My partner and I decided to set up a small business in 2008
which would help people invest. We grandly decided to call it
Independent Research Partners and in keeping with our Asian roots,
we called our product "Fund King". The name was inspired by and
sounds similar, in Mandarin, to our company name in Chinese.
Our original concept was to help Taiwanese investors navigate
through the maze of nearly three thousand mutual funds that are
licensed for sale here. While Morningstar does have a fledgling
presence here, no one is really looking at the investment universe
as a whole. As a result, clients are confused and their investment
results have been less than stellar of late (actually since about
And what do the clients want? Having worked with Taiwanese
customers extensively for many years, we were already well aware of
their main criteria: "Make me money!" OK, perhaps a bit blunt but
then again, isn't that why people invest? Our experience over the
last 18 months has convinced us that the criteria remains
So why ETFs? After getting the Taiwan Fund System set up, a
number of our clients asked us if we could apply our "System" to
other markets. Since our System was designed to work on
international mutual funds, it was not a very big step to
A system, you say? Yes, but we think our take on it is a little
different from your average turbo charged quant product. We wanted
a system that would work for a wide variety of investors, all of
whom have different long term investment goals.
How do we approach things? In a fairly standard manner, with a
few twists. We divide the investment process into two parts: Asset
Selection and Asset Investment.
Asset Selection -
In this first part, we define an "asset universe". To make this
more concrete, I will share my asset universe at the end of this
post and track it on a weekly basis. The idea behind the "asset
universe" is to pick assets that I would like to own under a
variety of investment conditions. Sometimes, Gold is hot...at other
times, it might be China or European stocks or Government bonds.
The key thing is to pick assets that YOU feel comfortable with.
Comfort level is as important as investment case because we are
trying to reduce the emotional component of investing to the lowest
possible level. To demonstrate, when I first set up my ETF
Portfolio (35 ETFs) in early 2008, I included [[EWP]] and [[XHB]],
Spain and Home Builders respectively. At the time, I thought that
these two asset classes had been clobbered and would bounce
strongly at some point in the future. I was right of course but
when the System flashed a switch into them, I hesitated.
More importantly, I made the same mistake twice. In each case, I
ignored the system at first, panicked and bought after the ETFs had
risen and then, after the system recommended a switch into more
promising assets, I hung on for too long hoping to get back to
even. By picking assets that were "marginal" for me, I managed to
defeat the system that we had spent so much time building. The hit
to my pride was much bigger than the monetary hit, fortunately.
So, I went back and took out the assets that others had
suggested were a good idea or that I had added to make my portfolio
more "balanced". US Microcaps are a good example. Is there anything
wrong with them? No. Will they outperform at some point over the
next two or three years? I am pretty sure they will. But when IWC's
number comes up, will I hesitate and second guess? Hmmm...Let's
make room for something I am more comfortable with.
Asset Investment -
Now that we have a universe we are comfortable with, how do we go
about investing in it? Rather than follow the traditional method of
spreading our money as thinly as possible and rebalancing on a
regular basis, we wondered what would happen if we periodically
ranked and selected the most promising 15% of our universe and
invested only in those. Rebalancing would not be a top slicing
issue but rather we would switch out of one position when another
asset class started to look more promising on a subsequent
reranking. There are literally thousands of ways to approach this
so we chose a very simple Relative Strength method and applied it
in a manner likely to rank our assets on a medium term (3-6 month)
The goal is to buy a promising asset, hold it as long as it
looks better than the alternatives and switch into something more
promising when the opportunity arises. After all, isn't that what
investing is supposed to be about? The trick is to systematize
those decisions so that we don't need to reinvent the wheel each
time and we do not get sideswiped by emotional considerations.
What about hedging and risk budgets and efficient investing
frontiers? These were all high end concepts that I had dealt with
when designing and repairing quant funds in a previous incarnation.
While the theory and math behind them are impressive, I noticed two
problems with these complex investment systems: they lagged on the
upside and they failed to provide the amount of asset protection
promised on the downside. My conclusion? By trying so hard to
reduce risk, these funds failed to perform in line with my
expectations (as well as my clients at the time).
Rather than always seeking to eliminate risk, why not accept
that investment is risky (substitute "volatile", if you prefer) and
proceed accordingly. As such, while our system is crude, one can
characterize it as a risk-on, risk-off investment signal. When risk
appetite is high, asset classes like emerging market equities will
dominate the top of the rankings. When global risk appetite is low,
government bonds and cash-like asset classes will float to the top
as risky assets rank lower.
Is the system ever wrong?
Actually the System is designed with failure in mind. As an
asset class gains momentum it moves up the rankings until it
reaches our predefined threshold (top three out of 20 in the case
of this example portfolio). When it crosses that point, an existing
asset class falls below the threshold. That is the signal to switch
How does that help you when one is wrong? Because one is
reranking the assets on a periodic basis (say, once a week), the
Fund King System is constantly checking one's assets against each
other. If a certain asset class starts to lose momentum, it will
lose its top ranking and be replaced by a more promising asset.
Does this happen instantly? No. What if all the risky assets are
showing weak relative strength? Then the money market assets will
move to the top rankings. So, the System can be wrong, but it is
unlikely to remain wrong for long and its ranking mechanism is
designed to provide self correcting feedback to the system.
The bottom line - does it make money?
In our experience, the two part system can produce solid long
term results. What do we define as long term? 5 years. What is
making money? More than 100% over that period which translates into
a compounded return in the high teens annually. Do all of our
portfolios produce these results? No, and in our experience, the
primary reason for failure is tied directly to the asset selection
part of the process. It seems that no system, no matter how good
you might think it to be, can improve performance significantly if
the underlying assets are crummy.
But, I think a better answer may be to track my ETF portfolio
through this blog. That way, you can watch over my shoulder as the
Fund King System reacts to the changing financial market
conditions. There is always a bull market somewhere and when there
isn't, we can always hide in cash.
- [[SPY]] - US Equity Market
- [[FEZ]] - European Equity Market
- [[EWH]] - Hong Kong Equity Market
- [[EWY]] - Korean Equity Market
- [[EWT]] - Taiwan Equity Market
- [[IXC]] - Global Energy Sector
- [[IXG]] - Global Financial Sector
- [[XPH]] - Pharmaceutical Sector
- [[EWZ]] - Brazilian Equity Market
- [[RSX]] - Russian Equity Market
- [[EPI]] - Indian Equity Market
- [[FXI]] - Chinese Equity Market
- [[EWW]] - Mexican Equity Market
- [[TUR]] - Turkish Equity Market
- [[TLT]] - 20+ Year US Treasuries
- [[FXY]] - Japanese Yen
- [[FXE]] - European Euro
- [[FXA]] - Australian Dollar
- [[DBA]] - Agricultural Futures
- [[GLD]] - Gold
As a demonstration, I plan to update this "story of an ETF
portfolio" on a weekly basis. In order to add some comment points
for readers, I plan to add observations about why certain ETFs are
ranking higher than others. If you have suggestions, comments or
criticisms, please chime in.
For next week, I will also start to delve into why I chose the
ETFs that I did.
I am long the top three ETFs in the rankings which are [[TUR]],
[[EWH]], and [[EPI]].
Handling China With Care: ETF Pullback Choices