AdvisorShares EquityPro And YieldPro ETFs' Strategy
ETF providers are offering investors more and more actively managed funds -- the biggest trend in the ETF industry.
Josh Emanuel serves as chief investment officer at Irvine, Calif.-based the Elements Financial Group, with $450 million in assets. He managesAdvisorShares EquityPro ETF ( EPRO ) andAdvisorShares YieldPro ETF ( YPRO ).
EPRO launched in July 2012 and YPRO debuted on the stock market on March 7. EPRO has nearly $16 million in assets under management. Categorized as a moderate-risk fund, it returned 19% last year and 1% year to date vs. 32% and 0.9% for SPDR S&P 500 ( SPY ).
Emanuel explains the investing strategies behind these two actively managed ETFs.
IBD: What are your investing strategies? How do you go about picking the holdings?
Emanuel: In YPRO, our portfolio construction process begins with an assessment of broad market conditions such as equity market valuations, economic conditions, financial stress, fund flows, technical analysis, and the yield difference between high-yield bonds and U.S. Treasury bonds, which serves as a good indication of market risk.
Given our assessment of broad market conditions, we then seek to determine how best to allocate our assets among investments that offer the most compelling yield relative to risk. We then seek to reduce equity risk and/or interest rate risk as needed by investing in put options.
The first investment decision made in EPRO is the percentage of assets to allocate to global equity markets. We use two indicators to determine this: The 200-day moving average of the S&P 500 Index and the slope of the U.S. Treasury yield curve.
The 200-day moving average is the average price level of an investment for the past 200 days, and the yield curve is a chart that plots interest rates of U.S. Treasury bonds at different maturity dates.
If either the S&P 500 Index falls below its 200-day moving average, or if shorter-term interest rates are higher than longer-term interest rates on the U.S. Treasury yield curve, we will lower the equity allocation.
The fund is constructed to diversify risk across sectors, which results in significant differences in our sector allocation relative to the S&P 500 because indexes tend to concentrate most of their risk in a few sectors. We then make active overweights and underweights based on the 200-day moving averages of each underlying sector.
IBD: What are your buy, sell rules?
Emanuel: The buy and sell rules for YPRO are EPRO are very disciplined. In YPRO, we buy investments that provide competitive yield given the risk of the underlying investment. If the yield is no longer sufficient to compensate us for the risk that we are accepting, we will sell the security.
In EPRO, we seek to have exposure to all 10 global sectors. However, our decision to increase or decrease our weightings will be based on how the sector is trading relative to its 200-day moving average. For example, if a sector is trading below its 200-day moving average, we will typically trim our allocation to the sector.
IBD: Why is YPRO currently invested in preferred, high-yield and intermediate-term corporate bonds? And why is EPRO invested in global consumer staples, health care and basic materials? What catalysts will make them outperform other sectors?
PGX and HYLD represent two of the most attractive yield opportunities, given the risk of these positions. We prefer HYLD to indexed ETFs because we believe that the securities in the index are overbought, and the indexes have historically provided a lower yield with more risk.
Although VCIT does not provide as competitive of a yield payout as the other two top positions, it plays a crucial role in providing diversification in the portfolio, and we hedge the interest-rate risk in VCIT by buying put option(s) on other, more interest-rate-sensitive positions which are expected to gain in value if interest rates rise. We also hedge some of the equity risk in HYLD and PGX by investing in put option(s) on equity ETFs, which are expected to rise if equity prices fall.
The top three positions in EPRO areiShares Global Consumer Staples (KXI), weighted 14%,iShares Global Health Care (IXJ), 13%, andiShares Global Energy (IXC), 9%. They are exhibiting lower risk and correlation to the rest of the portfolio, and also look competitive on a technical basis.
Although EPRO is fully invested, our sector positioning is more defensive in nature, which makes sense given valuations today.
IBD: What leads you to believe that your EPRO investment strategy can beat SPDR S&P 500 over a market cycle, as well as how can YPRO can beat its bond benchmark?
Emanuel: The investment process for EPRO is entirely quantitative and rules-based, and our signals are based on considerable historical analysis. Although past performance is not indicative of future results, we continue to enhance our models to evolve to the current environment. We believe that if we can capture most of the upside in equity markets, and protect in extreme down markets, we can outperform over a full market cycle.
YPRO is constructed to deliver a level of risk that is relatively consistent with the Barclays Capital Aggregate Index while delivering a considerably higher level of yield. On a forward-looking basis, our secular outlook is for bond yields to rise, which is likely to result in negative returns for fixed income. Our ability to hedge interest-rate exposure, while seeking alternative avenues to generate yield, provides us with a significant competitive advantage relative to the index.
IBD: Are there extra tax consequences for investors?
Emanuel: There are greater tax consequences for investors in EPRO and YPRO relative to a passive ETF, but not relative to active mutual funds. Investors continue to benefit from the in-kind creation/redemption process relative to mutual funds. Given the income orientation of YPRO, investors should also recognize that the fund will make monthly income distributions, which will be taxable if the fund is held in a taxable account.