3Q 2020 Rebalance - ETF Global Dynamic Model Portfolios

Tuesday, July 7, 2020 - The 3^rd quarter update of our ETF Global Dynamic Model Portfolios, including all 4 of the base portfolios and the 8 “tilts,” was performed yesterday after the close of trading. While a rising tide of investor sentiment seemed to lift nearly all indices back to their pre-COVID highs, our ETFG Quant model continues to favor funds with a “smaller focus” for the third quarter.

This trend can clearly be seen in our domestic allocation, where the two funds with a large cap orientation - the ALPS Sector Dividend Dogs ETF (SDOG) and Invesco S&P 500 Pure Value ETF (RPV) - were replaced by the First Trust Small Cap Core AlphaDEX Fund (FYX) and WisdomTree U.S. SmallCap Fund (EES), respectively. Both funds were strong performers, especially RPV, which handily outperformed the Russell 1000 Value Index over the past three months. So why has the model shifted its favor to smaller-cap funds now?

In fact, the trend toward small-cap funds began some time ago, partly driven by their substantially higher fundamental scores relative to their larger peers. There’s no denying that the early stages of the COVID relief rally that began in late March favored larger stocks, with Apple, Amazon and Microsoft up from 32% to 50% in the last three months, pushing the price multiples for market-cap weighted, large-cap funds to new heights. The SPDR S&P 500 ETF (SPY) now trades with a trailing P/E ratio of 23.6x, in the upper third of its historical range, while the iShares S&P SmallCap 600 ETF (IJR) with a P/E of 14.93x, is close to the bottom of its own range.

Meanwhile, our ETFG Quant Behavioral scores have risen for smaller funds, thanks to an increase in momentum along with higher values for our contrarian sentiment indicators. Smaller-cap focused funds clearly underperformed until mid-May, but they began to outperform their larger peers as investors shifted their focus to undervalued names, but not “value” ones. Value, the style, has continued to underperform core and growth funds and the Quant model has shifted away from value toward more “core” products.

The domestic allocation isn’t the only part of our strategy impacted by the Quant model’s preference for smaller-cap funds, as both international sleeves have shifted toward funds with a lower average market cap. This can be clearly seen in two funds joining the allocation this quarter, the WisdomTree Japan SmallCap Dividend Fund (DFJ) and iShares Edge MSCI Multifactor Intl ETF (INTF). Investors not familiar with INTF, or suspicious of ETFs with ambiguous terms like “multifactor” in their name, should know that its portfolio typically focuses on not just smaller names, but those with a distinct bent toward the value and quality factors.

Nor is the focus on smaller stocks the only change in the international developed sleeve, as a shift toward dollar hedged products becomes more pronounced thanks to the addition of two new funds. First is the broad iShares Currency Hedged MSCI EAFE Small-Cap ETF (HSCZ) as well as the iShares Currency Hedged MSCI Germany ETF (HEWG). That shift might represent something of a head scratcher as many are convinced that a substantial decline in the U.S. dollar is imminent thanks to the explosion in the deficit and subsequent record Treasury issuance, but our Quant model is focusing on hard numbers instead. Specifically, that multiple hedged funds like HEWG are trading at substantially lower price multiples compared to their unhedged counterparts, making them much more attractive buys.

Finally, our emerging market allocation has been buffeted by the shift toward smaller names with the addition of WisdomTree Emerging Markets SmallCap Dividend Fund (DGS) and First Trust Emerging Markets Small Cap AlphaDEX Fund (FEMS) to the line-up. Both funds have been strong performers in the last three months thanks in part to a willingness to take a different approach than the larger iShares MSCI Emerging Markets ETF (EEM.) EEM currently has over 40% of its portfolio invested in mainland Chinese names while DGS and FEMS are both heavily overweighted in Taiwan where local stocks have been strong performers thanks to the country’s ability to limit the spread of COVID-19.

To learn more about our ETFG Model Portfolio strategy, please email us at sales@etfg.com or call us at (212) 223-ETFG (3834).

You can find an overview and performance information for the ETF Global Dynamic Model Portfolios at http://www.etfg.com/about-model-portfolios

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