ETF Expert Corner

Transcript

You can listen to our interview with Chuck Self by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the iSectors Post-MPT Growth ETF. The ticker symbol on that is PMPT. Joining us via phone from Appleton, Wisconsin to discuss this ETF is the Portfolio Manager, Chuck Self. Chuck is also Chief Investment Officer for iSectors. Chuck, welcome to the ETF Store Show.

Chuck Self: Thank you very much, Nate.

Nate Geraci: Chuck, first explain to our listeners what MPT, or Modern Portfolio Theory is. Of course, there are full textbooks written on this, but what are some of the basic ideas here to understand?

Chuck Self: Modern Portfolio Theory was created in the 1950's. The father of MPT is Harry Markowitz from The University of Chicago, and he won a Nobel Prize by it. It's the basis of which all modern investing is done. Some of the aspects of Modern Portfolio Theory are that investors are risk adverse, and thus if they're going to take more risk, they're going to want to get more return. Secondly, that the markets are efficient. For the most part, the stock price reflects all the information that is known about stocks, and that portfolios, as a whole, are more important than individual stocks. Asset allocation between stocks or between sectors is more important than focusing on individual stocks and creating a portfolio.

Nate Geraci: Okay, and so then what is Post-MPT, or Post-Modern Portfolio Theory?

Chuck Self: Well, Post-MPT, and most Modern Portfolio Theory came about because there were chinks in the armor of MPT. It came mainly from the study called, "Behavioral Finance," that was developed in the 80's and 90's. Some of the things that Post-Modern Portfolio Theory believes is that the fear of loss is exponential. In other words, the more you lose, the even more you're upset about it. Investors care much more about losses than they do about gains. They feel more hurt by losses than the satisfaction they get by gains. The other thing is that risk is relative for every person. It's not the same for every person, so you always have to figure out what risk is for your client. Then, finally, that risk is not symmetric, meaning that in all portfolios, you either have more of a chance of upside risk or downside risk, and you want to create portfolios that have a greater chance to take on upside risk, or a greater chance to get gains.

Nate Geraci: Again, we're visiting with Chuck Self, Chief Investment Officer at iSectors. We're spotlighting the iSectors Post-MPT Growth ETF, ticker symbol PMPT. All right Chuck, let's talk about this ETF. Explain to us what it holds and what it's designed to do.

Chuck Self: The objective of a PMPT is to reduce the chances of losses. We have losses, like all securities do, but in creating the portfolio, our goal is to minimize downside risk. Our view, and the history of these kind of portfolios show that if you minimize downside risk, then you'll do very well in the marketplace. We do that by taking some of these Post-MPT theories and applying it to the portfolio. For instance, we don't measure risk as just volatility by how much the market moves in general. We only measure downside risk. One of our goals is to minimize downside risk. Also, we own portfolios that have securities that don't move in the same way that the other securities do. The statistical term is that they're uncorrelated to each other. Because of that, there's greater diversification so that when the market goes down, you have some securities that hopefully will go up. Then, finally, we do this all in a computer model so that it's not Chuck Self, or anyone on my team that determines what is in the portfolio. It's an objective model such that there's no guessing on where we expect the future returns of the different securities in the portfolios. What we do is we hold nine different sector funds. These are ETF funds, so we're an ETF of ETFs. Seven of those sectors are from the Standard & Poor 500 11 sectors. Then, we have long-term treasury bonds and gold stocks as the eighth and ninth sectors. With these nine sectors, we can create a truly diversified portfolio, and allocate between them to get with the hope of minimizing downside risk.

Nate Geraci: Chuck, are there any weighting caps on the individual sectors, or just on the broader asset classes?

Chuck Self: Yes. It's 33%, as far as the weighting caps are concerned, on any one sector, except for bonds. We could hold up to 50% in bonds. We always have three, four, five sectors represented. Most of the time we have seven, eight, or nine of them represented.

Nate Geraci: How is this ETF currently allocated? What are some of the top holdings right now?

Chuck Self: The top holding is IYE, the iShares US Energy Fund. We also have large holdings in utilities and technology in this fund. Our view is that the economy is going to continue to grow slowly, so we own securities that have a story within themselves, they're not depending on the economy to rebound.

Nate Geraci: This ETF can use leveraged ETFs as well, is that correct?

Chuck Self: Yes. The reason why we do that is because the problem with most asset allocation funds is that they have the ability to take risk off the table by going into bonds or if they go into cash, although cash is a terrible asset for an asset allocation strategy by the way. They don't usually have the ability to take advantage of very attractive market environments. Sometimes, they only go back to being a 100% in stocks. We allow the use of leveraged ETFs if we have sectors that look extremely positive in our modeling work. The leveraged ETFs can only be 33% of the portfolio. It's not a high risk situation. It turns out over time that the risk of our fund should be something close to the risk of the Standard & Poor 500. This is not a high risk fund by any stretch of the imagination.

Nate Geraci: Again, we're visiting with Chuck Self, Chief Investment Officer at iSectors. We're spotlighting the iSectors Post-MPT Growth ETF. Chuck, technically, this is an actively managed ETF, but as you mentioned, you are using a quantitative, rules-based methodology. I'm just curious, is there any manager discretion used here at all? Or, is this entirely an automated process?

Chuck Self: The active management designation is actually a technical term that the SEC uses. All that means is that we are not following some sort of standardized index fund. Unlike many other actively managed funds, there is no human intervention as far as the signals are concerned. The human intervention in the process was in building the model and in maintaining it. Once the model's been built, and it's run, then we take the results from it directly from the model, so it is ... No one has to wonder whether Chuck Self is the genius any day or not, because it's based on quantitative model. It's very important to understand this, and this is part of behavioral finance, that as human beings we are limited to our ability to process objectively information that comes in. We have all sorts of biases that we as humans use. The computational model, and we use a very 21st century statistic and computational model, doesn't do that. It truly looks at the patterns from the past using the inputs that we put into it and comes up with its best idea of a portfolio that minimizes downside risk.

Nate Geraci: Chuck, also, as you mentioned earlier, this ETF does hold other ETFs. It's an ETF of ETFs. Why did you decide this route?

Chuck Self: Because again, this is one of the positive things from Modern Portfolio Theory is that the asset allocation itself is the most important aspect in creating a portfolio. We want to allocate between sectors, we didn't want to have to choose stocks within sectors, and we wanted an indexed allocation between the different sectors. We use low cost ETFs that represent sectors in order to get the exposure. It makes sure that the portfolio is the broadest diversified portfolio it can be, because it holds all of these sector indices, and these low-cost ETFs have low fees, so that detracts less from the performance of the fund.

Nate Geraci: The stated goal of the iSectors Post-MPT Growth ETF is to outperform the S&P 500 with lower downside risk. Given that, where does this fit in an investor's portfolio? Give us some context here.

Chuck Self: Investors that we have in this strategy tend to use it as part of their equity strategy. Often they will use, if they have an allocation to equity, so say 60% allocation to equities, they'll have three of that 60% be in an index fund, an S&P 500 fund, so that they always know that they have some equity exposure. Then, they'll put 30% in a fund like PMPT because then they know that at times, when it's not worthwhile to take the risk, they'll have less exposure to the market. The financial advisors that use us do that because the most important thing is to stay in the market. Over time, the market is going to hit new highs, like it has today, but in majority of the years out there, you have at least a 10% correction, and so you got to be able to live through the corrections to be able to be there for the highs, and that's what PMPT is created to do.

Nate Geraci: With the remaining time we have on the show here today, I want to talk about the current investment environment. After Trump's election, I'm just curious, are there any areas catching your eye? Whether that be from a positive or negative standpoint?

Chuck Self: Obviously, the markets have done very well since the Trump election, and interest rates have risen because of concern that inflation is going to take place. We think the markets have overdone this reaction. Even if he gets what he wants, it's going to take a long time to go through Congress, write all the rules, and get it implemented, 2018 at the earliest. Right now, we think that treasury bonds and interest sensitive stock is on a black Friday sale here. They are so cheap because of what has happened. We think clients should be focused on treasury bonds, and also on the stock side, be focused on utilities and real estate, because both of these sectors have not done well as interest rates have risen, and yet, the economic fundamentals in these sectors are still quite attractive with the chance of rising dividends over time. This is the time to really focus on interest sensitive securities.

Nate Geraci: Chuck, any general thoughts on gold?

Chuck Self: We can have gold stocks in our strategy. Right now, the strategy does not own anything in gold stocks because again, it seems to feel that it is not going to be as attractive while interest rates are rising here. Gold doesn't pay any interest, and it doesn't have earnings power. We, as a place to hide, we would rather hide in long-term treasury bonds, utilities, real estate, and energy also. We think that people have overdone the supply concerns in the energy market, and so we've been very positive on energy, and we're happy to see that it's rebounding here.

Nate Geraci: Then, lastly here, we have about a minute left, I'm just curious, high-level, you mentioned perhaps the market's a little overdone now. As you look at valuations of US stocks, does anything stand out to you? There's been a lot of concern that maybe valuations are a bit stretched, a little bit to the high side. Do you share that view?

Chuck Self: Yes, we do. Especially in the sectors that are cyclically oriented, or that need growth from the economy, and also sectors that the hope was that the regulations would change so quickly, that they would be helped like the healthcare industry. We would avoid those sectors at the current time.

Nate Geraci: Well, Chuck, with that, we'll have to leave it there. Very interesting concept with this ETF. We greatly appreciate you joining us on the program today.

Chuck Self: Well, thank you very much, Nate.

Nate Geraci: That was Chuck Self, Chief Investment Officer at iSectors. Again, the ETF is the iSectors Post-MPT Growth ETF, ticker symbol PMPT. You can learn more about this ETF by visiting iSectorsETFs.com. That's iSectorsETF.com.