Shorting the 10 Yr. Treasury Is This Fund Manager's Highest Conviction Idea

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David McMillan submits:

David McMillan CFP, RFC is co-founder of Boulder, Colorado based Caledonia Wealth Management , Ltd., serving high net worth families and individuals.

David's financial expertise is largely focused on sustainable investment practices and investment solutions and follows a philosophy of achieving growth while reducing downside risk through tactical portfolio design. His areas of expertise extend to alternative investments, separate account management and international opportunities.

We had the opportunity to ask David about his current asset class allocation, and what asset class he's most bullish or bearish on at this time.

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SeekIng Alpha (( SA )): In your portfolios currently, how are you allocating among different asset classes?

David McMillan (( DM )): At the beginning of 2009 our biggest concerns came from a number of directions. We wanted to ensure that if the declines of the previous year continued we would be protected on the downside from further drops in portfolio values. We also needed to ensure that if we saw a dramatic recovery we could participate and generate respectable returns. It was the classic problem of trying to have low risk with solid growth, and in one of the most challenging economic periods of our time. As active managers, it wasn't enough for us to sit on the sidelines and hope that a recovery would erase some of the losses that 2008 delivered. This led to holding a diverse mix, heavily weighted in fixed income investing, including treasuries, inflation protected bonds, corporate bonds, international bond funds, high yield bonds, commodities, and limited number of domestic and international equities (particularly in the green and clean technology areas). This saw us outperform our market benchmarks with lower risk levels. We had seen numerous opportunities within the fixed income space, and they didn't fail to deliver. Even the higher risk fixed income investments were more attractive than most equity positions from a risk-return standpoint.

Moving into 2010, we are only looking one quarter ahead at this point. Equities look reasonably set to continue their trend but with a lower trajectory, and I think there is some steam left in corporate bonds and other fixed income positions as well as commodities for a good part of the year.

SA: Which single asset class do you think will perform best in 2010? What stocks or ETF would you choose to capture that?

DM: I am going to go out on a limb here with my ETF selection, as in general I see bearish positions having the best performances for 2010. Like I mentioned before, I don't think we will see this develop in the first quarter, but because our outlook is one that believes we are in a secular bear market, we will see some course corrections this year from that of 2009. I have yet to hear any compelling arguments from leading global economists that can support why this type of market rally is sustainable given the enormous underlying problems we have economically.

In line with this, if I was to pick an ETF that supports my greatest conviction fund for 2010 this it would be [[TBF]]. This is a ProShares ETF that is short the 20+ year Treasury. It aims to directly correspond to the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Index.

With the enormous amounts of government debt issued in the past 12 months, along with a dwindling supply of foreign treasury purchasers, an interest rate rise looks very likely in upcoming months, which will push yields up and bond prices down. Other supporting factors include price inflation, slowly creeping into the markets as the rally in commodities and equities filter down to Main Street. The need to retain price control and save consumers even greater pain than they are currently suffering, along with making longer yielding treasuries more appealing to outside investors, mean a rate hike and a corresponding increase in yields are all the more likely. While we are generally pessimistic on the long term outlook for the dollar, some short term strengthening should not be overlooked and will only continue to drive up yields. With the strong feeling we are on the cusp of a significantly sized bond bubble, this is a strategy that we are very comfortable holding for a multi-year period and will be one of our longer 'plays' in the upcoming months.

For an even more aggressive approach, ProShares offers [[TBT]], which corresponds to -200% of the return index target. Both funds have an expense ratio of 0.95%

SA: What instruments do you generally use to capture particular asset classes?

DM: We use multiple instruments to capture particular asset class exposure, from traditional mutual funds, bonds and ETFs to separately managed accounts, alternatives and private equity if we need to. The only area we typically don't advise in is with individual stock selection. While we can be quite active with our approach, we don't hold ourselves out to be stock pickers, as there are just too many variables to consider and the risk profile moves to another level altogether. It is also administratively burdensome (and an extra cost to the client) to do a good job in this area and we see better alpha coming from broader based management.

SA: Have any new instruments emerged in the past few years that you've adopted in your portfolio construction?

DM: Without a doubt, the growth of the ETF industry in the past few years has provided the most important instrument to emerge for our practice. The diverse range of funds now being offered, with competitive expense ratios, favorable tax treatment, liquidity, transparency and intra-day trading are hard to beat. As an asset managment company specializing in sustainable investments, seeing more funds that focus on this area is important to us. Having greater choices to work with from an investment strategy point of view and ultimately passing along this diversity to the client leads to more opportunities and management flexibility. Caution still needs to be exercised with some of the smaller funds, limited trading volumes and the counter-party risk of certain ETNs, but overall the outlook looks strong for this type of investment vehicle. More investors are craving simplicity and the other types of benefits associated with ETFs, and this will continue to drive the growth we have seen since the start of the century.

Looking further ahead, while it is not an instrument, the availability of investments targeting green and clean technologies, climate risk, alternative power, energy efficiency, carbon reductions and so on will unquestionably be the next big investment direction of this decade. I recently returned from the United Nations and was heartened to hear the Investor Summit on Climate Risk deliver strong support from the largest global institutional investment houses in this area. All major firms in the US and are now starting to embrace these areas as a critical part of future investing.

SA: Thank you for your time and candor, David.

DM: My pleasure.

If you are a fund manager and interested in doing an interview with us on your highest conviction stock holding, please email Rebecca Barnett:

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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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