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03/20/2012 6:30 am EST
Gold and silver make sense for investors as long as central banks are devaluing their currency, explains Paul Simon, chief investment officer at Tactical Allocation Group, a firm with $1.6 billion in total assets. In this vein, he names some of the firm’s ETF holdings.
Kate Stalter: Today, I am speaking with Paul Simon. He is chief investment officer at Tactical Allocation Group. Now, Paul, that’s a very interesting name for a company. Tell us, what do you mean by tactical allocation and how that works in practice?
Paul Simon: Sure. Tactical allocation is a style of investment management that is very proactive, as opposed to a strategic asset-allocation mix, which is pretty static and where you might rebalance if certain allocations move beyond a predetermined target.
Tactical asset allocation attempts to make forward projections on risk and returns of various asset classes, and then adjusting the portfolio mix in advance of those projections actually happening in the financial market.
Kate Stalter: So when it comes down then to selecting specific asset classes and using passive vs. active management: I know these are some of the factors you look at. How does that work?
Paul Simon: Our investment universe at TAG encompasses 30 asset classes around the globe, and that would include stocks, bonds, cash, real estate, and commodities...and then of course, the sub asset classes.
So, for example, in equities there’s domestic, there’s foreign, there’s large, there’s small, there’s value and growth. So there are a lot of ways to talk about asset class and then invest in the sub asset classes, and that’s what TAG does.
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You know, there are various ways which we could decide or choose to implement our portfolios. We could buy a mutual fund. We could buy individual securities. Or we can use an ETF.
And if you go back just to our own philosophy and you look at even the last 50 years of academic research and real-life experience, the prime determinant for a portfolio’s risk and return is going to come from the asset allocation decisions. So at TAG, we just believe that’s where the emphasis should be, in terms of where we spend our time and our resources.
Very little of a portfolio’s risk/return comes from actually market timing or individual security selection, and so if the prime determinant is the asset allocation work. Then what we really want is an investment allocation to an ETF that will approximate the asset class that we’re trying to get exposure to.
It’s very transparent. It’s very low cost, and it has a very low level of tracking error relative to the asset class. So we just think the combination of those features is just a natural harbinger for trying to make asset allocation decisions.
Kate Stalter: Let’s drill down then, and talk a little bit about some of the specific decisions. I understand that you recently have gone to being underweighted in emerging markets. Talk about that a little bit.
Paul Simon: Well, we reduced some of our exposure to emerging markets. We still have, relative to benchmark, an overweight position, and that’s in large-cap emerging markets.
We did decrease our emerging market small-cap exposure due to some of the slowdown that’s occurring, and some of the tightening measures that some of the central banks in the emerging markets are going through right now, because they are having some inflationary pressures.
You know, on a long-term secular basis, we still like emerging markets, and we think they are still a very good growth story. We just tempered some of our enthusiasm, given some of the short-term headwinds.
Kate Stalter: Which ETFs are you currently using to get some of this emerging-market exposure?
Paul Simon: MSCI Emerging Markets Index Fund (EEM) is the primary source of exposure. It’s a well-diversified, very liquid representation of the large-cap emerging-market universe.
Kate Stalter: How about gold and precious metals? I understand that’s also an area where you are allocating assets.
Paul Simon: With the developed markets—that being the US, Europe, and Japan—pursuing quantitative easing, suppressing interest rates to the point of real negative rates of return for investors...those are all inflationary, and they are also designed to basically make their currencies more competitive.
And when the currencies are losing value or devaluing, gold is usually a net beneficiary, because it’s a store of value. If your currency is being deflated, it takes more units of your currency to buy gold or silver or any other hard asset.
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So we think gold and silver—to a lesser extent than gold—but we like gold and silver as a way to protect or hedge against central-bank policies, which are designed to basically make their currencies more competitive. Which is another of saying they are devaluing their currencies.
Kate Stalter: What are some of the investment vehicles that you are using right now to get exposure to this area?
Paul Simon: Well, we own SPDR Gold Trust (GLD), which is an ETF where you can get exposure to the price movement of gold. We also own iShares Silver Trust (SLV). That’s meant for a more aggressive investor, and it's an exposure to the price of silver bullion.
And then also for aggressive investors, we also own the miners. Those are companies globally that mine or extract gold and silver out of the ground, and we do that through the Market Vectors Gold Miners ETF (GDX). It’s a way to get a global exposure to the miners, which should benefit with a rising gold and silver price. They have operating leverage relative to the price of bullion, so as long as gold prices and silver prices move higher, they should benefit as well.
Kate Stalter: Last question for you today, Paul. You mentioned a number of the different asset classes that you are in. Can you say a little bit about the fixed-income market? A lot of people obviously have questions about that these days.
Paul Simon: Yeah. Very tough to navigate when you have got record low interest rates and you have got real yields that are negative. The normal places that investors would look to pick up some income with some relative safety would be in the fixed-income market...so you have got to be very selective.
We have avoided the US market pretty much altogether, other than we do have exposure to TIPS—Treasury Inflation Protected Securities—and we do that through iShares Barclays Treasury Inflation Protected Securities Bond Fund (TIP).
Then, we also have emerging-market bonds. You know, we just think they have much, much better fundamentals than in the US or the developed markets, and yet they have got coupons or bond yields that are substantially above rates that you can get in, say, the US, Europe, or Japan.
So we think that’s still a very good place to be. We think they are actually safer than a lot of the developed markets in terms of credit quality and you can pick up some extra income.
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