Active Asset Allocation Strategies Using ETFs

1. Active Asset Allocation Strategies Using ETFs Marvin Appel, MD, PhD CEO, Appel Asset Management Corp. Great Neck, NY mappel@appelasset.com

3. Outline • Update relative strength strategies from my 2005 presentation to QWAFAFEW • Growth vs value • SPX vs EAFE—extended to include emerging markets • Covered call writing– Not all ETFs are created equal.

4. Concept of relative strength • Divide index1 by index2. These indexes may reflect price or total return. • Rising ratio means index1 (numerator) is stronger. • Falling ratio means index2 (denominator) is stronger. • Relative strength leadership does not tell you whether either or both indexes are showing profits or losses.

5. Hypothetical ideal relative strength switching model

6. Recognizing new trends in relative strength 40% drop

7. Growth versus value model • Select value and growth benchmarks for either large or small caps (eg: Russell 2000 value and growth indexes) • Calculate the monthly total return indexes and find the ratio as of the last day of each month. • Look for 10% reversals in the ratio to define new long term trends.

8. Trend-following strategy: large-cap value versus large-cap growth Source: Mutual Fund Expert as of 5/31/2010

9. History of value/growth model signals for large cap (Russell 1000) Indexes

10. Trend-following strategy: small-cap value versus small-cap growth Source: Mutual Fund Expert as of 5/31/2010

11. History of value/growth model signals for small-cap (Russell 2000) Indexes

12. Foreign (developed country) versus U.S. stock model • Use MSCI EAFE as the benchmark for foreign stocks and S&P 500 as the U.S. benchmark. • Calculate the ratio of EAFE / S&P 500 (price-only data) on the last day of each month. • A new trend is defined by a 15% reversal in relative strength.

13. MSCI U.S. versus EAFE Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)

14. History of EAFE / U.S. switch model

15. A Quarterly Asset Allocation Strategy for Foreign-Equity ETFs FT Press 2008

16. Three distinct areas of the world’s stock markets Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)

17. Quarterly rotation among broad areas of the foreign stock market • Evaluate MSCI gross total return, US Dollar indexes at the end of each quarter for Japan, Emerging Markets and Europe • Whichever area was strongest in the prior quarter should be held in the current quarter. • Can use ETF data instead: • EWJ for Japan • EEM or VWO for emerging markets • IEV for Europe

18. Europe / Japan / Emerging Mkts Source: MSCI Barra (http://www.mscibarra.com/products/indices/international_equity_indices/gimi/stdinde)x/performance.html)

19. Covered call writing • In return for a fixed payment up front, you agree to forego profits but bear losses that may occur within a limited period of time on a stock or ETF. • Example: I will accept 1.2% to forego all profits and bear all losses in the S&P 500 SPDR (SPY) between now and March 19, 2010 (12 trading days). • The maximum possible gain is the 1.2% of risk capital • Losses can be as large as the amount by which the S&P 500 SPDR (SPY) can fall between now and March 19. • But any loss will be mitigated by the 1.2% I collected. (So if the market falls 5%, my loss on the covered call position will be 3.8%.) • Not a “conservative” strategy • Good strategy for flat or slowly rising markets, like the second year of bull markets. • Important to choose the right ETFs or stocks • It has been possible historically to achieve a significant risk reduction without loss of profitability • Need to watch transaction costs

20. Covered call position • Buy 100 shares of stock and sell one option on the stock. • Gain is likely to occur, but is limited. • Losses are relatively unlimited, but in a losing month writing a covered call always reduces losses compared to owning the shares alone.

21. Covered call writing: S&P 500 Sources: www.cboe.com, Investors FastTrack

22. Covered call writing: Dow Jones Industrial Average Sources: www.cboe.com, Investors FastTrack

23. Covered call writing: NDX Sources: www.cboe.com, Investors FastTrack

24. Covered call writing: Russell 2000 Sources: www.cboe.com, Investors FastTrack

27. Shorter-term ETF relative strength rankings and trading strategies are reported in my newsletter, Systems and Forecasts (www.systemsandforecasts.com)