Wednesday, October 14, 2020

4Q 2020 Rebalance – ETF Global® Dynamic Model Portfolios

Wednesday, October 14, 2020With less than 30 days until one of the most pivotal presidential elections in a generation, confusion would seem to be the reigning power in our country. It is no wonder that equities have started to drift. Equities started the third quarter so strong that even the perpetually lagging Dow Jones Industrial Average was almost back to its pre-COVID highs before the September sell-off sent them reeling. Now investors are facing a sea of red in their heat maps as even the supposedly “defensive” FAANG stocks have suffered double digit losses over the past month and only interest rate sensitive utilities show any green shoots. Talk about a land of confusion.

Confusion may be king, but the start of another quarter at ETF Global means it’s time to turn to our analytically driven Quantitative Model to update our ETFG Dynamic Model Portfolios, including all 4 of the base portfolios and the 8 “tilts.”  While the recent selloff in the S&P 500 shows that larger-cap stocks are struggling for direction, our ETFG Quant model still favors small-cap funds as it has for several quarters. That might not surprise our regular readers, but the reasons why those small-cap funds score so highly in our Quant Model might not be what you think.

The ETFG Model Portfolios began overweighting mid and small-cap funds in 2019 driven by their substantially higher fundamental scores relative to their larger-peers as well as their own historical price multiples. That is encapsulated in our ETFG Fundamental score, where if we reranked the fund universe available to our model portfolio strategies, only a handful of the 25 highest scoring ETFs would be large-cap funds. Those selections would have a distinct bias towards value stocks. Strategists will of course argue valuations hardly matter in a world of permanently low interest rates, but funds like the SPDR S&P 500 ETF (SPY) are trading just below all-time high multiples, offering little room for further expansion where small-cap funds are substantially below even more recent, short-term averages.

Strong fundamental scores are only part of the reason the ETFG Quant Model favors small-cap funds, the continuing improvement in momentum along with higher values for our contrarian sentiment indicators has boosted their ETFG Behavioral scores as well!  Smaller-cap focused funds clearly underperformed over the past year, but 2020 has seen the beginnings of a shift with funds like the iShares S&P SmallCap 600 ETF (IJR) performing in line with SPY over the past three months. Price momentum is just one component, other new additions to the strategy like the iShares Russell 2000 Value ETF (IWN) find themselves included thanks to high short interest as well as an elevated put/call ratio which gives it a strong sentiment sub-score. 

Big changes are afoot within the International sleeve of our portfolio as the ETFG Quant model shifts both the average market cap and geographic location of its selections. The third quarter allocation was split between large and small-cap funds with a value focus as well as hedged and unhedged performance as the dollar weakened to levels not seen since 2018. With the dollar stabilizing, the model has shifted focus away from hedged products and towards larger names with the addition of the Invesco RAFI Strategic Developed ex-US ETF (ISDX) and Invesco S&P International Developed Low Volatility ETF (IDLV). Beyond a slight overweight to value stocks, the only other shared attribute of the two are large allocations to Japanese stocks, among the best international performers in the third quarter. Allocations to the Pacific Rim are boosted by the return of two country-specific funds offering enhanced exposure to stocks in South Korea and Singapore.

That shift towards larger value stocks in Asia also impacted our emerging market allocation with the addition of the Invesco RAFI Strategic Emerging Markets ETF (ISEM). The fund has a focus on high quality, large companies according to the Invesco website and need to have both a high size and quality score to make the portfolio. That might explain why the fund has nearly 60% of its assets in Chinese stocks, compared to 40% for the MSCI Emerging Market Index. Joining it is the WisdomTree Emerging Markets SmallCap Dividend Fund (DGS) whose focus on higher yielding Taiwanese names which seems to be the perfect counterbalance.

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

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