Larry Berman is a partner and chief investment officer with ETF Capital Management, which provides a range of research available for a fee from its website etfcm.com. Larry has been consistently ranked as one of Canada's top analysts and has embraced exchange-traded funds as his preferred investment vehicle for the customized portfolios he manages for clients. Close to 90 per cent of the assets managed by ETF Capital Management are referred by sophisticated financial planners.
I first met Larry in 1999 when he was the president of the Canadian Society of Technical Analysts. I have always respected his no-nonsense style and his willingness to say 'no' if conditions didn't meet his investment outlook.
Q. In the U.S. ETFs account for about 40 per cent of daily trading volume. Why have they grown so quickly?
A: Although there is a lot of attention paid to the lower management fees associated with ETFs compared to mutual funds, the lower costs only become a factor if you are going to take a buy-and-hold strategy. The reason that there is so much volume in ETFs is that traders use the flexibility of the instrument and the reduced risk of an ETF compared to a single stock.
Q. What are your thoughts on a buy-and-hold strategy?
A. This is not a buy-and-hold market. The demographics that gave rise to the success of buy-and-hold over the past 27 years seem to be behind us. The winding down of inflation from 1982 and the falling interest-rate environment gave rise to phenomenal growth that is not going to be repeated. I don't think the consumer is going to come back for 10 years at least, as they deal with debt and up their savings rate to get their personal balance sheets in order.
Q. How can investors use ETFs to overcome this change in market environment?
A. Investors either have to be ready to manage their asset allocation to take advantage of the volatility within asset classes, or they have to be prepared to hire someone to do it for them. Right now, we see an opportunity to increase equity exposure but the positions have to be managed. When conditions change you have to raise cash and shift back to bonds. Under the right conditions 70-per-cent exposure to equities would not be inappropriate and similarly under the right conditions 70-per-cent exposure to bonds and cash would not be out of the question. You can accomplish all of that using ETF's as the trading vehicle.
Q. What do you think of the class of Bull and Bear ETFs that offer leverage?
A. Those ETFs are for the more aggressive investor who has an appetite for risk and who also knows how to manage the instrument. The leveraged ETFs reset and that will change the outcome of a trade. Most people buy them as a trade and if their position goes underwater they hold them which just compounds the problem. You have to have the discipline to cut your losses and not let them run on you.
The other thing to keep in mind with the leveraged ETFs is that they are sweet in a market that is moving aggressively in a direction. Last fall, when the market was selling off every single day was a prime example of great conditions for the use of a leveraged ETF.
Leveraged ETFs provide a shorter term view of a position. When the conditions are right I will buy and sell the same leveraged ETF four or five times to take advantage of the trend.
Q. Any last thoughts on ETFs?
A. ETFs are a great investment instrument but like all tools you have to know how to use them under the right conditions.