2014 Year- in- Review Commentary

Transcription

1 2014 January 2015

2 2 Table of Contents Newfound Research Year- in- Review... 3 Newfound Direct Strategy Suite Review... 5 Risk Managed Global Sectors... 5 Risk Managed Small- Cap Sectors... 7 Multi- Asset Income... 9 Dynamic Alternatives Target Excess Yield Suite Total Return Tailwinds Tactical Portfolio Suite Strategy Index Return Table Disclosures... 20

3 3 Newfound Research Year- in- Review 1 In our mission to cultivate the most comprehensive suite of risk- managed investment strategies, 2014 a year during which we celebrated our 6 th birthday was a tremendous year of growth for us at Newfound Research. We expanded our team from 4 to a total of 9, bringing on- board some incredible talent, including: Nathan Faber (Associate, Investment Strategies), Andrew Gogerty (Vice President, Investment Strategies), Paula Boyd (Senior Vice President, Sales & Marketing), Genevieve Charest (Associate, Compliance) and Joseph Cundall (Director, Advisor Solutions). We continued to push our agenda of advisor education, authoring over 40 blog posts 2 on topics ranging from portfolio construction, our investment philosophies, asset class education, and quantitative topics. We also began writing weekly market and portfolio commentary (archive available on our website), providing transparency to the tactical shifts occurring in our direct strategy suite. We also participated in 13 education panels, presentations & webinars, and contributed to ETF.com s strategist corner, S&P Dow Jones Indices Indexology Blog, and Forbe.com s Great Speculations Blog. We came to market with our own direct product suite. From this suite we launched three mutual funds 3. Even though we did not gain first platform availability for these strategies until late April, assets in our direct strategy suite grew from near $0 to approximately $180mm by December 31 st. In late October, our performance composites for these strategies were verified compliant with Global Investment Portfolio Standards (GIPS ) on a firm level. In our continued effort to offer truly forward- thinking strategies, we launched several new portfolios in partnership with select asset managers, combining our best thinking to offer thoughtful new solutions. These new portfolios include: The PrudentPath Target Date Series with 3D Asset Management; The Risk Managed Series (Assets and Satellites) in collaboration with Congress Capital; The Toroso Newfound Tactical Allocation portfolio in conjunction with Toroso Investments; The Global Risk Managed Income Index (tracked by an exchange- traded fund launched by First Trust Canada) through NASDAQ OMX. 1 For our annual report, see reports/ See 3 See

4 4 Figure 1: Direct Strategy Suite Asset Growth in 2014 Despite relatively flat growth in the managed ETF strategist space in 2014, we continued to see our total assets under advisement ( AUA ) grow as strategies offered in collaboration with other asset managers continued to draw interest from advisors and investors. Our total ecosystem AUA grew by nearly $600mm. Figure 2: Total Newfound Ecosystem Asset Growth in 2014 To cap off the year, Corey Hoffstein, co- founder and Chief Investment Officer, was named a 2014 All- Star by ETF.com and its sister publication ETF Report. While Corey was given the individual credit, we believe the award reflects the enormous effort and commitment of the entire Newfound team. We look forward to sharing an incredible 2015 with you. Happy New Year!

5 5 Newfound Direct Strategy Suite Review Risk Managed Global Sectors The Newfound Risk Managed Global Sectors strategy provides access to global equities within a disciplined risk- management framework that aims to side- step material drawdowns. Looking Back Momentum signals across global sectors were fairly stable less a few speed bumps in February until Q4. Through Q4, we made several tactical shifts. The largest changes were the introduction of a short- term U.S. Treasury position in October and the removal of the global energy and materials sectors. The introduction of short- term Treasuries (peaking at 18.75%) ended up being a negative 100 basis point drag to performance against the MSCI ACWI. However, most of this drag was made up for by our general equal- weighting methodology we employed throughout the remainder of the year. Our removal of energy (IXC) and subsequent overweight towards health care (IXJ) and technology (IXN) helped further compensate for the cash drag, pushing performance approximately 100 basis points over the benchmark for the year. Going Forward Portfolio outlook remains mixed going into Three of the nine sectors currently have negative signals and one has a neutral signal still lingering from October s sell- off. Without broad momentum strength behind all the sectors, the portfolio remains poised to potentially introduce short- term Treasuries. We estimate that a 7.5% drawdown in global equities would be enough to trigger the momentum signal on select sectors to turn off and subsequently introduce a defensive positioning into the portfolio.

6 6 Figure 3: Allocations over time for Risk Managed Global Sectors Scale is dark red (0%) to yellow (12.5%) to dark green (25%)

7 7 Risk Managed Small- Cap Sectors The Newfound Risk Managed Small- Cap Sectors strategy provides access to domestic small- cap equities within a disciplined risk- management framework that aims to side- step material drawdowns. Looking Back While small- caps began to diverge from their large- cap peers early in the year, from a pure absolute momentum perspective, small- caps still had broad momentum tailwinds behind them, according to our models, until Q2. Early into Q2 we began to see cracking strength in technology and healthcare, which continued into Q3. In October s sell- off, enough momentum signals turned neutral or negative to warrant a small U.S. Treasury position being introduced into the portfolio rolling in and out of the portfolio over a 5 week period and peaking at 18.75%. The sharp rebound of small- caps during this period resulted in a cash drag of 183 basis points. Our equal- weight methodology also served as a net drag of 162 basis points on portfolio performance relative to the Russell While historically an equal- weight methodology outperforms a market- cap benchmark on both a total return and a risk- adjusted return basis on approximately 80% of rolling 1- year periods (from May 1999 to June 2014), it will from time- to- time underperform. Unfortunately, 2014 was one such period. Fortunately, our tactical shift to remove portfolio exposure to the small- cap energy sector added 227 basis points of performance, helping make up for a large part of the drag created from the equal- weighting methodology and October/November Treasury allocation. Going Forward While several small- cap sectors continue to show weakness energy in particular our signals show that the post- October environment for small- caps has been broadly positive. This positivity has translated into a fairly sizeable buffer between where small- caps currently stand and how far we estimate the portfolio would have to fall before we would begin to introduce a short- term Treasury position.

8 8 Figure 4: Allocations over time for Risk Managed Small- Cap Sectors Scale is dark red (0%) to yellow (12.5%) to dark green (25%)

9 9 Multi- Asset Income The Newfound Multi- Asset Income strategy seeks to generate an attractive risk- adjusted income profile within a disciplined risk management framework utilizing both traditional and alternative income generating asset class ETFs. Updates to Portfolio Methodology in 2014 In August, the investment committee approved changes to swap several ETFs for lower- costing alternatives that tracked similar, or identical, indices. In late December, the investment committee approved the removal of the Global Infrastructure ETF IGF and the addition of the S&P 500 Buy/Write Portfolio ETF PBP. This change reduced exposure to pure equity beta and introduced a new, unique income source. Looking Back Through 2014, the portfolio continuously reduced its weight to credit exposure. Starting the year with nearly 25% exposure to both high yield bonds and bank loans, increasing volatility led to reduced position sizes before our momentum signals pulled both sectors from the portfolio in Q4. This reduction was met with a corresponding increase to mortgage REITs and preferreds. A large number of asset classes were removed from the portfolio due to negative momentum signals throughout October and November. Many of these asset classes already had relatively reduced weights due the increasing volatility levels the preceded the momentum signals switching. Using a 50/50 S&P 500/Barclays Aggregate Bond benchmark, we can see that tilts towards satellite fixed- income and satellite equity were additive to our return profile. The less attractive risk- adjusted income profiles of long- dated U.S. Treasuries (TLT) and U.S. REITs (VNQ) led to a reduced portfolio allocation; their incredible total returns this year, however, meant that these tilts were a drag on performance relative to the benchmark. Going Forward Going forward, the portfolio is heavily tilted towards preferreds and mortgage REITs with an estimated forward yield north of 6.5%. Peering into the underlying dynamics of our momentum models, it is possible that bank loans and high yield are re- introduced into the portfolio sometime in the near future. We expect that if these momentum signals turn back positive that, based on current risk- adjusted income profiles, preferreds (PFF) and mortgage REITs (REM) would remain as the largest positions in the portfolio, followed by bank loans (BKLN), corporate bonds (LQD), high yield bonds (HYG) and emerging market (local currency) bonds (PCY). 8.00% Approximate Forward Yield 6.00% 4.00% 2.00% 0.00%

10 10 Figure 5: Allocations over time for Multi- Asset Income Scale is dark red (0%) to yellow (12.5%) to dark green (25%)

11 11 Dynamic Alternatives (Formerly Known as U.S. Equity Dynamic Long/Short) The Newfound Dynamic Alternatives strategy is a 100% rule- based managed ETF portfolio that begins with a core, strategic long/short portfolio and selectively adds U.S. equity market beta utilizing Newfound s proprietary momentum models. Updates to Portfolio Methodology in 2014 In May, the investment committee approved an addition to the long/short sleeve of the portfolio to include the multi- strategy alternatives ETF LALT. The ETF captures, within it, currency carry, forward rate bias, volatility risk premium, value long/short and hedge fund conviction. At the end of December, the investment committee approved a further increase in holdings in the long/short sleeve of the portfolio. Prior to the change, the long/short sleeve held dollar- neutral factor portfolios representing value, small- cap, momentum, and anti- beta premia. Due to potential liquidity issues, the investment universe was expanded to include strategies covering merger arbitrage, managed futures, and hedge- fund replication. Corresponding with the increased universe, the investment committee voted to approve a name change from U.S. Equity Dynamic Long/Short to Dynamic Alternatives to more accurately reflect the holdings within the portfolio. These changes have been implemented for January Looking Back The Dynamic Alternatives portfolio largely remained balanced between its long and long/short sleeves. Weakness in October led to a tilt towards the long/short sleeve, but the tilt was limited (57% allocation to long/shorts versus a minimum position of 50%) and short- lived. In 2014, on average, the portfolio was 53% allocated to the long/short sleeve and 47% allocated to the long- only sleeve. The domestic focus on the long- only sleeve helped buoy performance. The long/short factors, however, were a drag on performance, at best returning 3.16% for the year and at worst %. Despite lackluster total return, the long/short sleeve shined during periods of dislocation. From January 15 th to February 3 rd, the average long position lost 5.66%; the average long/short position only lost 0.72%. Similarly, from September 30 th through October 15 th, when the average long position lost 4.74%, the average long/short actually gained 0.33%. Going Forward As highlighted above, our investment committee approved a change to the long/short sleeve going into Specifically, our long/short positions in momentum, size, and value premiums are being replaced with a hedge- fund replication portfolio, a multi- factor long/short portfolio, a merger arbitrage strategy, and a managed futures strategy. These changes were made for two primary reasons: (1) liquidity and (2) less reliance on the performance of specific equity factors. We expect that the alternatives sleeve will continue to offer a profile that strongly diversifies the long- only U.S. equity sleeve.

12 12 Figure 6: Allocations over time for Dynamic Alternatives Scale is dark red (0%) to yellow (25%) to dark green (50%)

13 13 Target Excess Yield Suite The Newfound Target Excess Yield Suite of strategies are 100% rule- based managed ETF portfolios that target yield levels at a fixed premium above the yield offered by short- term (1-3 Year) U.S. treasuries and seek to achieve these yields at the lowest volatility levels possible. Updates to Portfolio Methodology in 2014 In August, the investment committee voted to increase the investable universe. The increased universe allowed for more finely tuned allocations for both duration and credit quality. The approval triggered a rebalance, moving most portfolios towards enhanced short- duration portfolios and short- term high yield bonds. In December, the investment committee voted to approve a change in covariance matrix construction, which implemented a statistical technique called shrinkage that helps make the estimation more robust to outliers. The committee also approved a proposal to utilize an exponential weighting scheme in calculating expected forward yield. This change will allow the portfolio to more quickly adapt to short- term changes both in the benchmark yield as well as the yield of the investible universe. Looking Back The Target Excess Yield suite portfolios remained stably allocated throughout the year, with the exception of the increase to the investible universe outlined above. Broadly, the portfolios were allocated to short- duration credit and high yield as well as enhanced short- duration fixed- income. Note: Many ETF sponsors issue two distributions in December and forego a distribution in January, creating an uneven yield profile over December and January, which can be seen in the graph on the right. Going Forward Increased volatility in short- term junk bonds as well a decreasing correlation profile between core bonds and junk bonds led to a late- year reallocation. This re- allocation broadly favored a reduction in exposure to enhanced duration fixed- income in favor of higher duration, core fixed- income. Figure 7: Trailing Annualized Yield of TEY 4% Index

14 14 Figure 8: Target Excess Yield 3% weights over time. Scale is dark red (0%) to yellow (50%) to dark green (100%) Figure 9: Target Excess Yield 4% weights over time. Scale is dark red (0%) to yellow (50%) to dark green (100%)

15 15 Total Return The Newfound Total Return strategy seeks to achieve income and capital appreciation by employing a flexible allocation strategy that invests across three independent strategies: a flexible bond portfolio for income generation (Target Excess Yield 4%), a multi- strategy alternatives portfolio for diversification (Dynamic Alternatives), and a position in long- dated U.S. Treasuries to serve as a hedge to equity market volatility. The sleeves are actively managed to target a balanced contribution to the overall return profile. Looking Back The relative allocations between the three sleeves in Total Return were fairly steady. The income generation sleeve had an average allocation of 49%, the diversification sleeve an allocation of 37%, and the equity volatility hedging sleeve an allocation of 14%. The equity volatility- hedging sleeve dipped in allocation mid- year, from 14% to 10%, due to increasing relative volatility of long- dated Treasuries. However, by year- end, relative volatility had normalized and the long- dated Treasury position returned to approximately 16% of the portfolio s weight. Going Forward While U.S. equity momentum remains positive, the portfolio will continue to incorporate long- equity exposure into the diversification sleeve in effort to take advantage of total return tailwinds. With the recent increase in short- term junk volatility as well as the decreased correlation of high yield with core U.S. bonds, the income sleeve has reduced exposure to enhanced- duration short- term portfolios in favor of longer- duration core fixed income. This has had the effect of increasing the overall duration and yield profile of the portfolio, but decreasing the overall volatility profile. A recent increase in the allocation to the equity volatility- hedging sleeve has also served to increase the duration profile of the portfolio. Due to the dynamic nature of this portfolio, we expect that an increase in volatility of interest rates will translate to an increased volatility of long- dated Treasuries, which will reduce the size of the equity- volatility hedging sleeve. Estimated forward income 4 for the portfolio is 2.74% with an effective duration of In comparison, estimated forward yield for the ishares Core U.S. Aggregate Bond ETF AGG is 2.31% with an effective duration of Based on weighted average trailing twelve- month yields and weighted average durations from Morningstar, ishares, Guggenheim, and SPDR 5 Source: ishares

16 16 Figure 10: Trailing allocations of the individual sleeves of Total Return. Scale is dark red (0%) to dark green (50%).

17 17 Tailwinds Tactical Portfolio Suite The Newfound Tailwinds Suite consists of three globally diversified tactical portfolios (Conservative, Moderate, Growth) with an emphasis on downside protection and upside participation. Each portfolio offers exposure to five of Newfound s core strategies. Looking Back Two structural tilts within the Tailwinds Suite were a drag on performance this year. The first is the tilt towards domestic small- caps, which underperformed their large- cap peers by just over 800 basis points. The second is the nearly equal distribution of weight between U.S. and international equities within our large- cap allocation. With All- World Ex- US indices underperforming U.S. by nearly 1800 basis points, this equal- weight allocation was a massive drag on total return. These structural tilts are embedded in the portfolio to take advantage of the long- term small- cap premium as well as the benefits of global diversification. While we believe that these tilts are value- add over full market cycles, 2014 proved to be a period during which they worked against portfolio total return. The major trends throughout the year were a decreased allocation towards satellite fixed- income (e.g. high yield bonds, emerging market bonds, and bank loans) in favor of satellite equity (e.g. mortgage REITs, preferreds, REITs, dividend equities and MLPs). This tilt was largely driven by changes within our Multi- Asset Income portfolio, which reduced high yield and bank loan allocations and increased exposure to mortgage REITs and preferreds. Going Forward From a momentum perspective, the global equity outlook remains mixed (see commentary for our Risk Managed Global Sectors portfolio). Should conditions deteriorate further, we would expect to begin building a short- term U.S. Treasury position in that sleeve. Due to the waterfall overlay employed by the Tailwinds suite, that U.S. Treasury position would be re- allocated to the Risk Managed Small- Caps and Multi- Asset Income portfolios, which both continue to show strong absolute momentum strength. Therefore, in the short- term, we do not expect to be making any large tilts towards defensive positioning unless global risky asset momentum significantly weakens.

18 18 Figure 11: Allocations over time in Tailwinds Moderate. Scale is dark red (0%) to yellow (16.25%) to dark green (33%).

19 19 Strategy Index Return Table Newfound s strategy index returns assume a 50 basis point annualized fee. This fee is applied in equal quarterly amounts at the end of each quarter. These index returns do not reflect the performance of actual, live accounts. Composite information, containing both gross and net of fee returns for each strategy, is available within strategy brochures found at All returns presented below are net of underlying ETF expense ratios Q1 Q2 Q3 Q4 Annual Annual Sharpe Return Volatility Ratio 6 Risk Managed Global Sectors 1.67% 5.47% % 0.725% 4.69% 9.12% 0.51 Risk Managed Small- Cap Sectors 1.99% 1.89% % 7.56% 3.61% 13.57% 0.26 Multi- Asset Income 2.69% 3.67% % 2.22% 6.27% 5.71% 1.09 Dynamic Alternatives 1.01% 2.25% % 1.83% 3.42% 4.76% 0.72 Target Excess Yield 3% 1.26% 1.19% % % 0.53% 2.70% 0.20 Target Excess Yield 4% 1.91% 1.68% % % 0.97% 3.81% 0.25 Total Return 2.29% 2.38% % 1.27% 4.91% 3.80% 1.29 Tailwinds Conservative 1.64% 2.54% % 1.94% 4.12% 4.89% 0.84 Tailwinds Moderate 1.66% 2.90% % 2.32% 4.03% 6.64% 0.61 Tailwinds Growth 1.56% 3.55% % 2.65% 4.10% 8.54% 0.48 S&P 500 (SPY) % 5.15% 1.13% 4.89% 13.46% 8.23% 1.63 All- World ex- US (VEU) 0.00% 5.15% % % % 11.21% MSCI ACWI (ACWI) 0.91% 5.08% % 0.17% 3.83% 9.62% 0.39 Russell 2000 (IWM) 1.12% 2.12% % 9.80% 5.04% 15.41% 0.32 Barclays Aggregate (AGG) 1.77% 1.95% 0.28% 1.88% 6.00% 2.36% Sharpe ratio assumes a 0% risk- free rate 7 SPY, VEU, ACWI, IWM and AGG returns are presented net of fees and transaction costs

20 20 Disclosures For more information about Newfound Research call us at , visit us at or us at These materials represent an assessment of the market environment at specific points in time and are intended neither to be a guarantee of future events nor as a primary basis for investment decisions. The performance results should not be construed as advice meeting the particular needs of any investor. Neither the information presented nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any security. Past performance is not indicative of future performance and investments in equity securities do present risk of loss. Newfound Research LLC s results are historical and their ability to repeat could be effected by material market or economic conditions, among other things. Except as noted, model and index results are gross of fees, costs and expenses. Index or model results do not reflect the performance results of a live, actual account or fund that invested to track the results of the index. All index and model results are total return, meaning they reflect the reinvestment of all dividends, capital gains, interest and other income. The commentary is prepared by Newfound Research LLC for informational purposes only and is not presented as an offer or solicitation for the purchase or sale of any security. The information contained herein is neither investment advice nor legal opinion. The views expressed are those of the author as of the date of the publication of this report, and are subject to change without notice. Performance results are presented in U.S. dollars. Actual fees may vary based on, among other factors, account size and custodial relationship. No current or prospective client should assume future performance of any specific investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may cause the performance results of your portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client's investment portfolio. Historical performance results for market indices generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. The investment strategy and types of securities held by comparison indices may be substantially different from the investment strategy and the types of securities held by the Newfound Research LLC strategies.