iSectors CEO Vern Sumnicht recently sat down with ETFdb.com and shared his thoughts on his new ETF, the iSectors Post-MPT Growth ETF. We discuss how the ETF improves upon the principles of modern portfolio theory, and how investors can utilize it to generate higher risk-adjusted returns. Vern also shares his thoughts on how investors can navigate the volatile markets in 2017.
ETFdb.com (ETFdb): Please tell us a little about yourself.
Vern Sumnicht (V.S.): I am the founder and CEO of iSectors, an SEC-registered investment advisor that provides a comprehensive suite of 14 proprietary exchange-traded fund (ETF)-based asset allocation models and services.
iSectors developed its suite of asset allocation models to offer advisors and their clients a broad selection of strategies, services and support to assist them in building and managing investment solutions designed to achieve a wide range of investor financial objectives. The iSectors asset allocation models are categorized by risk and return characteristics. We have ten asset allocation models including Domestic, Global, Endowment and Post-MPT Series.
iSectors launched its first ETF, the iSectors Post-MPT Growth ETF (PMPT ), in 2016.
iSectors’ ETF Strategy
ETFdb: What is iSectors’ overall strategy in the ETF space?
V.S.: The iSectors Post-MPT Growth strategy uses passive index ETFs to bring costs down and increase liquidity and transparency versus active mutual funds. The iSectors Post-MPT Growth strategy also uses a proprietary objective algorithm to optimally allocate the portfolio on a risk-adjusted return basis and to monthly re-optimize the asset allocation. Therefore, you might consider iSectors an active/passive strategist.
Our main objectives in the ETF space are to provide innovative asset allocation strategies in a disciplined, objective and low-cost way, so that investors can position their investment portfolios with low-correlation ETFs. This in turn, we believe, will help improve investors’ risk-adjusted returns.
ETFdb.com’s ETF Issuers page provides you with a list of all ETF issuers. Click on any ETF issuer, such as Vanguard, and get a complete list of their ETFs. You can find (PMPT ) under Virtus’ issuer name.
Improving Upon the Principles of Modern Portfolio Theory
ETFdb: What inspired the creation of the iSectors Post-Modern Portfolio Theory Growth ETF (PMPT )? How does PMPT (PMPT ) utilize modern research and technology to build and improve upon the principles of Modern Portfolio Theory in order to maximize risk-adjusted returns?
V.S.: The iSectors Post-MPT Growth strategy was inspired by my effort to improve the investment results for wealth management clients at Sumnicht & Associates, LLC. Academic research published since the 1950s was clear on issues and changes that should be addressed. iSectors resulted from an effort to implement the changes suggested by the latest academic research. The iSectors Post-MPT strategy utilizes advancements in Modern Portfolio Theory (MPT) – by including behavioral finance research – to allocate the portfolio among up to nine unique, uncorrelated asset classes which include basic materials, energy, financials, healthcare, real estate, technology, utilities, gold and Treasury bonds.
The underlying fundamental principles upon which the iSectors Post-MPT models have been developed are:
- Equating risk with standard deviation implies that clients are just as concerned with an investment’s unexpected gains as they are with unexpected losses. This violates investor utility research that shows that investors are much more concerned with unexpected losses than they are by a similar amount of unexpected gains. Simply put, the real risk to an investor is losing money.
- Investors can reduce their investment risk through diversification by allocating to asset classes that have a low correlation to one another.
- The economy, investment markets and investment portfolios are all affected by more than the three factors of standard deviation, expected return and correlation. Therefore, asset allocation algorithms should consider additional relevant capital and economic factors when attempting to determine a portfolio’s optimal asset allocation or rebalancing decisions. A few obvious examples of relevant factors would be interest rates, inflation, GDP, unemployment and money supply.
- Lower-cost vehicles, like ETFs, now offer investors a 2% to 3% lower total annual fee structure than managed equity mutual funds. The savings generated can improve client returns over time.
An ETF for Risk-Averse Investors
ETFdb: What type of investor should hold this ETF? Which market environments would PMPT outperform in?
V.S.: The iSectors Post-MPT Growth ETF (PMPT ) is appropriate for risk-averse investors seeking protection in a downturn while still benefiting from possible market gains. The iSectors Post-MPT Growth strategy has a low correlation to stocks and bonds, so it helps improve the risk-adjusted returns of stock and bond portfolios. There is some monthly portfolio reallocation which can cause turnover. This can lead to capital gains tax. Qualified portfolios can avoid capital gains.
However, I personally believe the potential tax is overwhelmed by the portfolio returns. I think using the iSectors Post-MPT Growth strategy makes a great stand-alone core portfolio investment.
Since its inception in February 2005, iSectors Post-MPT Growth Allocation has shown relative outperformance in nearly all market environments, with one exception. At times, when equity markets make sharp upward advances over short periods of time, such as the second quarter of 2009 or the first quarter of 2012, then the model tends to lag the S&P 500.
The iSectors Post-MPT Growth strategy employs a new and unique algorithm for asset allocation of investment portfolios versus the traditional mean-variance optimization allocation algorithm. The iSectors Post-MPT Growth Allocation improves upon the traditional mean-variance optimization approach to asset allocation.
Passive Index Investor Actively Allocating Among Sectors
ETFdb: Passive ETFs are praised for their low fees, transparency and tax efficiencies, as well as their ability to outperform actively managed ETFs after costs. Given that (PMPT ) is an actively managed ETF, where do you stand in this active versus passive debate?
V.S.: There are three methods for a manager to add value to a portfolio: security selection, market timing and asset allocation. Active managers utilize security selection and/or market timing in the pursuit of alpha, or returns in excess of a benchmark index. However, the risk of an active management approach is that active managers could significantly underperform the benchmark. Passive investors often invest in an index that replicates the investment weightings and returns of its benchmark index.
iSectors Post-MPT Growth is an asset allocation strategy whose goal is to provide better risk-adjusted returns through better asset allocation. The quantitative model determines an allocation among as many as nine low-correlated market sectors based upon changes in the capital market and economic data on a monthly basis. Each month when the sectors are selected, iSectors allocates to these sectors by utilizing passive sector-indexed ETFs. Thus, there is no active management risk or cost within the investments held.
Because the asset allocation is re-optimized monthly, it may have the “look and feel” of a tactical model, but it is not a sector rotator, momentum strategy, trend follower, market-timing or econometric model. Post-MPT strives to provide optimal risk-adjusted returns through asset allocation. Therefore, iSectors Post-MPT Growth strategy is a passive index investor, but we are actively allocating among the sector indexes.
Future of the ETF Industry
ETFdb: Back in 2010, there were roughly 900 ETFs; in 2016, there are 1900+ ETFs competing for more than $2 trillion dollars in the United States alone. How do you see the ETF industry evolving over the next five years?
V.S.: There may be $2 trillion invested in 1900+ ETFs, but I believe the transition from mutual funds to ETFs is still in the early stages. To date, most ETFs are index funds, and most of these are equity indexes. There is still a need for more fixed-income ETFs, ETFs of alternative investments and especially active and active/passive ETFs.
As more advisors and investors research the structure and cost advantages of ETFs versus mutual funds, the ETF advantage will become more widely understood and accepted. This will continue the trend of more ETFs being introduced and more investors moving out of mutual funds and into ETFs.
Mutual funds are simply too inefficient. Their fees (expense ratios) are too high, they have hidden costs in them that are legally not disclosed in the form of commissions, and you can end up on the hook for taxes even if you don’t realize any gains.
Our analysis agrees with most other analysts that, on average, investors can save 2% to 3% annually using ETFs in a portfolio versus mutual funds, and this can save investors a substantial amount over a lifetime of investing. The challenge for the industry is to find ways of being profitable in an investment world of lower fees. Yet, great opportunities lie in developing low-cost actively managed ETFs. As for demand, very little 401(k) money has moved to ETFs. I think I would be safe in betting that over the next five years, 401(k) plans will move in earnest to ETFs and away from mutual funds, which could grow the ETF industry by trillions of dollars.
For a full comparison of ETFs versus mutual funds, read ETFs vs. Mutual Funds: Fees and Expenses.
Navigating Global Uncertainty
ETFdb: There is significant global uncertainty in the financial markets currently. Examples include the election of Donald Trump, the Brexit fallout and the Italy referendum, to name a few. What is your advice to investors and advisors on ways to best navigate this uncertain financial landscape in 2017?
V.S.: We are likely in the late stages of an economic recovery that began in the second quarter of 2009.
There are several uncertainties facing the global financial markets in 2017, as you mentioned.
The number one principle to remember when investing in a volatile market environment is diversification. We would also suggest that investors own gold and/or silver as insurance against currency risk.
We believe there are also opportunities in financials, infrastructure, energy and technology equities. Investors should avoid bonds, healthcare and international equities.
A number of technology companies have been moving offshore to avoid the 35% state and federal U.S. tax rates on corporations. We believe that President Trump will succeed in lowering corporate tax rates and improving the regulatory environment for technology companies. An improved regulatory environment and lower corporate tax rates could improve tech companies’ earnings and reverse the offshore flows of capital, jobs and brain power. Therefore, we suggest overweighting the technology sector in investor portfolios.
Corporate and individual tax reductions will provide enough fiscal stimulus to allow the Federal Reserve some room to raise interest rates beginning this year. In a rising interest rate environment, financial securities do well, while bonds, especially longer maturities, lose value. Therefore, we are overweighting the financial sector and underweighting longer-term bonds.
Mr. Trump has expressed his support for the energy industry. His policies are likely to improve the outlook for energy companies in the U.S.; therefore, investors should consider overweighting energy equities in their portfolio.
President-elect Trump has discussed significant investment in improving U.S. infrastructure. He plans on funding some of this investment in infrastructure by offering companies, with a reported $3 trillion offshore, a one-time tax amnesty. This would allow the repatriation of these dollars at a 10% tax rate. If 66% of that money was repatriated, we would have $200 billion available to improve U.S. infrastructure. Along with financial and energy equities, investors may want to consider overweighting infrastructure equities as well.
Until we can get more transparency regarding specific health care reforms, we would suggest underweighting health care, and until the EU addresses its banking issues, we would also underweight the international markets.
Despite the potential uncertainty and market volatility, now is not the time to sit in cash. We believe 2017 will be a positive year for the U.S. stock market.
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The Bottom Line
The iSectors Post-MPT Growth ETF (PMPT ) is appropriate for risk-averse investors seeking protection in a downturn while still benefiting from possible market gains. iSectors Post-MPT Growth is an asset allocation strategy whose goal is to provide better risk-adjusted returns through better asset allocation in as many as nine low-correlated market sectors.
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