Chris Kuflik - ScotiaMcLeod Montreal

Over the past few years, International Equities have gained much greater attention as a viable means for investment. The opening up of the world from an investment standpoint has come, in large part, because of the ETF product. The Exchange Traded Fund has given investors the ability to easily invest in a basket of international stocks, be it a basket made up of Chinese, Brazilian, Turkish, or even Indian stocks to name a few. With over 1,000 ETFs readily available, which ones should you invest in and more importantly, when is the right time to invest?

It is essential that investors realize there are two segments to foreign ETFs: Developed Markets and Emerging Markets. For example, the US, Japan and the United Kingdom would undoubtedly be considered "developed", whereas Turkey, Chile, and India would be classified as "emerging, or developing". It is crucial to make the distinction between Emerging and Developed as the returns (performance) can vary greatly. The first question that investors ask is “Aren’t these emerging countries riskier than developed?” It is true that they can be more volatile, but these are high growth areas which, with the appropriate risk controls, can improve the return of your portfolio. Some of these ETFs also pay good dividends. To determine which of these ETFs warrant an investment, we use relative strength calculations.

We begin with a relative strength calculation to determine whether the investment focus should be towards developed or emerging markets. For a review of the benefits of relative strength (RS), please access my presentation on this subject under the investor education - strategies section of my website or click here:  http://www.chriskwealth.ca/Strategies/Point-Figure-Analysis.html .Currently, the developed markets are mired with a multitude of problems that we have discussed in previous commentaries. The RS comparison presently favours emerging markets.

Next, we compare using relative strength with the various ETFs to decide where in the world to invest as there are plenty of countries, regions and styles to consider. We want to own the strongest relative strength ETFs to improve our odds of having a successful investment. We need to mention that many times when we saw a relative strength change, either to positive or negative, it didn’t seem to follow conventional wisdom or the headlines of the day. In fact, there are many times in which one simply can't find fundamental reasons as to why a change is happening - but it is happening just the same. What we have found over the years is that the reasons for the change often become apparent much later; too late to capitalize on any movement in the markets.

Everyone likes to be right. If you are in doubt, think back to the last time you told your child they did something wrong. They will have a million excuses as to why they are right and you are wrong. It’s not different in the stock market. When managing a relative strength portfolio what we find is that only 55% to 60% of the trades will be “right.” Meaning that is they will outperform the market on a relative basis. It’s not so much the number of winning trades but rather the size of the winning trades that makes the biggest difference to success in investing. It takes tremendous willpower to hold onto that winning trade for the bulk of the run because whenever we take a small profit we are affirming to the market “we are right -- we won the argument.” Conversely, we don’t want to hold the losing trade in the portfolio because that drags down performance, but to book that small loss admits “we were wrong” and we’ve established that no one likes to do that. Adopting RS strategies, and coping with it over time, means coming to grips with the idea that it is okay to be wrong ... we are going to be wrong plenty, but it is NOT okay to stay wrong. This is why we find that 80% of the profits in a relative strength strategy come from just 20% of the trades. It’s the same phenomena you find in just about any business -- 80% of the profits come from 20% of the business. Those 20%, which we call outliers, will control your investing success and RS is one approach that clusters those 20% in the positive territory.

No strategy outperforms in every single market. It is important to identify when and why your strategy is going to struggle. For instance, if you are evaluating a Growth strategy this type of strategy is going to struggle during periods where Value is leading the charge. For strategies that concentrate in a specific style, they could be out of favour for years at a time. In the aforementioned example, Value led the charge in the markets from 2000 to 2008, so choosing a strategy which concentrated in Growth would have likely struggled for an eight or nine year period. A Relative Strength strategy on the other hand is going to cross styles. When Growth is in favour the portfolio will contain more growth oriented ETFs and then shift to a Value focus when that asset class comes into favour. The Relative Strength strategy is nimble with respect to finding market leadership. This is an important key to the strategies success but it also helps us understand when to expect some underperforming quarters. Relative strength performs best in “trending” markets. Choppy markets, or periods of time when there are no consistent long-term RS signals, typically present tough stretches for any RS-based portfolio. Choppiness tends not to be sustainable over a long period of time. Rather thematic changes will emerge with a handful of sectors or asset classes outperforming others and relative strength will seek out this leadership. Relative Strength strategies tend to perform best when there is a large differential between the best and the worst performing within your inventory. A look at the best and worst performing sectors each year shows that, on average, we see divergence of over 100% each year during the last decade. The difference between the best and worst performing countries is over 130% per year for the last decade as well.

We believe that you should consider the use of foreign ETFs for both exposure to high growth markets and sectors and possible dividends. Including them in your portfolio will help you to diversify your assets, mitigate risk and potentially increase your returns. As you can see, there is a great deal of analysis that must be done to find the ETFs with the best possible odds of succeeding. 

Please feel free to share this article with someone you feel could benefit from its contents.

 Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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Visit our website at www.chriskwealth.com

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