personal αlpha TM PŮR INVESTING INC. Advanced ETF Strategies

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1 ADVANCED ETF STRATEGIES PŮR INVESTING INC. Advanced ETF Strategies PŮR investing Inc. is registered as a portfolio manager and builds long term investment solutions for DC pension plans and investors while providing the technology and analysis for advisors to do the same for their clients. Beta captures market return and alpha refers to returns in excess of the benchmark. In the investment context, alpha is attributable to skill or luck. For our clients, this is not good enough. We need to take out the guesswork and control and manage all the risks that we can. We submit that what clients really want is personal αlpha. personal αlpha TM Personal αlpha addresses clients actual needs and goals. If their funds are scheduled to run out at age 84 and we can help to make them last five years longer, that five years is personal αlpha. Creating Personal αlpha 1% 9 years This 40 year old with $100k contributes $10k/yr and gets an 8% return scaling to 6% at retirement when he starts to withdraw $40k/yr adjusted for inflation at 2.5%. By saving 1%/ year, we can extend his retirement by 9 years. This is personal αlpha. By using ETFs (0.50% MER) and charging 1% in fees, we can save this investor 1%/yr when compared with his mutual fund portfolio costing 2.5%. But investment return is only part of the possible solution. Tax savings, budgeting advice and other strategies can contribute and provide value.

2 target capital risk dynamic risk allocation capital accumulation path (est.) o o o How to measure Personal αlpha Once target capital is established, creating an accumulation path is easy. Progress towards the goal can be measured by the distance above (ahead of) the path or below (behind). Advisors can add value by making modest risk adjustments based upon this progress. Systems allow this to be done automatically. A personal target date fund is more sophisticated than a DIY investor could contemplate. Inverse, active and leveraged ETFs Inverse, Active & Leveraged ETFs Inverse strategies have negative expected return so have no place in a long term strategy. They are trading vehicles only. Active products are partly caught up in the debate about passive investing. Although PŮR is in the passive camp, we use some active products. An example is the Claymore Global Commodity ETF that is based upon a flexible index that is not as heavily energy-weighted as others. Volatility Drag VOLATILITY DRAG Rolling 12 month return advantage (disadvantage) of a leveraged ETF* S&P 500 less dividends We use leveraged ETFs in a measured way for some of our clients because there have historically been more periods during which leverage has helped exceed the two times index return than hurt it. The frequency with which a 10% advantage was achieved far surpasses the negative (yellow dots). The Drag Queen is a free tool that estimates volatility drag for leveraged ETFs: under tools.

3 TRANSPARENT Plugging the Gap Plugging the gap in a portfolio requires caution and latex protection. ETF providers are bringing new products to market all the time and it is increasingly difficult to select the ones you need. But caution is required. It is important to know what is underlying each ETF. You don t want surprises! The good thing about ETFs is their transparency. You know what you own at all times, unlike mutual funds that post their holdings perhaps once a quarter or every six months. It is important to know to which risks your portfolio is exposed.

4 LARGE CAP A conventional way to plug a gap in your portfolio is illustrated at the top of the ETF Screener that is powered by PŮR on the TMX Money website. Eugene Fama and Kenneth French s recently completed work confirming that small cap stocks outperform in Europe, North America and globally with the exception of Japan. As a recent commercial proclaims, size matters, but small offers better performance than large. Staying current with these research trends is important. You can also use the characteristics unique to ETFs. The best of each criteria is shown at the top of each box; most diversified, highest liquidity, lowest cost, most tax efficient and lowest tracking error. I ve used the slider on the left side of the box to screen for lower cost ETFs and rolled my cursor over the ishares DEX Bond Index Fund. The rank of this ETF is shown in each of the other category boxes. In each box, those ETFs with more units outstanding are shown towards the right. Understanding what underlies each ETF is important in preventing an asset from becoming a liability.

5 BRINSON HOOD BEEBOWER-2009 Death of asset allocation as you know it Brinson, Hood, and Beebower pointed to asset allocation as the key explanation for return differences between portfolios. The investment management community generally has embraced diversification as the most important tool to fight risk. However it failed in The technology sector s weight in the S&P 500 from 1990 to 2004 is shown as the shaded green area. The smoothed volatility of the S&P 500 (252 day moving average of standard deviation) is represented by the red line. The Technology Bubble is clearly seen. This parallels the Nortel effect in Canada. Technology Bubble S&P Volatility Technology/S&P Most investment managers of balanced portfolios have a policy asset mix and rebalance to it. As the stock market moved sharply higher, managers were selling stocks and buying other assets. While intuitively correct (selling high) the result was that portfolios had the same asset mix at the top of the bubble as they did before it started. However, the risk in the market was clearly different. Risk-based S&P 500 Return Risk Worst 12 months S&P volatility Hypothetical: PŮR Investing We suggest that markets seem friendlier to investments when volatility is stable or falling and less friendly when it is rising. A simple stock-cash example showed that returns were better by 6% annualized and risk was substantially lower. Importantly for advisors, the worst 12 month performance of the consistent risk portfolio was substantially better than the S&P 500 alone.

6 PASSIVE EMBEDDED STRATEGIES When evaluating ETFs for inclusion in client portfolios establish whether they are passive or have an embedded strategy. Cap-weighted ETFs following a traditional index are passive. Everything else has an embedded strategy that usually means higher cost, credit risk, or both. In any case more information is warranted. Understanding the underlying assets behind any ETF is the most important first step to building a successful portfolio. It is not difficult if you know what to look for and there are many resources available to help in addition to PŮR Investing s suite of ETF tools. personal αlpha TM Advancing the idea of Personal αlpha will focus you on managing costs effectively and provide you with an increasing role in your client s affairs beyond trying to beat a benchmark. Sophisticated solutions distinguish your practice. By serving as your client s GP you can call in the expertise needed when required. Your obligation is to know what ETFs and strategies can do to expand the Personal αlpha you can generate. Providing more value is worth more money!