Managing ETF Risk the Tactical Way

Using exchange traded funds as the cornerstones of tactically-driven asset allocation strategies continues to gain traction.

It is also becoming easier to build asset allocation models around ETFs. Some ETF strategists adhere to the traditional 60/40 equities and bonds split, but others, using measured approaches to risk management, increase equity exposure depending on the market environment.

“Windham Risk Regime I strategy, for example, can have as much as 80% of its assets in defensive assets (global fixed income) and as little as 20% in growth assets (global equities, global real estate and commodities) or could shift to a 20% defensive/80% growth mix. Windham focuses on measuring and identifying global risk factors before adjusting portfolio allocation that are optimal for the future risk environment,” said S&P Capital IQ in a new research note.

On the expectation of volatility continuing to remain subdued, Windham was aggressively allocated at the end of 2013 with 78% assets allocated toward growth themes, notes S&P Capital. [VIX ETNs Highlight Complacency]

One of the firm’s largest holdings is the popular Vanguard Total Stock Market ETF (NYSEArca: VTI). Prized for its deep lineup (the ETF holds nearly 3,700 stocks) and paltry fees (VTI charges just 0.05% per year), VTI is often used by advisors and investors as a S&P 500 replacement tool because of its massive number of holdings. [One-Stop Shopping With Total Stock ETFs]

VTI, which S&P Capital IQ rates overweight, has taken in $2.8 billion in new assets this year. Only seven ETFs have garnered more cash in 2014.

Windham also sees emerging markets as attractively valued compared to developed market equivalents, according to S&P Capital IQ. The strategist holds a stake in the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), the largest emerging markets ETF by assets.