Carl Choy is a Principal at CKW Financial Group. His focus is on asset allocation, estate planning and client strategies. We recently spoke with Carl, who will be speaking at our ETF Strategy Summit (Oct. 15 – 16 – Dallas), as he shared his thoughts on tactical strategies.
ETF Strategy Summit: What trends should inform the selection of tactical ETFs in the current environment?
Carl Choy: As a dynamic strategist (1 to 3 year tactical positions versus bench) CKW uses industry consensus information regarding economic trends and factors as potential predictive indicators of future investment revenue and earnings. Many market trends are the behavioral finance conclusions of humans using our pattern recognition expertise and the confidence we are right. Predicting the degree, duration, relevance and persistence of both trends are important to all portfolios. CKW’s current economic beliefs are: GDP growth will be higher over next 5 years for almost every major economy in the world. Corporate earnings of investable daily liquid companies will continue to grow faster relative to fixed income yields as they increase, the interest rate rise of the 10 year treasury will not rise higher than the S&P 500 E/P (but we hope it will by P/E’s going higher as rates remain relatively low), the current E/P of equity is good relative to the E/P of fixed income. Therefore, we are overweight equity. Market Trends conclusions: short term volatility will increase but is too expensive to hedge at this time. Increasing exposure to sector (commodity, energy, gold etc) increases concentration and probability of having a different result we are unwilling to take at this time. CKW currently has no intentional overweight to any sector or traditional factor. We have an overweight to Japan and Europe to underweight Australia in EAFE. Due to demographics, rising rates, consumer behavioral change we are underweight space (real estate). Amazon, working from anywhere, self driving cars, AI, and us old people with large houses full of stuff our kids don’t want and we don’t need all reduce the need for space. Rising rates will make space less affordable too. We characterize space as a market that will rust (maintenance, repairs, general cost of ownership) not bust. The government noise will get louder, increasing volatility due to less certainty as the midterm elections get closer. Once the midterms are over, uncertainty will go down and hopefully increase confidence. We are hopeful that the 30+ percent increase in consensus earnings over the next few years vs 2017 will at least hold the market at current levels and believe at some point in time the price of daily liquid stocks follow earnings.
ETF Strategy Summit: If advisors use tactical ETF strategies as satellites to a core holding, how big do the allocations need to be to be effective?
Carl Choy: As always it depends on what you are trying to accomplish. In general, the position size needs to have a better risk to reward trade off than what will be underweighted. CKW believes in a Global dynamic core. Global Stocks (G/V, cap, region), Global bonds (rates, credit, duration, region). Remember when modeling that adding a satellite also underweights what it replaced. This may double the SD if the satellite does not work.
ETF Strategy Summit: How does CKW Financial Group think about tactical ETF positioning using a blend of active and passive strategies?
Carl Choy: CKW believes asset allocation can add value, net of fees over time. Ultimately the responsibility of passive or active manager selection as it relates to performance is the asset allocators. The distinguishing feature of our strategy is to first play dynamic defense by isolating and underweighting asset classes that we believe have low probability of the risk to return characteristics used in traditional models. If we do not have a reason to use active we will use passive.
ETF Strategy Summit: Many advisors have struggled with how to approach fixed income as rates are rising and debts, public and private, have surged – is it possible today to derive sufficient downside protection from fixed income while still generating income for wealth management clients?
Carl Choy: People and Institutions live on cash flow not income. CKW uses the total return approach. CKW is a Global Balanced Dynamic Strategist because wealthy individuals and institutions have a long term balanced mandate. CKW like many of you have underweighted rates and overweighed credit and equity. The downside volatility of rates at the long end of the government curve could be as much as equity downside volatility with little upside probability. The additional equity over time should compensate for lack of government fixed income returns vs 3 to 5 year risk, is our view.
ETF Strategy Summit: With volatility returning despite many positive signs for the economy and the bull market, is it a good time to focus on tactical strategies for risk management?
Carl Choy: CKW invest in daily liquid assets where volatility is the norm. Hedging short term volatility is too expensive at this time. Matching volatility time horizon with client emotional time horizon (how long until they give up on you) will allow the client to hear the same thing many times and stay for the long run. Current data suggest that individuals and corporations globally are better financially. The financially challenged are governments. Governments are struggling to find revenue versus the expenses they create. The noise from this struggle will move markets depending on the volume and duration of the government noise. S&P earnings consensus of 30%+ over the next few years support an overweight to equity. If the market trades at a E/P of 5% (P/E = 20) relative to the 10 year treasury 3-4%, find a bullish strategist. If the price of the market does not follow earnings up (too much noise) the E/P will be ~7% without dividends (P/E = 14 to 15), hide. At some point the $12.5 trillion sitting in cash held by rational investors will be invested. An allocation to stuff, stocks, bonds, real estate, crypto, or tulip bulbs will happen (don’t know when). CKW’s discipline to a global balanced approach to investing in daily liquid assets with earnings and revenue is what clients were taught by our industry. They do not understand fancy math. Keep a simple, low cost, institutional-quality asset allocation process your client can understand and they will stick with you.
ETF Strategy Summit: Thanks Carl. We look forward to hearing more of your thoughts at the ETF Strategy Summit October 15 – 16 in Dallas.