Quantitative Investment Decision’s portfolios have one common theme – protect assets in the event of an extended market downturn. The result is more desirable performance over a market cycle.
Each QID Tactical portfolio utilizes built-in downside loss protection. This mechanism provides “signals” to take defensive actions (e.g. move to cash or treasuries) during periods it identifies as having a high probability of substantial market loss. Exchange traded funds (ETFs) are used to represent each sector, sub-sector, asset class, and/or international market held in the portfolio.
QID employs a proprietary four-step process in building and managing its tactical portfolios:
- Decide if there is more risk in owning or not owning a specific sector or asset class
- Select the appropriate ETF for each category
- Determine how much of each ETF to own
- When a defensive position is employed, determine the appropriate investment (cash equivalents, U.S. Treasury instruments, etc.) to be used
A sequence of proprietary quantitative models will calculate an estimated risk level and generate a binary “on” or “off” signal for each ETF category. There is no middle ground in this process. Based on the model’s risk level, a sector, sub-sector, or asset class may either be owned or not owned.
The second step involves selecting the specific ETFs used in the portfolios. ETFs are the preferred investment vehicle in that they are low cost and provide broad diversification. A proprietary scoring system, that considers such factors as tracking error, cost efficiency, and liquidity, is utilized. Depending on the portfolio, ETFs can come from a single sponsor or multiple sponsors.
Next, each strategy utilizes a unique weighting system that is dependent on the number of sectors, sub-sectors or asset classes held in each category of the portfolio. This system will determine if an asset class or sector is over, under, or equal weighted. In general, the system is designed to avoid increasing the weight of a portfolio position that demonstrates a high likelihood to decline in value in the near term. A defensive position (i.e. cash equivalents / U.S. Treasury instruments) will begin to build when the number of ETFs, representing each sector, region, or asset class, falls below a certain threshold.
If necessary, the final step utilizes a proprietary algorithm to determine how the defensive portion of the portfolio should be invested; e.g. in a money market fund or a U.S. Treasury instrument.
In addition to the standard Tactical portfolios, QID also offers an “Adaptive” strategy version for the U.S. equity and the international equity portfolios. The systems controlling the signals of the adaptive strategies tend to react at a slower pace to changes, vs. the tactical strategies, thus resulting in lower turnover. Long-term, the tactical and adaptive models tend to provide similar results, however, due to the lower turnover, the adaptive strategy may be more tax efficient.
For investors who desire a risk-based or age-based portfolio, QID offers several predetermined diversified strategic portfolios. Each portfolio includes the four major asset classes: U.S. equity, non-U.S. equity, fixed income and alternative assets. In addition to the predetermined models, each strategy can also be customized to meet an investor’s unique circumstances and needs.
TACTICAL U.S. EQUITY / ADAPTIVE U.S. EQUITY
The U.S. Equity strategies provide broad exposure to the U.S. equity markets. The portfolios, when fully invested, are diversified across the ten major sectors of the economy. In addition, each sector allocation may include one or more sub-sectors, with each sector or sub-sector represented by a single exchange traded fund. A sector is signaled “off” (sold) when the model determines that there is a high probability of significant market loss in the sector.
The Tactical U.S. Equity portfolio will begin to build a defensive position, in 25% increments, when seven major sectors have been sold. The portfolio will go 100% defensive when either nine or ten major sectors are no longer owned (i.e. 7 sectors “off” = 25%; 8 sectors “off” = 50%; 9 or 10 sectors “off” = 100% defensive).
The Adaptive U.S. Equity strategy incorporates the use of sub-sectors within each major sector category. Sub-sectors are only used if analysis suggests that the sub-sector will improve the performance of the strategy. When no sub-sector demonstrates a clear advantage, a single suitable ETF, representing the major sector will be used. The adaptive strategy begins to build a defensive position, in 25% increments, when seven sectors are “off”. However, the Adaptive portfolio will not go 100% defensive until all ten sectors have been sold (i.e. 7 sectors “off = 25%; 8 sectors “off” = 50%; 9 sectors “off” = 75%; 10 sectors “off = 100% defensive).
U.S. Equity Major Sectors:
Materials, Energy, Financials, REITS, Industrials, Technology, Utilities, Healthcare, Consumer Staples, Consumer Discretionary
TACTICAL INTERNATIONAL EQUITY / ADAPTIVE INTERNATIONAL EQUITY
The International Equity strategies provide broad exposure to international equities and allocates the portfolio across major international economic areas. When fully invested, the portfolio is constructed with up to five country/regional ETFs. The model will calculate the likelihood of a significant loss, for each country or region represented in the portfolio, and deliver an “on” or “off” signal accordingly.
For the Tactical International Equity portfolio, the weighting of the country / regional ETFs is based on the market cap weight of the world economy (excluding the U.S.). For the Adaptive portfolio, the allocation is based on a GDP weighting system which results in a higher exposure to emerging markets.
For both the Tactical and Adaptive strategies, a defensive position will begin to build as each regional / country ETF is sold, and the portfolio will go 100% defensive once all international ETFs have been sold.
Tactical / Adaptive International Equity Strategy Regions:
Canada, Europe, Japan, Asia (excluding Japan), Emerging Markets
TACTICAL GLOBAL EQUITY
The Tactical Global Equity strategy provides broad exposure to both U.S. and international equities and is a combination of the Tactical U.S. Equity strategy and the Tactical International strategy. The target allocation for the U.S. sleeve of the portfolio is 60%, and 40% for the international sleeve.
Each sleeve of the portfolio maintains its own defensive strategy. As with the standalone U.S. equity strategy, the U.S. portion of the portfolio will begin to build a defensive position once a certain number of sectors are signaled “off”, and will go 100% defensive when nine or more sectors are no longer owned. Within the international sleeve of the portfolio, a defensive position will begin to build as each regional / country ETF is sold and the sleeve will go 100% defensive once all international ETFs are sold.
TACTICAL FIXED INCOME
The Tactical Fixed Income strategy seeks risk-controlled, long-term capital appreciation by investing in ETFs representing domestic and international fixed income. The strategy provides downside protection by tactically allocating the portfolio across a variety of fixed income asset classes. The portfolio may include U.S. corporate, mortgage and municipal bonds, as well as Treasury Inflation Protected Securuties (TIPS). In addition, on an opportunistic basis, the portfolio may use global, international developed market and emerging market debt. Each category is represented by one corresponding ETF.
The allocation to the various fixed income asset classes are interdependent upon one another. The model will calculate the likelihood of significant loss associated with each asset class and generate either an “on” or “off” signal. Depending on which categories are “on” will determine if and how other fixed income categories are used in the portfolio.
As fixed income asset classes are determined to be too risky, and signaled “off” (sold), the portfolio may build a defensive position equal to the allocation to the style that was sold. When an ETF is sold, the proceeds are placed into a U.S. Treasury ETF. If all fixed income asset classes are “off”, the portfolio will become 100% defensive. The default defensive position is an intermediate Treasury bond ETF, however, a separate algorithm is used to determine if a money market fund/ETF might be more appropriate.
Note: A municipal bond ETF is used as a diversifying asset class and we believe it is appropriate for both taxable and tax-exempt accounts.
TACTICAL ALTERNATIVE INVESTMENTS
The Tactical Alternative Investments strategy seeks risk-controlled, long-term capital appreciation, and provides downside protection by tactically allocating the portfolio across a range of alternative asset classes. The alternative investment strategy encompasses agricultural products, energy, precious metals and real estate. The precious metals sector may use a gold and/or silver ETF and the energy sector may use an oil and/or natural gas ETF. The strategy not only provides diversification attributes, but also provides protection from rising inflation.
The model will look at each asset class separately to determine the likelihood of significant loss. Because these asset classes are highly volatile, the portfolio can go defensive utilizing either a money market fund, or ETFs representing U.S. Treasury instruments. As with the Tactical Fixed Income portfolio, a separate model is used to determine whether the Treasury position in the model will be an intermediate Treasury ETF or a money market fund/ETF.
With regards to the agriculture sector ETF, the implementation of a defensive posture, should the ETF be sold, is governed by the positioning of the Tactical U.S. portfolio. If the U.S. equity portfolio is fully invested (i.e. not defensive and holds no significant cash/treasuries/cash equivalents) and the agriculture ETF is sold, the proceeds from the sale are invested into an S&P 500 index ETF. However, if the U.S. equity model is in a defensive mode or begins to build a defensive position, then the proceeds from the sale of the agriculture ETF would be invested in a U.S. intermediate Treasury ETF (default).
Note: The agriculture cycle tends to be very long and can be turned “off” for extended periods of time.