Investors who are wary of potential sudden turns that could derail a bull market run could look to a tactical ETF investment strategy as a way to navigate volatile markets.
On the recent webcast (available On Demand for CE Credit), Running with the Bulls Safely in Today’s Market, Edward Lopez, Head of ETF Product Management at VanEck, highlighted growing concerns in an extended bull market as more are prepping to navigate market storms. While advisors are trying to get clients to stay the course, more are also looking for ways to protect downside than earlier in the year. Some advisors don’t know exactly what they are going to do and many advisors don’t have the resources or time for it.
Despite growing concerns over potential corrections, the overall outlook remains positive. Robert Schuster, Chief Product Officer at Ned Davis Research, pointed out that U.S. credit conditions remain relatively stable and the declining corporate tax rates over the years have contributed to strong U.S. company growth.
Nevertheless, Stephen Blumenthal, Executive Chairman and Chief Investment Officer for CMG Capital Management Group, argued that investors may be able to enhance their portfolio’s risk-adjusted returns by limiting their exposures to market drawdowns. Historically, there have been secular bull markets only 54% of the time. Equity markets spent 70% of the time in market declines and recovery periods.
“A rules-based tactical equity allocation strategy may help manage risk and could potentially limit losses from downturns,” Blumenthal said.
Managing downside risk may help investors better control for upside potential. Blumenthal contended that managing the risk of deep and extended periods of loss is critical for long-term success and peace of mind. Avoiding loss could help increase market participation by potentially reducing the amount needed to recoup. For example, if a security fell 50%, the position would have to rise 100% to recoup its previous losses and break even.
To help investors better manage downside risk, Ned Davis Research in conjunction with Capital Management Group developed the Ned Davis Research CMG US Large Cap Long/Flat Index that measures overall market health using robust industry-level data over multiple horizons. The index acts as the benchmark for the VanEck Vectors NDR CMG Long/Flat Allocation ETF (NYSEArca: LFEQ).
The indexing methodology covers the S&P 500 Index or Solactive 13-week U.S. T-bill Index, or both, depending on prevailing market conditions. The index would observe the market breadth, and direction of the S&P 500 is assessed. Equity allocation would then be determined by composite score and directional trend. Lastly, the index will rebalance to new allocation percentages intra-month if trade signals change.
Schuster explained that the model produces a market breadth composite of S&P 500 industries to analyze each industry’s price level returns; applies multiple technical indicators to each industry to measure trends, countertrends, and overall market health; and then allocations are based on both the composite’s score of market bullishness or bearishness and its directional trend.
During declining directional trends, the portfolio may include a 100%, 80%, 40% or 0% allocation to equities with the other portion allocated to T-bills, depending on the composite score. During improving directional trends, the portfolio is 100% long equities, regardless of its composite score.
“Index’s embedded risk management minimized losses during years with significant drawdowns,” Blumenthal said. “Tactical allocations offered significant downside protection and participation, keeping pace overall with the market.”
Financial advisors who are interested in learning more about an alternative equity market strategy can watch the webcast here demand.