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08/28/14 05:08:10 PM
TECH KNOWLEDGE

A TACTICAL GROWTH & INCOME ETF STRATEGY

In light of various equity indices trading at or near record highs in July, we believe investors are increasingly searching for new investment opportunities. We think the global, tactical, asset allocation portfolio from Riverfront Investment Group, a large ETF strategist firm, offers a number of interesting ideas.

Using a proprietary Price Matters framework, Riverfront constructs its Moderate Growth & Income portfolio by setting a long-term asset allocation framework. The portfolio, which is one of five asset allocation strategies offered by Riverfront, is measured against a 50% equity/50% fixed income benchmark, with a five-to-seven year time horizon. Typically, the portfolio holds over two dozen ETFs, with a combination of core, diversified holdings as well as narrowly focused ETFs where Riverfront sees short-term opportunities. Beyond the asset allocation decisions, two additional layers form the backbone of the investment process that are based on expected returns. First, Riverfront determines whether to focus on US or international securities. Then the respective specialist teams select securities based on a bottom-up, quantitative analysis of each security to determine the best value. A separate risk management process also helps to determine which securities should be sold or trimmed based on relative performance.

Low-cost ETFs are increasingly popular with wealth managers and their clients because they allow them to create tactical, yet diversified portfolios. But at the same time, some wealth managers are turning to investment strategist firms to help manage these portfolios. S&P Capital IQ profiles some of these strategies, focusing on the approach and ETF composition. While ETF usage is common in portfolio construction, top-down and bottom-up allocations are distinct. Many of the ETFs inside the Riverfront strategy have a number of favorable traits based on our holdings-based and ETF-attribute analysis.

RiverFront's Chief Investment Officer Michael Jones spoke to S&P Capital IQ in early July to discuss this equity income strategy. He noted that low interest rates and relatively muted expected fixed income returns steered the portfolio to an above-average 65% weighting in equities. While the equity exposure is spread across U.S. and international markets, Jones considers developed international markets, specifically Europe, to be particularly undervalued.

Core holdings include Vanguard European Stock Market (VGK 59 Marketweight) and iShares MSCI EAFE Index (EFA 68 Marketweight) that have expense ratios of 0.12% and 0.34%, respectively and have $0.01 bid/ask spreads. Both ETFs provide exposure to a range of developed countries, including France, Germany and the United Kingdom. However, the international exposure for this strategy is rounded out by some currency hedged products such as db X-trackers MSCI EAFE Index (DBEF 28 Marketweight). Jones noted that the European Central Bank is taking action to stimulate the Eurozone that will be good for European stocks but adds currency risks that can be hedged.

Other country specific ETFs inside this strategy include iShares MSCI United Kingdom (EWU 21 Marketweight) and iShares MSCI Australia (EWA 27 Overweight). The latter ETF has nearly half of its assets in Financials companies with strong credit ratings according to Standard & Poor's Ratings Services.

Within the U.S., Jones said the strategy shifted recently to more dividend-focused and Real Estate ETFs to reduce the overall risk profile. The largest position is in WisdomTree Large Cap Dividend (DLN 71 Overweight) that is well-diversified across all 10 GICS sectors and holds many stocks with above-average S&P Capital IQ Quality Rankings. First Trust NASDAQ Technology Dividend (TDIV 27 Overweight) and FlexShares Quality Dividend (QDF 35 Overweight) are additional positions that provide different sector exposures than DLN.

Meanwhile Schwab US REIT (SCHH 36 Overweight), an ETF whose holdings are viewed as undervalued according to S&P Capital IQ equity analysts, has a relatively large allocation. Jones expects many REIT industries to benefit from an improving U.S. economy.

The portfolio's smaller fixed income exposure (35% of assets) is largely focused on the high-yield credit space, as Riverfront believes the broader asset class is overvalued amid expectations of increasing interest rates. Jones and his colleagues believe short-term, high-yield bonds offer the best risk-reward opportunity among fixed income alternatives. Allocations include PIMCO 0-5 Year High Yield Corporate Bond (HYS 106 Marketweight) and SPDR Short Term High Yield Bond (SJNK 31 Marketweight), each of which have relatively low duration of about three years and a large percentage BB-rated bonds. Meanwhile short-term investment grade exposure included iShares Barclays 1-3 Credit Bond (CSJ 105 Marketweight), which holds A- and BBB-rated bonds while the average duration is two years.

Recently the portfolio held over 30 exchange traded products, though Jones noted Riverfront moderated its trading activity over the last 12 months due to the reduced equity market volatility. The Moderate Growth and Income Portfolio and other asset allocation strategies from the firm can be accessed on a number of wealth management and RIA platforms or interested investors can go to https://www.riverfrontig.com/advisors/ to learn more. Reports on the ETFs listed above can be found on MarketScope Advisor.

 

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