Casey Smith Positions For 2013: Passively Allocating To Long-Term Healthy Asset Classes

By Casey Smith :

This is the eighth piece in Seeking Alpha's Positioning for 2013 series . This year we have taken a slightly different approach, asking experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction.

Casey Smith is President of Wiser Wealth Management , a Marietta, Georgia-based fee-only fiduciary wealth management firm offering asset management, tax preparation, estate planning and financial planning services. Wiser's unique investing techniques have earned Casey speaking engagements at top ETF conferences around the world. When not running Wiser Wealth, Casey doubles as a pilot for an Atlanta-based commercial airline.

Seeking Alpha's Jonathan Liss recently spoke with Casey to find out how he planned to use ETFs to position clients across a range of healthy asset classes in the coming year.

Jonathan Liss ((JL)): How would you describe your investing style/philosophy?

Casey Smith (( CS )): We have a passive investment management style. However, we are always in search of new ways to best allocate to long-term healthy asset classes. We focus on building portfolios based on the client's risk tolerance so that changes do not have to be made when there is uncertainty in the market or rapid growth. This allows for broad diversification and eliminates the mistakes made in market timing.

We manage five core risk models using all exchange-traded products. Our low risk models focus on portfolio income. The more aggressive models are built for income and growth as well as pure growth. Our core philosophy is to maintain a diversified portfolio, keep costs low and always invest for the long term.

JL: As we approach 2013, are you bullish or bearish?

CS: Bullish, but not in a 1990s way. As we muddle through the fiscal cliff headlines the market will be nervous. But as we continue through 2013, I see the market overall trending upward.

JL: What are the major catalysts for markets in 2013?

CS: The Fed has shown its playbook and all the plays are pumping money into the economy as the market moves up on each announcement. The current low interest rate environment appears to be in place through 2014. Foreign markets appear to be stabilizing and US stocks are still reasonably priced. The threats that are still looming are Europe reversing course, US politicians not formulating a plan to address fiscal responsibility, and China's growth falling faster than expected. We build our portfolios on a five-year outlook. We are prepared for volatility in 2013 and are willing to give up some growth for protection to the downside.

JL: Which asset classes are you overweight? Which are you underweight?

CS: We do not manage portfolios using a sector rotation strategy, or change asset class weightings frequently. Analyzing our core models we do currently have a value tilt in US and foreign large caps. This is because of our deployment of low volatility and dividend based exchange traded funds to complement the core ETFs.

JL: To which index or fund - if any - do you benchmark your performance? Has this changed recently, and if so, why?

CS: Our clients see the S&P 500's performance on their statements as a default benchmark, as well as the Bar Cap US Aggregate Bond Index. If your investment has 30% exposure to equities then you would look at the same percentage of the S&P 500's return to give you a very general risk adjusted comparison.

Internally when constructing portfolios we will use S&P's risk based models. These models are available on the S&P website but also are the indexes tracked by the iShares risk based allocation ETFs. Those tickers are [[AOK]], [[AOM]], [[AOR]] and [[AOA]]. These are great portfolios to compare your own portfolio to. We have used this approach for many years, and I do not foresee any changes.

JL: What is your highest conviction pick heading into the new year?

CS: I like low volatility funds, such as PowerShares S&P 500 Low Volatility Portfolio ETF ( SPLV ) and iShares MSCI USA Minimum Volatility Index ETF ( USMV ), being added to portfolios to reduce volatility. These ETFs can complement a stock portfolio or simply be used to reduce core holdings in the S&P 500, MSCI Emerging Markets or MSCI Developed Europe. With the economic uncertainty around Europe and the US, I like adding these ETFs so that portfolios are still invested in equities and I do not have to add more to treasury bonds. The yields of these ETFs are attractive as a secondary objective.

It should be noted that if the market has large gains these funds will not follow, but they have outperformed the market over the last ten years. Another pick that I chose two years ago was emerging market debt. Using an ETF like iShares JP Morgan USD Emerging Market Bond ETF ( EMB ) is still attractive. Emerging market debt has stock-like performance with bond yields.

JL: Speaking of yield, where have you been having retirees turn for income in this record low rate environment? How have potential changes to the tax code affected your assessment of interest-paying investments?

CS: In early 2011 we began adding dividend-focused ETFs such as iShares High Dividend Equity ETF ( HDV ) to complement our portfolios. Adding these funds has increased portfolio yield and kept the portfolio risk virtually the same. We did not want to move out of bonds into equities to chase yield, as our mandate from the clients was not to take on more risk.

In the past idle cash would sit in a brokerage account at a reasonable money market yield. We now will use CDs and ETFs like PIMCO Enhanced Short Maturity Strategy ETF (MINT) and Vanguard Short-Term Corporate Bond Index ETF (VCSH) to put a portion of that cash to work. We do not like any products involving insurance such as index annuities. The fine print of these products is rather disturbing.

ETFs are very tax efficient with only a few passing through capital gains this year. However, the dividends and interest that our clients receive could be taxed at a much higher rate. If this becomes a reality, we then will use more Muni bonds within our models for taxable accounts. Many of our clients are retired so we hope that there is an earned income component to the higher rates.

We have several clients who saved well during their working years who are now barely keeping up with their $6,500 per month nursing home bills paid for by interest and dividends. Only a politician needing money can explain how these people get labeled as "wealthy". For our younger investors we will make sure that Roth IRAs are being used effectively as part of their saving strategy.

JL: Turning to younger investors, what is the ideal asset allocation for someone with a long-term horizon (greater than a decade) and no need to touch their investments? Can investors continue to rely on stocks for the bulk of their capital appreciation?

CS: Historical data shows us that over the last 10 years equities have not paid off in relation to their risk compared to previous time periods. This is assuming that you simply invested money ten years ago and then added no more.

However, this is generally not how young people save. Part of each paycheck goes into their 401k plan or other means of saving. The ability to purchase more stock in March of 2009 proved to be a very good investment. So, yes, stocks should be a very big part of a young person's portfolio with the benefit of dollar cost averaging. The key for these investors is to have good investment behavior and keep the cost of investing as low as possible.

I like an aggressive portfolio to look as follows:

click to enlarge

JL: How bad is the current gridlock in Washington and the uncertainty it breeds for investors? How closely do you watch political developments when formulating an overall investing thesis/asset allocation mix?

CS: There is no doubt that news headlines are affected by politicians through their actions or inactions. The debt-ceiling debacle in 2011 and now the fiscal cliff headlines add volatility to the market. As the market falls it makes investors feel bad, thus they may not buy that car, house or take that trip right away which in turn hurts the economy. A falling market applies more pressure on Washington to compromise on their agenda and to take action. Investors, especially individual investors, have to avoid this noise and focus on long term healthy asset classes. Pulling money out of the portfolio using fear as the main driver only adds to more losses.

Certainly a change to current tax laws will drive how we invest. We are a full service firm offering tax preparation, portfolio management, financial planning, 401k plans and through our attorney partner, business and estate legal advice. We understand how all of this gets funneled down to an efficient portfolio for our client. We do not make any changes based on 'noise' events, such as the debt ceiling 2011 debates. Remember that much of the market's short-term movements are based on emotions, not long-term valuations. Investors should focus on five years out. Anything you may require in less than five years should be in CDs.

JL: Which global issue is most likely to adversely affect U.S. markets in the coming year? Issues which feature prominently in our minds at present include continued Eurozone contagion risks; the Iranian nuclear threat/potential disruption to global energy markets; a Chinese economic slowdown; and accelerated climate change and weather-related events.

CS: The most negative impact on the US Markets is either an unknown event or a known event taking a turn for the worse. Investors cannot control any of this; they simply have to build portfolios with some down-side risk protection. While US treasuries are not appealing in yield, they are good at hedging risk.

JL: Do you believe gold and other precious metals are a genuine hedge in uncertain markets? If so, how much exposure do you have? If not, where are you turning for potential downside diversification?

CS: There is no doubt that when investors are fearful, gold is on their purchase list. Purchasing gold in the past certainly has produced a good return and in this environment it could move higher. However, the majority of our clients are retired and in this low yield environment I have a hard time investing in something that does not have any yield.

When gold became very popular to add to portfolios, we researched adding it to our mix. The big concern at the time was a falling dollar. We found that gold was not a perfect hedge against a falling dollar. Instead we found purchasing foreign treasuries in their local currencies was a much better investment. Using an ETF such as iShares S&P/Citigroup International Treasury ETF (IGOV) gave us this capability. IGOV at the time had a .95% negative correlation with the US Dollar index and paid a 3.3% yield. Gold did not pay us and was more speculative in nature.

We do own gold through our commodity funds, iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP) and PowerShares DB Commodity Index Tracking ETF (DBC). Downside market protection or reduced volatility as we look at it is done through short term treasuries iShares Barclays 1-3 Year Treasury Bond ETF (SHY) and corporate bonds, via the previously mentioned Vanguard Short-Term Corporate Bond Index ETF (VCSH).

JL: Finally,what advice would you give to a 'do-it-yourself' investor in the present investing environment?

CS: This certainly depends on their objectives. All investors should stay away from product salespeople that refer to themselves as financial advisors. They are financial sales people that work under inferior standards compared to fiduciary standard, fee-only advisors. This advice will help with keeping your portfolio cost low. Every penny you pay in fees is less money that you have in your pocket.

Also, investors today must think long term and ignore the noise of the daily markets. Fear is not an investment strategy. Build a portfolio not based on feeling but rather on analysis of long-term healthy asset classes. Consider using ETFs that actually hold real assets. These ETFs are designed under the 1940 act, and while considered plain vanilla, offer investors more protection and are simpler to understand. If you are managing your portfolio yourself and doing it in an active manner, meaning moving in and out of stocks on a regular basis, statistically you are set up for failure. Very few professional managers beat the S&P 500 over a long time horizon.

To read other pieces from Seeking Alpha's Positioning for 2013 series,click here.

Disclosure: Casey Smith is long AOK, AOM, AOR, AOA, USMV, SPLV, MINT, VCSH, HDV, RWO, IGOV, SHY and DJP in either client or personal accounts (or both).

See also Inovio Pharmaceuticals: The Risks Outweigh The Rewards on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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