Exchange-traded fund (ETF) expert and portfolio strategist James Breech can offer considerable detail about the theories he uses to construct portfolios of ETFs. But, in the end, his approach boils down to some basic principles: think ahead and take it slow.
"We are slow thinkers. We take our time trading. We update our outlook once a month and then we make our decisions," says Breech, president of Cougar Global Investments Ltd. of Toronto, a tactical ETF global investment strategist that recently was purchased by St. Petersburg, Fla.-based Raymond James Financial Inc.
"We have just under $200 million in the direct business in Canada, " he adds. "In the U.S., we have about US$1.2 billion. We were discovered in the U.S. about six years ago; we launched in July 2010 and we grew very rapidly there."
Every month, Breech and his team review their asset allocations with reference to macroeconomic events - growth projections, inflation and recession fears, and chaotic or unexpected events that economists refer to as "black swans."
An example of a black swan might be the plunge in oil prices in the last year after most analysts had predicted high prices for the foreseeable future. "Oil prices have stabilized and are probably going to trade in a range," Breech says. Other macroeconomic events of note include the strong U.S. dollar, which is a problem for U.S. multinationals.
Breech foresees a 6% possibility of black swans from eight possible trouble areas, ranging from problems in Iraq and Syria and possible lone wolf terrorist attacks in Western countries to the discord among the European Union's economies.
Breech's global tactical asset calculators apply a version of the postmodern portfolio theory developed by Frank Sortino of San Francisco State University, an early proponent of downside risk minimization, to Cougar Global's portfolios. Rather than focusing on overall volatility, Sortino's ratios measure the risk-adjusted return of an investment, portfolio or strategy, with the goal of achieving returns required to meet each investor's needs.
Breech says return on investment is what usually concerns clients the most. "Sortino said that the only risk you need to worry about is the rate of return you need to fund your liabilities," Breech says. "You shouldn't consider it risky if you're making money above your rate of return."
In the real world, people care more about losing money and downside risk and less about making excessive returns, he adds. "If we make 20%, they don't call me and say, 'James, that's too risky.' But if we lose money, they're disappointed."
As a result, a client's income needs are key. "We integrate financial planning and investment management," Breech says. "If we have a financial planner on the front end, we can determine [a client's] financial goals."
Breech designs four portfolios based on a sliding scale of risk scenarios - portfolios with the least risk of negative returns are for clients who are in the withdrawal stage of their investing lives, while portfolios with the most risk in the short term are for clients with a longer investment horizon and who can withstand more volatility.
Earlier this year, Breech narrowed his focus in the U.S. market, concentrating on mid-capitalization stocks with a domestic bias and, thus, less vulnerability to the negative impact that the strengthening U.S. dollar and European economic weakness have on export-oriented, U.S.-based firms.
"We decided to reduce our exposure to the S&P 500 [composite index]," he says. "We use the SPDR S&P 500 ETF. We reduced [S&P 500] exposure across the board, for all portfolios."
At the same time, Cougar Global has increased exposure to domestically oriented U.S. mid-cap companies in all portfolios by using SPDR Mid Cap Trust Series I. For U.S. small-cap companies, Cougar Global uses iShares Core S&P Small Cap ETF, but the small-cap exposure is held only in the more aggressive portfolio. For Canadian equities, Cougar Global uses iShares Core S&P/TSX Capped Composite Index ETF.
However, Breech is less positive on the outlook for Canada, as he believes lower oil prices will take a toll.
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