Originally published as a letter to clients on 9/8/2022.
Investors have a lot of choices. They can invest in stocks, bonds, mutual funds, and exchange traded funds (ETFs). They can invest in passive indexes or with active managers. They can pick from an almost unlimited number of investment styles (growth, value, international, small-cap, etc.)
When it is time to put an investment plan together, most investors use a strategic approach. An investor may allocate a certain percentage of their portfolio to bonds and a certain percentage to equities. They determine what types of investment styles and instruments to use. Over time, the portfolio is rebalanced and new investments may be added. The goal of strategic investing is to maintain an allocation and ride out any downturns with the prospect of achieving long-term positive results.
Strategic investing is what we do at NBZ, and over long periods of time, we believe the results have generally met our expectations. There are some drawbacks to strategic investing, though. In a prolonged downturn, your investment balances will decline. You can lose money, sometimes a lot of money. It is easy to get discouraged and forget the long-term benefits when both stocks and bonds are down double digits, and your portfolio is down more than ??%. In retirement, losses can seem magnified, because you might not have time to see those long-term benefits.
There is another approach to investing that we believe can complement strategic investing. It is called tactical investing, and it is more focused on the short to medium term than the long term. Tactical investing responds to market conditions, and changes the investment mix to meet those market conditions. In many ways, it follows the old adage, buy low and sell high. We looked for tactical mutual funds and ETFs that had lower losses than the S&P 500 in down periods and positive returns in up periods. Our goal in identifying sound tactical investments was not to “beat” the market. Instead, the goal was solid long-term performance without the short-term drastic downturns.
Here is a brief description of three different tactical investments that use very different approaches with the goal of minimizing losses and making positive long-term returns:
T. Rowe Price Capital Appreciation
This is classified as a balanced fund (stocks and bonds) and we have owned it in most portfolios for years. As of 9/8/2022, Morningstar ranks it as the #1 balanced fund for the last 3, 5 ,10, and 15 year periods. One of the reasons we believe the fund has had such positive results is the tactical approach the manager, David Giroux, takes. David increases or decreases his equity exposure based on market valuation and economic factors. For example, in late 2019, when the PE ratio of the market approached 25, David reduced equity exposure from the standard 60% to 45%. In March 2020, after the initial Covid panic and 35% losses, he increased equity exposure to over 70%.
Over its long history (started in 1986), T. Rowe Capital Appreciation has outperformed down months in the S&P 500 89% of the time. In down periods for the S&P 500, the fund lost only 46% of the loss of the S&P 500. In the 15-year period ended June 30, 2022 the S&P 500 returned an annualized percentage of 8.54%. The fund over that same period returned 8.64% (net). This fund will be the anchor of our tactical allocation.
Fairlead Tactical Sector ETF (TACK)
Unlike the T. Rowe fund above with its impressive history, TACK is a brand new ETF, started in March 2022. The manager, Katie Stockton, has been using the methodology behind the fund for many years, however. Her approach is relatively simple. Using various market tools over multiple time frames, she aims to determine if the market is “risk-off” (with a negative bias) or “risk-on” (with a positive bias). When the market is negative, she invests in items such as treasury bonds, utilities, gold, energy, and consumer staples. When the market is positive, she invests in items such as technology, consumer discretionary, industrials, and health care.
Given the data available to us and through our research, we believe this ETF may provide increased protection from negative market volatility while still providing potential for positive returns during upmarket swings. As an example, in the second quarter of this year, the S&P 500 was down 16.10%. TACK was down only 6.26% (net).
Amplify CWP Enhanced Dividend Income (DIVO)
DIVO is an ETF that owns high quality companies with a history of dividend growth, along with a tactical covered call strategy. DIVO sells call options on the stocks it owns to generate additional income. The tactical part of the strategy is when the calls are sold. Option sales bring in option premium. In stable or rising markets, premiums tend to be modest. When the market is volatile or declining, premiums increase. DIVO sells most call options during these periods. This increases income, and has the effect of limiting downside risk.
DIVO has a 5.5-year history. In that time period, in months when the S&P 500 was negative, DIVO outperformed 68% of the time. At 6/30/22, with the S&P 500 down 19.96% for the year, DIVO had declined 10.01%. For the five year period ended 6/30/22, DIVO had an annualized return of 11.43% (net) versus the S&P 500 return of 11.31%. We believe DIVO can produce high income (4.5%+) with limited downturns and positive long-term performance.
How Will We Use the Tactical Investments?
Most portfolios will have some or all of the funds above as part of your allocation. For those who are not in or near retirement, a typical 60% stock, 40% bond allocation will have approximately 35% of your equity allocation invested in tactical funds. For those who are in or near retirement, with a 60% stock, 40% bond allocation, the tactical allocation will be approximately 45% of your equity allocation. We think almost everyone can benefit in the short-term and long-term with a dose of tactical investments. Please contact us if you want to discuss these new investments and their inclusion in your portfolio.
You might notice some trading activity in the coming weeks. Most of that trading will be to rebalance and reconfigure allocations for the new tactical investments. You might see some funds being sold that have losses. In most cases, we are using the losses to offset gains in other funds we are trimming. We intend to buy back the majority of the loss funds after the 30 day wash period is over.
Disclosures
The opinions expressed are those of NBZ Investment Advisors, LLC (“NBZ”). The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.
The holdings identified above are examples of holdings and are subject to change without notice. The holdings have been selected to help illustrate the investment process described herein. A complete list of holdings is available upon request. This information should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the holdings listed have been or will be profitable, or that investment recommendations or decisions we make in the future will be profitable.
Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Any investment strategies presented may not be appropriate for every investor and individual clients should review with their financial advisors the terms and conditions and risk involved with specific products or services. As with all investments, past performance does not indicate future results. Investing involves risk including the potential loss of principal. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income.
The S&P 500 Index is the Standard & Poor’s Composite Index and is widely regarded as a single gauge of large cap U.S. equities. It is market cap weighted and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization.
NBZ is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about NBZ’s investment advisory services can be found in its Form ADV Part 2, which is available at nbzinvest.com or by calling (865) 584-1184. NBZ-22-04.