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Stock, Bond ETF Strategies to Build a Better Core

This article was originally published on ETFTrends.com.

Investors who are interested in smart beta or factor-based ETFs should consider some of the best practices when incorporating these alternative strategies into a diversified portfolio.

On the recent webcast (available On Demand for CE Credit), Core Values, Core Portfolio Building Blocks, Lance Humphrey, Portfolio Manager for USAA Asset Allocation, warned that current valuations in U.S. stocks are elevated in the extended bull market environment. Furthermore, fixed-income assets are also exhibiting stretched valuations and low yields after a three-decade bull run.

Consequently, Humphrey argued that investors could look to smart beta or factor-based strategies that eschew traditional market capitalization weighting methodologies to seek out ways to access the markets and diminish potential risks along the way. Specifically, at USAA, the smart beta approach should track core factors, offer balanced risks, include thoughtful implementation and provide consistent returns.

The core factors include securities that should be selected using the most researched and empirically validated factors from both academic and practitioner research. Smart beta should provide balanced risk or stocks selection should be weighted in a portfolio in such a way to balance the risk of each individual security. Through thoughtful implementation, indices should be constructed thoughtfully to account for implementation concerns such as turnover, liquidity, and rebalancing. Lastly, the investment should provide consistent results by combining complementary factors in a balanced approach, which can lead to more consistent results relative to market capitalization weighted indices,

Among the various market factors that has produced a premium over the years, USAA focused on the value and momentum factors to enhance their investment objectives. Humphrey argued that value and momentum has helped investors generate attractive risk-adjusted returns over time. By complimenting a passive ETF portfolio with factors and active bond strategies, an investor may enhance their overall returns over time and diminish drawdowns during more volatile conditions.

USAA ETFs to Better Manage Risk

To help investors better manage risks and access the markets in a smarter way, USAA has launched two actively managed bond ETFs and four smart beta stock ETFs, including USAA Core Short-Term Bond ETF (USTB) , USAA Core Intermediate-Term Bond ETF (UITB) , USAA MSCI USA Value Momentum Blend Index ETF (ULVM) , USAA MSCI USA Small Cap Value Momentum Blend Index ETF (USVM) , USAA MSCI International Value Momentum Blend Index ETF (UIVM) and USAA MSCI Emerging Markets Value Momentum Blend Index ETF (UEVM) .

To build a better core portfolio, Humphrey argued that investors should consider building a globally diversified portfolio, focus on long-term proven equity factors and include skilled actively managed fixed-income.

Based on historical relationships, expected returns in international and emerging markets appear more favorable. Academic research suggests that focusing on stock companies with factors like attractive valuations and improving momentum have led to higher excess returns. Lastly, with interest rates near their all time low levels, investors should consider adding higher-yielding, actively managed fixed income to their portfolios.

Financial advisors who are interested in learning more about portfolio construction can watch the webcast here on demand.