ETF Plays To Heed Bill Gross’ Warnings

by on September 10, 2012 | Updated September 24, 2012 | ETFs Mentioned:

Since the unprecedented financial crash of 2008, investors have witnessed some of the most radical and controversial practices being adopted by our central bank to save our sputtering economy. Perhaps the most sensational of the measures taken were the infamous quantitative easing programs, where the Fed proceeded to “monetize” the debt by printing  massive amounts of money. In addition, interest rates have been slashed to record low levels – to an unthinkable zero percent interest rate. And given the fact that the U.S. economy is still sluggish at best, many experts are weighing in on the various asset-purchasing programs and whether or not they agree with the action of the Fed [see also ETF Profile: Credit Suisse 130/30 (CSM)].

Those who have spoken out against the Fed include none other than the legendary Bond King himself, Bill Gross. Gross warns that the Fed’s rampant money printing and zero-percent interest rates are actually hurting the economy, not helping it. The logic behind his argument is actually quite simple. Low interest rates create low spreads, making credit lending no longer profitable. And when creditors are in this type of environment, the system will stall or perhaps even tip over.  Gross explains that “A lender will not easily lend money to an obese over-indebted borrower — that much is clear — but she will also not extend a check when the yield, carry and return on investment is so low that it cannot compensate for historic business model overheads.”

All of us have already witnessed what happens when the credit valve is shut off: liquidity dries up, real returns are eaten away, and the economy struggles to pull itself out of the rut. And although many analysts would agree that QE1 actually helped boost the economy when this happened, it is widely believed that the programs that have followed have been considered failures. For those who are putting all their eggs in one basket, hoping for the Fed to whip out yet another quantitative easing program, Gross warns that this could have catastrophic impacts on bottom line returns if one is not careful. “The age of credit expansion which led to double-digit portfolio returns is over. The age of inflation is upon us, which typically provides a headwind, not a tailwind, to securities price – both stocks and bonds,” states Gross. Furthermore, the Bond King predicts that investors should expect overall returns of an average 3-4% annually, with inflation of course eating into the real return of the investment.

As the manager of largest bond fund in the world, it is hard to disagree with Mr. Gross on his opinions and theories of the current economy. But with his prediction of both stocks and bonds struggling due to the Fed’s policies, where can investors turn to for any kind of real return? But of course Gross has several suggestions for those who share his bearish outlook: minimize fees and balance your asset mix according to your age. And thanks to the rapid evolution of the ETF industry, there are already a slew of products that meet Gross’ requirements all through a single ETF ticker [see also How To But The Right ETF Every Time]:

  • iShares S&P Target Date ETFs: These hands-free portfolios are essentially designed to shift asset allocations with an investors’s changing risk profile. For example, as an investor approaches his or her retirement, a higher allocation will go to fixed income products, while a younger investor would have a heavier weighting towards equity exposure. With expenses ranging from a low 0.29% to 0.31%, investors can choose from a number of target retirement dates: 2015 (TZE), 2020 (TZG), 2025 (TZI), 2030 (TZL), 2035 (TZO), and 2040 (TZV) [see also Visualizing Target Retirement Date ETFs].
  • Aggressive ETFs: For those investors who are further away from retirement, a more aggressive approach would be appropriate since this person has a longer time horizon over which they are able to recover value in event of major losses. ETFs that apply this methodology place higher weighting towards riskier asset classes like equities. Funds in this category include IndexIQ’s IQ Hedge Multi-Strategy Tracker ETF (QAI), iShares’ S&P Aggressive Allocation Fund (AOA) and PowerShares’ Autonomic Growth NFA Global Asset Portfolio (PTO). It should be noted that QAI and PTO are on the more expensive side, but AOA charges only 0.34%.
  • Conservative ETFs: This investment style is more appropriate for investors who are nearing retirement and wish to allocate their assets towards safer segments of the market. iShares’ S&P Conservative Allocation Fund (AOK) is designed to give investors a tilt towards fixed income and away from equities. AOK is also relatively inexpensive with its expense ratio of only 31 basis points.
  • Moderate ETFs: For those investors who are considered to be neither “young” nor “old,” a strategy that has a healthy mix of both equity and fixed income exposure is more ideal. Currently there are five ETPs that follow this methodology: iShares AOM and AOR, Powershares’ PAO and PCA, and Goldman Sachs’ GCE.
Although these products do fit Gross’ bill of requirements, it should be noted that risk tolerance concepts and objectives vary from investor to investor, so using a “one size fits all” approach might not be advisable. Investors will want to use other products to fine tune the risk/return portfolio these fund offer.

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Disclosure: No positions at time of writing.