Short-term risks and swings could hit markets and investment portfolios. If investors want to reduce the uncertainties they are facing in an aging pull market, one may turn to actively managed stock exchange traded funds that are better able to manage risks and adapt to changing conditions.
On the recent webcast, Does the Bull Market Still Have Legs?, Christopher Davis, Chairman and Portfolio Manager of Davis Advisors, warned that while observers may point to a steadily improving market environment, reality is never so accommodating as markets are unknowable and susceptible to short-term turns.
For example, with the Federal Reserve eyeing interest rate normalization ahead, the markets have not showed a good track record in predicting the changes. Since 1982, the six month average forecasted direction of short-term interest rates were incorrect 64% of the time, compared to the actual direction of interest rates.
Given the number of unknowns, Davis argued that investors should focus on the specifics and data that is readily available. For instance, what we do know is that equities are more likely to outperform debt securities, especially as the Fed eyes a tighter monetary policy and the U.S. economy continues to slowly expand.
Specifically, Davis pointed out that a rise in interest rates will result in a negative price impact in a variety of fixed-income assets. A 1% rise in interest rates could translate to about a -1.9% return in 2-year Treasury notes or a -8.9% return in benchmark 10-year Treasuries.
Davis warned that market dips are inevitable and investors often overreact during sell-offs. In the 88-year period ended 2016, the markets showed a 5% dip for every 3 months on average, a 10% decline for every 8 months and a 20% falloff every two-and-a-half years.
Davis argued that investors’ may be their worst enemies as investor behavior has been the most significant cause of expenses. Data has shown that hiring and firing managers have resulted in diminished value over the short-term since the investor would not be able to capitalize on the long-term potential of the asset manager.
Lastly, Davis believed that there is a compelling opportunity in select financial companies in the current market environment. Given their outlook on potential opportunities, Davis Advisors has focused on the financial sector as a “triple play” opportunity, pointing to attractive earnings, multiples and buybacks/dividends.
S&P 500 financial companies are currently trading at the greatest discount to the broader market, reflecting their cheap valuations. Additionally, banks and insurers are also paying out some of the lowest dividends, which leaves them more room to grow their payouts in the years ahead.
Davis mentioned a number of compelling company names given these three factors, including Goldman Sachs, J.P. Morgan Chase, Wells Fargo, American Express, Chubb, BNY Mellon and US Bank, which can be found in the actively managed Davis Select Financial ETF (NasdaqGM: DFNL).
Davis Advisors’ preference for the financial sector is also reflected in the other active Davis Select U.S. Equity ETF (NasdaqGM: DUSA), which includes 38.0% financials.
Overall, an active manager may be better positioned to adapt to a changing market environment, especially in an aging bull market where any small thing could pause the forward momentum. In a survey of advisors attending the webcast, 70% of respondents indicated that an active strategy would outperform in 2017. However, active ETFs may continue to find trouble in gaining traction among the investment community that has grown increasingly more interested in low-cost, passive funds, with 44% of respondents indicating that passive ETFs could gather the most assets in 2017, compared to 23% of advisors who think active ETFs will gain the most assets this year.
Davis Advisors’ selection process may also allow investors to gain greater potential. For instance, DFNL includes a greater tilt toward mid-sized companies that are more capable of growth, whereas the S&P Financial Index focuses on the largest financial names.
Financial advisors who are interested in learning more about opportunities in the financial sector in the current market environment can watch the webcast here on demand.