FMD Capital Management

How to Strengthen Your Portfolio Core

Written by David Fabian, September 11th, 2013

In strength training and investing, your core is everything.  It’s the foundation or base from which you build upon to reach new levels of success.  Without a solid core, you are doomed to underachieve because you don’t have the right balance needed to attain your goals.  By starting from the ground up using concrete core holdings, you can add additional tactical positions from which to enhance your returns.  That way you will have a well-rounded portfolio strategy that is easy to understand.   

I define core investments positions as large, diversified, and liquid holdings that give you correlation to a broad index or segment of the market.  Typically I allocate anywhere between 40-60% of my portfolio to core positions at any given time.  The allocation typically shifts in response to changing market conditions in the context of an actively managed risk framework.

ETFs are without a doubt the easiest way to add core positions to your portfolio because, in addition to the aforementioned traits, they are transparent, low-cost, and easy to trade.  There is an ETF for virtually any stock, bond, or commodity index that will give you instant access to a subset of underlying assets.  However, with so many ETFs to choose from, many investors get overwhelmed by the breadth of options and settle for plain vanilla positions.

Examples of plain vanilla core holdings include:

SPDR S&P 500 ETF (SPY)

Vanguard Total Stock Market ETF (VTI)

iShares MSCI EAFE ETF (EFA)

iShares Aggregate Bond Fund (AGG)

Not to be outdone, iShares has recently renamed and consolidated a suite of ETFs geared towards the core portfolio theme.  Without a doubt these 10 ETFs are aimed squarely at retail investors that are looking for easy-to-access correlation to domestic stocks, international stocks, or bonds.   They are definitely a step in the right direction when it comes to adding exposure to your portfolio, but they fall short in the excitement factor.

While there is nothing wrong with these funds and I have used them regularly in the past, there are many other innovative choices in the ETF universe that may offer unique advantages over a bland index.   Let’s examine some three alternative strategies that may enhance your core returns.

1.  Equal Weight – ETFs that follow a market cap weighted index allocate the majority of their assets to the largest stocks in their portfolio. By contrast, equal weight ETFs allocate their portfolios equally across every stock in the index no matter what their fundamental characteristics may be.

The Guggenheim S&P 500 Equal Weight ETF (RSP) has the same number of stocks as SPY but every stock in the ETF has between 0.15%-0.25% in weighting.  This will allow smaller companies within the index to have a much greater effect on the total return of the fund.   Over time, the performance discrepancy can be quite significant if smaller stocks outperform.  Just this year, RSP has outperformed SPY by over 6%.

2.  Minimum Volatility – Volatility is a word that has become increasingly synonymous with today’s fast paced markets.  One way to lower the volatility of your portfolio is to consider adding core ETFs that are designed to select stocks with the smallest price fluctuations.  Two funds that accomplish this are the PowerShares S&P International Developed Low Volatility Portfolio (IDLV) or the iShares MSCI U.S. Minimum Volatility ETF (USMV).

Generally you will see these low volatility funds decline less than their fully loaded index peers during periods of price decline.  For trend followers and active managers these funds may give us the ability to stay invested during periods of short-term market corrections instead of getting stopped out of a position.

3.  Dividend Investing – Dividend yield has become an increasingly popular focus among investors trying to generate an income stream from their portfolio.  Two of my favorite ETFs that focus exclusively on dividend yield are the iShares Select Dividend ETF (DVY) and the First Trust NASDAQ Technology Dividend Index (TDIV).

Both of these funds screen for dividend paying stocks with the highest yields within their respective indexes.  The addition of the dividend back into the total return of the ETF over time can have a major impact on long-term performance and enhance shareholder value.

The Final Word

No matter how you ultimately structure your portfolio, it is important to consider strengthening your game plan with new strategies.  Because the ETFs mentioned in this article are already broadly diversified, you only need between 4-6 positions in order to have a well-balanced core.  This keeps your portfolio simple and easy to track.

In addition, you can implement stop losses on these ETFs to limit your downside risk in the event that the market turns lower.  If you get stopped out of a position, you can move to cash and then reassess new opportunities as they present themselves.

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