Quantitative Investment Decision’s strategies 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 strategy 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 strategy.
QID employs a proprietary four-step process in building and managing its strategies:
- 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 strategy’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 strategies. 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 strategy, 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 strategy. 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.
For investors who desire a risk-based or age-based portfolio, QID offers several predetermined diversified strategic portfolios. Each strategy 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.
U.S. EQUITY SECTOR STRATEGY
The U.S. Equity Sector Strategy provides 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 U.S. Equity Sector 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 strategy begins to build a defensive position, in 25% increments, when seven sectors are “off”. However, the strategy 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 Sectors:
Materials, Energy, Financials, REITS, Industrials, Technology, Utilities, Healthcare, Consumer Staples, Consumer Discretionary
INTERNATIONAL EQUITY GDP STRATEGY
The International Equity GDP Strategy provides broad exposure to international equities and allocates the strategy 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.
The strategy allocation is based on a GDP weighting system which results in a higher exposure to emerging markets than traditional benchmarks.
For the strategy, a defensive position will begin to build as each regional / country ETF is sold, and the strategy will go 100% defensive once all international ETFs have been sold.
International Equity GDP Strategy Regions:
Canada, Europe, Japan, Asia (excluding Japan), Emerging Markets
TACTICAL FIXED INCOME STRATEGY
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 strategy across a variety of fixed income asset classes. The strategy may include U.S. corporate, mortgage, and municipal bonds, as well as Treasury Inflation Protected Securities (TIPS). In addition, on an opportunistic basis, the strategy may use global, international developed market and emerging market debt. One corresponding ETF represents each category.
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 strategy.
As fixed income asset classes are determined to be too risky, and signaled “off” (sold), the strategy 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 strategy 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.
ALTERNATIVE ASSET STRATEGY
The Alternative Asset Strategy seeks risk-controlled, long-term capital appreciation, and provides downside protection by tactically allocating the strategy 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 strategy 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 strategy, 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 U.S. Equity Sector Strategy. If the U.S. Equity Sector Strategy 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 Sector Strategy 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.