Thursday, July 5, 2012

ETF tips from the rink: Handy hockey tactics for portfolio construction

In hockey, as in portfolio management, offense is not always the best defense. Coaches know what investment professionals too often forget: a balanced two-way capability is usually most effective.
Constructing a portfolio, like drafting and coaching a hockey team, demands a fundamental understanding of what it takes to win. Portfolios built strictly to maximize gains are akin to lineups consisting of five forwards. Any coach knows that’s risky. Investment advisors could learn something from hockey tactics, particularly when facing big volatile markets that can slam any game plan into the boards.
Getting the right lineup on the ice at the right time is a coach’s primary job. If you wish to manage tactically for your clients, here are two ideas to help exploit game situations.
Battle for control
If the puck is in the neutral zone and control is at issue [DASH] trendless market, lacklustre economy [DASH] a balanced attack with a defensive emphasis may be suitable.
One strategy involves a 1-2-2 with one forechecking forward, two supporting forwards and two defensive players back. This approach was popular with Jacques Lemaire when he coached the Wild and Devils.
Diversified exposure to global and international economic growth is a good objective for the forechecking forward position. The support can be broad Canadian and U.S. equity exposure (see “1-2-2 Forecheck,” this page). There’s a lot of choice for defence. Mid-term and laddered options are versatile and broad-based bond exchange traded funds (ETFs) can anchor the blue line. Short target maturity ETFs like RBC Target 2017 (RQE) and short term index-based ETFs could act like a hard-checking defence that minimizes risk around the net.  
Green light
When playing opportunistically [DASH] low volatility, upward trending stock market, and a positive economic backdrop [DASH] coaches may favour an aggressive 2-1-2 structure with two penetrating forwards on forecheck, supported by a forward and a rushing pair on defence. This tactic makes best use of goal-scoring skills and was favoured by Scotty Bowman with the Habs in the 1970s and Mike Babcock with the current Red Wings. Ironically, Lemaire played on many Scotty Bowman teams!
Attacking forwards can include aggressive ETFs for broad scoring punch, including emerging markets, growth, and small-cap strategies [DASH] think Guy Lafleur and Evgeni Malkin (see “Aggressive 2-1-2,” this page). More concentrated exposure from country, region or industry-specific ETFs is also possible, like BMO Junior Oil (ZJO), BMO Junior Gas (ZJN), iShares Latin America (XLA), Claymore China (CHI), iShares MSCI Brazil ( XBZ), iShares S&P CNX Nifty India (XID). 
Broadly-based exposure to technology-rich NASDAQ or Russell 2000 ETFs offers good support. Rushing defensemen with offensive potential like Bobby Orr, or currently Drew Doughty (Kings) and Kris Letang (Penguins), include high yield and convertible bond funds. Long-term corporate bond funds may be good for a quick shift if you expect corporate-government yield spreads to narrow [DASH] iShares IG Corporate Bond (XIG), BMO Long Corporate Bond (ZLC), Horizons Corporate Bond (HAB) and any of the longer-dated target bond funds RBC Target 2020 or 2019 (RQH, RQG), BMO 2020 or 2025 Corporate Bond (ZXC, ZXD) (see “Rushing defensemen,” this page).
This is clearly an aggressive lineup with obvious risks. If the market turns nasty, the portfolio is vulnerable and may be caught “up ice”. The only stopper is the goaltender (cash and cash equivalents). Nimbleness is required to shift sufficient assets to cash if this occurs.
Conclusion: Puck control
Controlling the puck is important, but not always possible. Similarly, controlling portfolio risk is essential, but from time to time the market dominates [DASH] usually on the downside. Having specific tactics for different market environments can be an effective way to respond.

Next time: the neutral zone trap, the chip and chase, and goaltending.

Thanks to Dr. Jim Sugiyama, hockey savant, for his valuable contribution to this article.

TABLE 1: HED: 1-2-2 Forecheck

Fore-checking forward
Supporting forwards
iShares MSCI World (XWD)
iShares S&P/TSX Capped Composite (XIC)
Claymore 1-10 year Laddered Government Bond (CLG)
Vanguard MSCI EAFE (VEE)
Horizons S&P/TSX 60 (HXT)

Vanguard Canadian Aggregate Bond (VAB)
BMO International Equity (ZDM)
iShares S&P/TSX 60 Index (XIU)
iShares DEX Universe Bond (XBB)
BMO Dow Jones Canada Titans (ZCN)
Claymore 1-5 Laddered Corporate Bond (CBO)

Vanguard MSCI US Broad Market (VUS)
Powershares 1-5 Laddered Investment Grade Corp. (PSB)

BMO US Equity hedged (ZUE)

iShares S&P 500 (XSP)

TABLE 2: HED: Rushing defensemen

TABLE 3: HED: Aggressive 2-1-2

Attacking forwards
Supporting forwards
Rushing defensemen
Vanguard MSCI Emerging Markets (VEE)
Powershares QQQ (QQC)
Claymore Advantaged High Yield Bond (CHB)
iShare Dow Jones Canada Select Growth (XCG)
iShares NASDAQ 100 (XQQ)
iShares US High Yield Bond (XHY)
iShares S&P/TSX Smallcap (XCS)
iShares Russell 2000 (XSU)
Powershares Fundamental High Yield Corporate (PFH)
Claymore BRIC (CBQ)
BMO High Yield Corporate Bond (ZHY)
BMO Emerging Markets (ZEM)

Claymore Advantaged Convertible Bond (CVD)
Claymore Broad Emerging Markets (CWO)

Convertible bond XTF (CXF)
Horizons North American Growth (HAW)

iShares JP Morgan Emerging Markets Bond (XEB)

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