With more than 10,000 hedge funds in the market hold 1.5 trillion U.S. dollars in business if you do not have the money in a hedge fund can be asked if they are not in the big game. Yale University Endowment 25% invested in hedge funds, absolute returns.
But with the advent of Exchange Traded Funds or ETFs, you have at hand the possibility of building a global portfolio ETF hedge that is the envy of your friends - and do not need to give away 20% ofTheir profits in a Hedge Fund Manager.
What is a hedge fund?
Before us, as you build your portfolio of ETFs Hedge, look at the historical record of hedge funds and their evolution. Hedging means to reduce risk, while speculation is more looking back, focusing on more risks. A hedge fund is a private equity firm that invests with the objective of higher investment returns as a risk for every dollar. The first hedge fund was started by a former Fortune magazine journalist AlfredWinslow Jones in 1949 and he also set the standard for fees which continues to this day: a fee equal to 2% of assets and a performance fee of 20% of gains.
There are an infinite variety of hedge funds but they can be broken down into two categories. Non-directional funds seek absolute returns by using a long/short approach and tend to generate steady but unspectacular returns. Directional funds allocate assets using only limited hedging. Both seek alpha – return over a benchmark from The investment process, the ability of fund managers and let's face it, just lucky.
Hedge mediocre
Since hedge funds do? In 2005, the CS / Tremont index, average global macro fund returned 7.6% versus 10% for the MSCI EAFE Index - and in 2006, 13.5% versus 18% for the MSCI World Index. According to Henry Kat London Business School, only 17.7% of hedge fund investors are not the study has been produced. Why?
Most attempt to exploit anomalies within markets and asset classes rather than between markets and asset classes. Many hedge funds try to do too much and look at too many markets but still lack global diversification. The result? Hedge funds have become commodities competing for opportunities in the same markets.
ETF Advantages
You can build a diversified global ETF hedge portfolio by tactically allocating ETFs with the goal of exploiting anomalies between global markets rather in the markets. instruments that are certainly more than 400 ETFs now on hand from 20 different countries, ETFs, sectors and subsectors of the United States, international transport sectors worldwide, commodities, precious metals, currencies, Regional, inverse ETF, different classes of assets and growth / value decisions.
Investors now have a choice in terms of how companies selected and weighted ETF baskets. Corporate weighted basket of ETF is made on the basis of market value, sales,Fundamentals, technical factors are only some of the possibilities cash dividend record.
In addition to diversity, there are other reasons to use ETFs as tax efficiency, flexibility, transparency to go, and the increasing availability of risk management, such as inverse ETFs, put options, to stop the losses and sell the capacity short.
Despite these advantages, ETFs, you'll still need a disciplined process with clear action and active risk management tools to lock in profits, minimizeEffects of errors and a level of comfort with a regular high levels of cash.
Cash, cash and profits come first
We must also think about how it fits into your overall investment portfolio plan. Effective September ample liquidity with cash or money market funds. You also need a strong comfort in terms of income to meet your current needs and long term. A consultant can perform a good model for you so that even in the worst cases, you will be safe and secure. Thissecurity plan in place, you can then look confidently and at more creative and higher potential for growth portfolios such as a global ETF hedge portfolio.
Set Global Asset Allocations
But what should be the investment process for selecting and removing ETFs from your global hedge portfolio? Here is how Chartwell approaches it.
Before jumping ahead to select a basket of ETFs, we first use a top down approach by allocating assets among different equity markets such as the U.S., Europe, Asia-Pacific and emerging markets as well as some foreign currencies.
Then we set a target allocation for fixed income and inverse ETFs which move opposite of markets and serve as a hedge or portfolio buffer for down markets. Next, we address real assets by making allocations for precious metals, real estate, timber, oil and other commodities.
The Yale Model
This is close to how large endowments are managed at universities across America. For example, below is the asset allocation for Yale University which was described in a recent New York Times article. Yale’s endowment has grown at an annual compound rate of 16% from $1.3 billion in 1986 to $14 billion in 2006.
Real Assets 7.8%
Hedge Funds 23.3%
Private Equity 16.4%
Foreign Equity 14.6%
Domestic Equity 11.6%
Fixed Income 3.8%
Cash 2.5%
At this stage in the cycle and accepting that most investors will have less access to hedge funds and private equity, my preference would be to allocate more to U.S. and foreign equities and to have a larger cash position than the Yale model.
A Process to Filling Your Allocations
The next step is to fill your allocations with appropriate ETFs. Here is the selection process we use that might serve as a model.
First, you need to look at the fundamentals of the top 5-10 companies in the ETF you are considering. These include the composite price to book, p/e ratio relative to other companies and countries. We call this the ETF XRAY.
Next, consider price momentum looking at 50 and 200 day moving averages. Then consider where top global managers are putting their cash to work and where in the world net cash inflows and country and sector allocations are increasing.
You also need to look at the big picture macro economic factors such as interest rates, currency, fiscal discipline and economic growth rates. The direction and pace of this
Variables is more important where you sit. Political developments and events such as elections and market reforms are also crucial.
Finally, consider technical factors such as Point & Figure charts as the ultimate test, times, and to determine where their support could be levels.
Introduction of a risk management system
In order to manage risk and to decide when to sell a position with a clear and disciplined.
Have a maximum 10% position in any one ETF with a 5% cap for emerging markets.
Sell an ETF position if it falls below 200 day moving average or if it falls 8% below its trailing high. Purchase put options on ETFs when available and appropriate. Use modest levels of inverse, sector, precious metal, currency ETFs to buffer your overall portfolio. Rebalance annually to take some gains off the table.
Finally, use the discipline of limiting your portfolio to no more than twenty ETFs. Fifteen ETFs is probably a pretty good number with five 10% positions and ten 5% positions. This avoids the problem of having too many positions in your portfolio since this dilutes the contribution of your best performing ETFs. Having a limit also forces you to sell an ETF before adding an ETF.
Case Study: Brazil
How does this whole process work? Here are two examples for the Brazil (EWZ) and Sweden (EWD) ETFs during 2006.
For Brazil in early 2006 the international fund flows were positive with global equity managers moving to overweight positions and nice net cash inflows. The macro fundamentals were also positive with 3% inflation, foreign exchange reserves $100 billion, $46 billion trade surplus and interest rates high but beginning to fall. The Brazilian companies in the ETF were trading at just over 10 times earnings and the technical chart was also promising. The re-election of President Lula and continued market reforms was anticipated with a fair amount of Trust. ETF Brazil was 45.4% in 2006
Case study: Sweden
In the Swedish case, the flows of international funds have been positive and the macro. Fundamentals impressive: strong fiscal discipline, inflation of 2%, slowly rising interest rates leads to a rising currency. The top ten holdings of the ETF Ericsson (21% guided) has shared a good balance between capital, technology and banking. The relative valuation of investments was only 12 times earnings.
Technical factorsEWD fixed price listings were positive momentum. Politically, introduced in the upcoming elections, the coalition of Mr Reinfeldt's center-right platform of tax cuts and privatization East seems a good chance of victory. The Ishara Sweden was 25% in 2006 and is still strong.
You can see that ETFs give as one of the most important investment vehicles for individual investors the opportunity to build world-class global portfolio that until recently were the responsibility of only the largestand most sophisticated institutional investors. For example, there is a team of 100 money managers that oversea the Yale University endowment and a sizable staff that oversees the investment process.
Getting Some Help
If you think you might need some help in putting together your ETF portfolio, I encourage you to go to [http://www.ETFarchitect.com] for Chartwell portfolio consulting options. Or you may just wish to have us manage your ETF portfolio and will find at this website some preliminary information on this option as well. Please don’t hesitate to call me directly at 719-264-1503 to discuss your personal situation.
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