Assets under management using model ETF portfolios among registered investment advisors (RIAs) in the U.S. have been exploding. These discretionary managers control $2 trillion in assets and are looking not only for efficient and effective ways to manage assets but also ways to streamline their practices. In Canada, model ETF portfolios are becoming more popular as the value proposition for traditional mutual fund “wrap” programs is challenged by low interest rates, single-digit capital market returns, and the number and variety of ETFs that make comprehensive solutions possible.

In this series, we have used three model types to demonstrate the construction of ETF-based portfolios:

  1. Global Macro is the fundamental, top-down approach that is easy to explain to clients. Using ETFs eliminates the need for stock picking, an activity that provides diminishing returns as more holdings are added. Better diversification is the payoff. Global macro’s challenge is to harness notoriously unreliable economic projections to structure an asset allocation that gets the geographic mix of assets, sectors and industries correct at the right time. This approach requires close monitoring and rebalancing as circumstances change and new information becomes available.
  2. Core/Satellite recognizes that returns occur in two main parts: those that are related to the market in general, or beta (β), and those in excess of market returns, or alpha (α). Institutions have long recognized that multi-manager structures lead to overlapping assets and holdings that produce index-like returns at full fees. The objective is to establish a “core” that reflects the long-term strategic mix of a mandate and make active alpha “bets” based upon mix, country, industry shifts or credit, sector, duration and term that add returns incremental to the core.
  3. Target Risk is used by sophisticated institutions. Because ETFs offer efficient packages of pre-diversified risk, this approach is available to investors with more modest portfolios. The principle is that risk can be allocated between assets in a systematic way to maintain consistent portfolio exposure over time. The benefit is the recognition that risk changes over time and with it the correlations between asset classes that impact diversification. The approach succeeds by avoiding losses and avoids market extremes both on the upside and downside.

In this article, we stress the importance of rebalancing portfolios based upon the construction methodology. Global Macro requires the most scrutiny because it is based upon economic projections for markets, sectors and industries that are constantly changing. The core portion of Core/Satellite strategies should be stable but the satellite portfolio will change, much like elements of Global Macro, and Target Risk changes as market volatility changes.

We thought it would be both interesting and instructive to revisit portfolios created a year ago to test our hypotheses about rebalancing and to update the portfolios for the current environment.