not designed to track the S&P 500; it’s a global macro portfolio with a much broader mandate.  But I expect its returns to be competitive, so a stretch of underperformance like this is cause for reflection.  Let’s take a look at the holdings one by one.

What’s Working

I’ll start with one of my newest holdings, the ProShares UltraShort Yen ETF (YCS).  I consider shorting the yen to be the closest thing to a “risk free” trade for the remainder of this year, and we’re sitting on modest gains since I added it to the portfolio earlier this month.  This is a modest position for us, at about 7% of the portfolio.  But I expect it to be a strong performer for us over the coming months.  Short of a loss for Japanese prime minister Abe, I don’t see too many potential macro events on the horizon that would cause the trend of a falling yen to reverse.

Next up is our single largest position, the Cambria Shareholder Yield ETF (SYLD), at 16% of the portfolio. SYLD fell a little harder than the broader S&P 500 during the September and October swoon.  It’s mid-cap bias has hurt it relative to the mega-cap-weighted S&P 500.  Interestingly, SYLD has modestly outperformed since the mid-October low.

I consider SYLD a core position.  Given the general state of overvaluation among large-cap stocks–and particularly major dividend payers–I prefer to focus on smaller companies taking a more holistic view of shareholder return, and SYLD fits the bill.

Next up is our second-largest holding, the UBS ETRACS Monthly-Pay 2X Mortgage REIT ETN (MORL).  On a pure price basis, MORL has modestly outperformed the S&P 500 this year.  But adding in its massive 22% dividend, its returns have thoroughly trounced the S&P 500.

I do not consider MORL a core, long-term holding.  This is a security I intend to hold for as long as market conditions warrant.  If–and yes, I say “if” rather than “when”–the Fed starts raising short-term rates, mortgage REITs will see their interest spreads get squeezed.  But until that day, I  consider an outsized position in mortgage REITs to be entirely appropriate.  If you want to read my argument for mortgage REITs, you can read this article.  This is a leveraged position and thus one I have to consider “risky.”  But I also consider the potential rewards to be well worth any potential risk.

It’s debatable whether our position in the iShares China Large Cap ETF (FXI) is “working.”  Since the beginning of February, it has delivered returns about on par with the S&P 500.  But it’s also seen much wilder price swings.  FXI was hit by democracy protests in Hong Kong and by a general investor abandonment of emerging markets.  But I expect FXI to have a strong finish to the year.  Chinese shares are cheap, underowned by investors, and quietly enjoying a rally.

The same holds true of our position in South Africa, the iShares MSCI South Africa ETF (EZA).  Since the beginning of February, EZA has quietly outperformed the S&P 500.  But like FXI, it gave up most of those gains during the September and October selloff.  The Ebola scare was certainly a factor, but the larger issue was simply an investor aversion to emerging markets in general.

What’s Not

My more speculative positions in the Market Vectors Russia ETF(RSX) and iShares MSCI Brazil ETF (EWZ) have not performed as expected and have had a negative effect on portfolio performance.  The same is true of the Cambria Global Value ETF (GVAL), which–coincidentally–happens to have allocations to Russia and Brazil.  RSX, EWZ and GVAL make up 8.5%, 9.2% and 6.1% of the portfolio, respectively.

In both Russia and Brazil, the issues are political.  Both markets are among the cheapest in the world.  But both have sluggish economies heavily dependent on commodity prices, and Russia is getting hit by Western sanctions from the standoff in Ukraine.

In both RSX and EWZ, it appeared to me that sentiment had reached that point of maximum pessimism where things couldn’t get worse…and yet in both cases, things have indeed gotten worse.  We’re still waiting to see who Brazilian President Dilma Rousseff chooses as her next finance minister–whether she chooses someone perceived to be more market friendly than Guido Mantega or whether she plays political hardball by picking a committed leftist.  With no new news, the market appears to be pricing in the worst.  And in Russia, President Vladimir Putin appears to be escalating the conflict in Ukraine…again…thus threatening more punative sanctions.

Too Early to Say

My most recent addition was the Energy Select SPDR ETF (XLE), but it is far too early to say whether this trade is working or not.  Energy is an interesting sector at the moment.  Energy stocks were the cheapest of all S&P 500 sectors with the exception of financials before the recent sell off in crude oil and in energy stocks.  The slide in crude oil prices–which I believe is overdone–has only made them cheaper.  And in the meantime, company insiders are accumulating energy shares at the fastest rate in two years.

And finally, we get to Argentina.  My small investment in the Global X MSCI Argentina ETF (ARGT) hasn’t amounted to much.  That’s ok.  As I wrote in early October, I consider Argentina a coiled spring just waiting for president Cristina Fernandez de Kirchner to leave office.  I’m prepared to give this trade several more months to work itself out.

I’m a value investor and generally pretty patient.  I like to give my positions time to perform.  But sometimes, investment theses don’t quite work out the way you planned and you have to move on.  In the case of RSX and EWZ, my patience is wearing thin. Both of these positions are under review.  

Until next week,

Charles Sizemore

This article first appeared on Sizemore Insights as This Week’s Sizemore Insights: The Tactical ETF Portfolio; What’s Working and What’s Not

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