The Banyan Market Letter
How to Turn Volatility into New Opportunity
by MIKE BURNICK on November 9, 2011 Issue 42
Markets continue to swing wildly from one week to the next with gut-wrenching volatility.
Recent events in Greece... throughout Europe... and even right here in America... are telling us that the global economy has not yet returned to business as usual. The result, clearly displayed in financial markets is elevated levels of volatility.
Last week, I joined my colleague, Sharon Daniels, Executive Vice President of Banyan Partners, for a timely webcast: Mastering Global Asset Class Rotation, to introduce you to a new investment approach that can help you navigate today’s turbulent markets.
If you missed the webcast or just want to see it again to absorb all the details … you can access a special, on-demand replay of the webcast by going here now. Or, to read the detailed analysis, we are including an edited transcript of the full briefing in today’s issue of the Banyan Market Letter. Enjoy.
Mastering Global
Asset Class Rotation
(edited, as needed, for clarity)
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Sherri Daniels: Financial markets are on a roller-coaster ride and if recent history tells us anything — this activity may continue.
The crisis in Europe, an uncertain global economy, and partisan bickering in Washington have created a crisis of confidence among investors.
I’ve been following market trends for nearly three decades and I’ve yet to see anyone who can predict the future with certainty. What I have learned is that crisis can also breed opportunity for savvy investors.
Oftentimes the greater the uncertainty, the greater the investment opportunity can be.
To explore how you can uncover new investment opportunities, even in turbulent markets, we’re going to provide details about a unique approach to investing that offers worldwide asset class diversification AND has the potential to thrive under a wide range of market conditions by …
Giving you access to all of the major global asset classes in a single portfolio …
In this briefing, we will show you how two time-honored investing concepts — asset class diversification and momentum investing — can help you rotate your portfolio into virtually any global asset class as market trends change.
So let’s jump right in and talk about a couple of the investment concepts that have a history of delivering market-beating returns.
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Mike Burnick: Our research shows that following an approach that includes proper asset allocation AND momentum, in the right combination, delivers the potential to limit draw downs in volatile markets and outperform over time …
Sherri: In our research, we historically tested these powerful concepts of asset class diversification combined with momentum and found impressive results could have been achieved on a consistent basis.
Mike: Certainly impressive enough to give us the confidence to invest our own money in this approach — to put our research to the ultimate test.
Here’s the key point, this unique approach to asset class diversification, when combined with momentum, has the potential to deliver more stable returns with less draw downs. This is critical in today’s volatile markets.
Sherri: Why is it so important to have the right asset class diversification in your portfolio?
Mike: We all know that different asset classes (stocks, bonds, commodities, etc.) tend to perform differently depending on where we are in the economic cycle. The proof is in the illustration.
It shows which asset classes posted the best investment performance over the last few years. You can see how asset classes frequently shift order in terms of performance.
Top performing asset classes often trade places … or rotate leadership. This asset class rotation appears to be happening much faster these days, making it difficult for investors to keep up.
For example, just look at how Real Estate Investment Trusts (REITs) went from #1 in performance during 2006 to dead last in 2007. Foreign stocks claimed the top spot in 2007, but fell to dead last the very next year in 2008.1
Sherri: They went from first to worst, which is a round trip in performance that you want to avoid at all costs if possible.
Mike: And you can see the same rapid rotation happening in bonds too. Investment grade corporate bonds were the worst performing asset class in 2006, but moved to the top of the list in 2008.2
Sherri: Then this asset class fell to dead last again in 2009 and 2010.3
Mike: The lesson is this: In an age of heightened market volatility, the buy-and-hold approach clearly isn’t working well. One way to overcome this is to rotate your portfolio more frequently among the major asset classes.
But, the trick is finding a reliable, consistent way of capturing the shifts in leadership so you can potentially profit from them.
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Sherri: We’ll cover exactly how we capture these shifts in leadership, but I want to point out another key to asset class diversification. You may want to broaden your horizons to alternative and especially non-correlated asset classes as well — beyond just stocks and bonds.
In other words, you want access to a broad mix of asset classes within your portfolio that don’t always move in lock-step with one another.
Mike: In order to enjoy the benefits of true diversification, seek out asset classes that tend to show different patterns of return under different circumstances.4
Sherri: Unfortunately, it’s not until markets are under stress when investors find out the hard way that they aren’t as diversified as they thought. A simple mix of stocks and bonds may not be enough today.
Mike: To get proper diversification, you’ve got to drill down to the sectors; distinguish between international stocks and bonds as opposed to purely domestic securities; large cap stocks versus small. For bonds, differentiate between government versus corporate issues and carefully consider the maturity range.
Sherri: Plus, it’s absolutely crucial to include alternative assets like commodities — especially gold, global currencies and real estate in your asset class mix — since they can offer some of the strongest diversification benefits.5 Thankfully, it’s easier now than ever before to invest in diverse asset classes using a few carefully selected exchange traded funds (ETFs).
Mike: Understand that you don’t need to own ALL of these assets all of the time within your portfolio. Instead, the goal is to zero in on the top performing asset classes at any one time. Our historical analysis and testing reveal two critically important factors to portfolio construction:
First, you need to make sure there is enough variation in your asset mix so you can allocate capital to wherever the strongest performance is found in global markets — and focus your allocation in the top-performing ETFs.
Second, you especially need the ability to concentrate your portfolio in just a handful of asset class ETFs during difficult market conditions.6
Mike: In the graph you can see how the total return potential increases as you add asset classes (top left). Meanwhile, the volatility of returns decreases as you add asset classes (bottom left) with the four asset class portfolio having the best combination.
Sherri: In other words, a four asset class portfolio appears to have the highest risk-adjusted return.
Mike: And it’s easy to build a portfolio like this with just a handful of carefully selected ETFs.
Sherri: We’ve talked about which asset class selections offer the best diversification potential and why, now the hard question is: How do you know which asset class ETFs to own and when?
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Mike: That’s the all-important momentum element of this strategy. Momentum is simply a measure of the relative performance of one asset class compared to another. It is the tendency of every asset class — whether stocks, bonds, commodities or currencies — to show a well-defined trend in performance.
Sherri: Momentum isn’t a new concept; it’s been used as a tool for analyzing stocks for many decades. And it’s been used in other financial markets, for identifying commodity and interest rate cycles, for example, dating back centuries.
Mike: Research shows that momentum-driven strategies have a long history of delivering market-beating returns, and performs very well under a wide variety of market conditions. Our own internal research confirms this.7
For example, one study of momentum covering over eight decades of data on US stocks shows us that a portfolio grouped by the best upside momentum outperforms stocks with poor momentum by more than three-to-one in annual total return over the next 12 months.8
And momentum appears to have even greater potential when applied to global asset classes rather than individual stocks alone.9
Mike: In the graph above we see an asset class rotation strategy driven by momentum has not only outperformed buy-and-hold consistently, but the magnitude of outperformance is eye-opening — ranging from 3 percent to 6 percent per year on average.10
The overall results show a big improvement in terms of risk-adjusted returns. Why? Because you’re combining the time-honored benefit of diverse, non-correlated asset classes WITH the potential for market-beating returns delivered by momentum investing.11
Sherri: This leads us to our ETF Global Rotation Strategy. The focus of this managed portfolio is to rotate among the top-ranked global asset classes, using ETFs, based on our internal trend-following performance indicators.
Mike: We narrow down the universe of ETFs. From the thousands available, our analysts developed a select list of ETFs representing the broadly diversified global asset classes. Here’s how the strategy works:
Sherri: We put our own money behind this strategy, managing the ETF Global Rotation portfolio internally and in real-time trading conditions, since November 29, 2010 — almost one year ago. Here are the actual results …
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
The ETF Global Rotation Strategy produced a total return of 14.25 percent since inception, from November 29, 2010 through the close of the third quarter on September 30, 2011. By comparison, the S&P 500 Index lost a little over 3 percent during this same period, which has been a difficult one for global markets.
Now, let’s cover the details of our portfolio allocation responsible for this performance during the difficult markets we encountered this year to help further illustrate how ETF Global Rotation operates.
Mike: Early this year, as most global markets were trending to the upside, half of the portfolio was in equities; one-quarter was allocated to broad-based commodities and another 25 percent to international real estate as you can see in this chart.
Sherri: Broad asset class diversification in an up-trending market makes sense, but as conditions deteriorated in the spring and summer with heightened market volatility, we progressively dialed back risk exposure by moving into more defensive asset classes.
Mike: First, we added a gold ETF in May, which worked well as a safe-haven investment amid the uncertainty.
At the same time, we cut our stock market exposure in half. By July, just as stocks were about to peak and begin a steeper correction, we completely sold out of our equity ETFs and rotated into a more defensive allocation to international bonds instead. This move helped us avoid many of the affects of the gathering financial storm.
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Sherri: At this point, our global asset allocation was 25 percent bonds, 25 percent gold, plus equal parts international and US real estate ETFs.
Mike: And as the downtrend in global markets gathered steam in August, we had the ability to rotate into a still more defensive asset allocation, selling real estate and adding two more fixed income ETFs; one tracks intermediate US government bonds, the other tracks investment grade corporate bonds, which turned out to be among the top-performing asset classes during a difficult third quarter.
Sherri: So during the worst of the market’s decline, our ETF Global Rotation Strategy was 75 percent invested in fixed income and 25 percent in gold — that’s pretty good portfolio protection for a volatile market.
Mike: It’s a go-anywhere global asset allocation strategy that can thrive in a wide range of different markets.
Sherri: Above all, it’s designed to shift to defensive asset classes when market conditions take a turn for the worse, which is really the most important part of the equation for investors.
Mike: That’s the primary objective of ETF Global Rotation: To produce superior risk-adjusted returns while limiting your risk in turbulent markets.
Editor’s Note: Go Here Now to View the Webcast in its Entirety!
Editor’s Note: To learn more about the ETF Global Rotation Strategy and see for yourself if you could benefit from this unique approach, simply click here and we’ll give you immediate access to all the information you need to make an informed decision. Plus, you’ll receive a free copy of our just-published special report: Rewards of Global Asset Rotation.
The report includes all the essential information about this unique investment approach, including:
How to properly diversify among ALL of the major global asset classes using a single investment portfolio …
For a limited time we’re accepting new clients in the ETF Global Rotation Strategy with an investment minimum of $500,000. Normally, the standard management fee is 1.5 percent, but we’re making the strategy available to new clients for a special LIFETIME fee discount – this applies only to new clients accepted into the strategy by December 31!
We’ll be glad to discuss all the details with you one-on-one. Just contact us by clicking on this link, or you can speak to a Banyan investment consultant directly by calling us at: 800-422-6172 during regular business hours.
Good investing,
Mike Burnick
Director of Client Communications
Banyan Partners, LLC
1 Principal Funds as of April, 2011
2 Ibid.
3 Ibid.
4 The Rewards of Multiple Asset Class Investing, Roger C. Gibson, 2006
5 Ibid.
6 Ibid.
7 Dorsey Wright Money Management: Relative Strength and Asset Class Rotation, March 2010
8 AQR Capital Management: The Case for Momentum Investing,2009
9 Ibid.
10 Cambria Investment Management: Relative Strength Strategies for Investing, April 2010.
11 Dorsey Wright Money Management: Relative Strength and Asset Class Rotation, March 2010
Disclaimers:
Suitability & Risk:
The ETF Global Rotation Strategy is designed for an investor with an aggressive risk tolerance who is seeking long-term growth by investing in ETFs over a three to five year investment horizon. The Strategy’s potential investment in a limited number of asset classes may vary depending on market conditions and as a result returns may differ from performance of its benchmark, the S&P 500 Index, particularly over the short term. Additionally, investments that are concentrated in a specific sector may be subject to a higher degree of market risk than those in a diversified portfolio.
International investing presents certain risks not associated with investing solely in the United States. These include, for instance, risks related to fluctuations in the value of the US dollar relative to the values of other currencies, custody arrangements made for foreign securities, political risks, differences in accounting procedures, and the lesser degree of public information required of non-US companies.
ETFs investing in commodities and commodity-linked derivative instruments may be subject to greater volatility than investments in traditional securities. Overall market movement, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity can have a material, adverse affect on value.
Performance:
The Strategy’s returns are based on a composite of actual accounts. Individual client returns may vary, depending on, among other things account opening date, contributions, withdrawals and fees. Actual fees may vary depending on, among other things, applicable fee schedule and portfolio size. Not all clients in the Strategy achieved the types of results presented in this webcast. Net returns cited include actual management fees, commissions, and other similar fees charged on transactions, and reinvestment of dividends, income and capital gains.
The Strategy’s benchmark, the S&P 500 Index,is a capitalization-weighted index that is comprised of 500 large-cap US stocks that assumes the reinvestment of dividends and capital gains, and excludes management fees, transactions costs and expenses. It is not possible to invest in an index.
Past performance is not indicative of future returns and there are no guarantees that the Strategy will achieve its stated objectives. It is possible to lose money by investing in the Strategy.
Please review all Strategy materials and Banyan’s ADV Part II before investing.
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