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Blue Sky offers risk managed ETF exposure


Earlier this year Blue Sky Asset Management launched four ETF fund of funds, designed to help investors achieve different investment goals with built-in risk management.

David Varadi, (pictured) Director of Research, Blue Sky Asset Management, explains that the ETF funds of funds aim to fulfil different investment needs such as Growth or Capital Appreciation, Income, Real Returns (returns linked to inflation) or Absolute Return. They also serve as substitutes for different desired exposures such as Equity, Fixed Income, Commodity/Natural Resources, and Alternatives.

Varadi says: “Depending on the type of exposure an investor is looking for, they can blend allocations to each of our funds depending on their respective need for higher levels of income, growth, total return or real returns to achieve their desired goals.”

Each ETF fund of funds is diversified across different assets classes in accordance with their target exposure. For example, the growth fund is invested in domestic and international emerging equities. The multi-asset income fund has exposure to asset classes such as high yield bonds, real estate investment trusts, convertible bonds, Treasury bonds and high dividend yield paying stocks to name a few.

All the risk managed funds employ a unique dynamic asset allocation approach. Varadi says: “Starting from a base strategic allocation within each fund which reflects our long-term outlook, we dynamically adjust the allocations by over or under-weighting different positions as a function of their momentum.  Risk management is applied to each position by determining the appropriate allocation as a function of how much offensive or defensive exposure is appropriate. This is determined daily by looking at underlying momentum and trends for each underlying position.  If momentum is positive, we will tend to have a higher exposure to that market and if it is negative, we will tend to have a higher cash or bond position.”
The risk management strategy is designed primarily to allow Blue Sky to reduce drawdowns in a scenario such as the 2008 global financial crisis.

“Rapid spikes are inherently unpredictable and we don’t believe it’s possible to adjust the portfolio for those types of risk,” Varadi says. “We are trying to shift the portfolio away from secular risks – the bigger trends that take months or years to develop. We seek to gradually de-risk and reallocate risks on longer term trends.”

As a fund of funds’ ETF structure, Blue Sky generally seeks to use the lowest cost ETFs they can find. “We strike a balance. If we feel that a particular ETF can add more alpha or a unique source of exposure to a particular area then we will still include them along with our lower cost ETFs. A lot of thought goes into universe selection.”
Varadi’s partner, Managing Partner Keys Tinney, says: “We are at a critical time in the market– each day we get further away from the last bear market like 2008, we’re getting closer to the next.  This is why we believe it is imperative to add a risk management ‘parachute’ to the portfolio.”

“Now with markets at all-time highs, protecting capital is more important than ever.  Most investors don’t have infinite timeline where they can absorb and recover from a deep drawdown, they have specific time-bound goals such as retirement and they have to focus on making sure that the capital is there to pay for it. 

Traditional approaches to managing risk such as Modern Portfolio Theory (MPT) are a good start because they reduce risk through diversification, he says.  However, correlations tend to converge in a crisis such as 2008, and this limits the risk reduction benefits of traditional diversification and can lead to large drawdowns.

It is this possibility of large drawdowns that can leave an investor who is close to or just starting retirement with difficult choices that they probably don’t want to have to make like continue to work longer or reduce their retirement spending, he says.

“We believe that adding risk management overlays to MPT has the benefit of adding a layer of downside protection by having the ability to automatically de-risk the portfolio if the markets throw us a curve ball.”

Blue Sky has USD195 million in the funds and distribute primarily through large financial advisory firms and increasingly institutions. They are also looking at expanding their product line to include other new and innovative solutions.  

Varadi says: “The vast majority of ETFs provide you with buy and hold exposure to specific areas of the market. ETF holders are  essentially passive investors with no protection against bear markets and no strategy for shifting their allocations as certain markets out or underperform. We  offer the ability for investors to have a fully automated solution within our risk managed funds to gain exposure to certain asset classes that they want in their portfolio but with the downside protection and the ability to tilt toward better performing markets.
“Our philosophy is we aim to capture much of the upside and reduce the downside during large drawdowns substantially. You can add our funds to a traditional portfolio as a compliment to reduce the overall portfolio drawdown risk which is better for investors who are close to retirement as who are seeking to have a greater probability of achieving their financial planning outcomes.”


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