The use of Dynamic Investments (DIs) will increase the sales of Exchange Traded Funds (ETFs) exponentially. They will also uncover value in ETF product lines that is currently lying dormant. On this page you will get just a glimpse of how DIs will make ETFs the market's top selling investment type and enable ETF creators and vendors to significantly increase their value and revenues. This topic is also discussed in detail on this page.

Unleashing the Power of Exchange Traded Funds (ETFs)

Most NAOI members and students with whom I speak have no idea what Exchange Traded Funds (ETFs) are. While I believe that the introduction of ETFs is one of the most significant investing developments in decades, the investing public does not understand them or buy them in great numbers. Why? Because financial advisors have more incentive to recommend mutual funds that provide them with higher sales commissions. Another reason why ETFs are not mainstream investments today is that their main advantage of being easy and inexpensive to trade means nothing in an investing world dominated by buy-and-hold, Modern Portfolio Theory (MPT) portfolios. As a result, unfortunately, ETFs are not mainstream investments today and their massive potential is unrealized.

 

This all changes with the introduction of the NAOI Dynamic Investment Theory (DIT) approach to investing. As you will learn by reading this site, ETFs are the primary investing vehicle used by Dynamic Investments (DIs). And because of their buy-and-sell management strategy, DIs exploit all of the advantages of ETFs including their ease of trading, comprehensive market coverage and low fees.

When Dynamic Investments become an accepted and frequently used investment type, the demand for ETFs will explode. And mutual funds, with their high management expenses, restrictions on trading and ambiguous goals, will be forced to fight to survive. 

 

Uncovering Hidden Value in ETF Product Lines

Many financial organizations offer an extensive ETF product line. But its sales potential is not being fully realized in today's world of investing. Let's look at an example of how hidden value in a an ETF product line can be uncovered through the use of Dynamic Investments.

The Blackrock organization, via their iShares product line, offers scores of ETFs that enable the public to invest in virtually every area of the market. Below are three ETFs in the iShare product line that I will use in this example. Each tracks the index or asset type shown.

  • IVV - S&P Small Cap 600 Index ETF
  • IJR - S&P 500 Index ETF
  • TLT - Barclay's Long Term Treasury Bond ETF

Today such ETFs are sold as one element of an MPT, buy-and-hold, static portfolio where their unique features are not fully exploited. To unlock additional value currently hidden in these three ETFs they need to be combined in the DEP of a Dynamic Investment and traded. Let's look at how doing so releases their full value.

Value Creation Example

 

In the Table below I show an example of how these ETFs are used today in an MPT portfolio and how they will be used in the future as a part of a Dynamic Investment.

First let's create an MPT, asset-allocation portfolio and give a 33.3% allocation to each of the the above listed ETFs. Combined in this type of "static" investment these ETFs are just bought and held for the long term. The returns and Sharpe Ratio (a measure of Risk) of this portfolio for the time period from 2007 to 2016 are shown in the middle row of the table below. You can see that performance is mediocre at best and with relatively high risk.

Next let's create a Dynamic Investment that I will call the "Dynamic iShare". It holds all three ETFs listed just above in its DEP. Remember, in a DEP these ETFs are simply purchase candidates. Only the one that is moving up most strongly at review time (quarterly in this example) is purchased and held until the next review (a three month holding period.) The performance of this simple DI is shown in the bottom row of the table.

 
 
 

You can see that the Dynamic Investment's returns, using the same three ETFs as in the MPT portfolio, are astounding. The average annual return of the DI is more than double that of the MPT portfolio and with half the risk as indicated by the increased Sharpe Ratio!

This simple example shows the power of Dynamic Investments to exploit the value of ETF combinations in an ETF product line that is currently lying dormant. With the help of an NAOI consulting contract, ETF creators and vendors can exponentially increase the value of their existing ETFs with little time, expense or effort. All that's needed is the Dynamic Investment education that the NAOI can provide.

Of course I am using iShares as an example only, the same results will be obtained by ANY ETF developer with a diverse product line,

Breathing New Life into Failing ETFs

Dynamic Investments can also breathe new life into low-volume ETFs that are on the verge of failing. Let's discuss.

The product lines of virtually all organizations that create and sell ETFs include several that do not have sufficient sales and trading volume to justify their existence. Many of these ETFs track areas of the market with great returns potential but, for whatever reason, they simply don’t sell.

Granted, some are simply not well constructed ETFs or charge fees that are excessive and deserve to go away. Others, however, don’t deserve this fate. Perhaps they track indexes that are too volatile to work well in the MPT world of buy-and-hold portfolios. Or, perhaps they track the same index as multiple other ETFs created by companies with more marketing power. Whatever the case, not all ETFs survive, even some that, if used correctly, would be extremely valuable. The DIT approach brings these ETFs back to life!

Low volume ETFs can be placed in the Dynamic ETF Pools (DEPs) of Dynamic Investments where they will wait to be automatically bought when/if they start a strong upward price trend at which point they will be purchased and held until the uptrend ends or until another ETF in the DEP starts moving up more strongly. If their price starts to fall during the short time that they are held, the ETF is sold and it recedes back into the DEP to await its next uptrend. 

Buying volatile ETFs only when they are moving up and automatically selling them when they start to move down will rescue many valuable ETFs that are now on the verge of extinction in an MPT buy-and-hold world. PLUS this manner of usage can stimulate the creation of any number of new, volatile ETFs that are designed primarily to be used in Dynamic Investments!

Dynamic Investments Expand and Magnify the Benefits of ETFs

On this page I have discussed why ETFs today are seen by the public as "quirky" mutual funds - assuming the public even knows what they are. In a buy-and-hold MPT world, the ETF benefits of being easy to trade with low expenses are not seen as benefits at all. In the DIT world of buy-and-sell portfolios, the benefits of ETFs are fully exploited - and they can become the mainstream investments that they are meant to be.

Refer to the Portfolio Manager area of this section to see how Dynamic Investments tame the volatility of risky ETFs and enable even the most conservative investors to take advantage of their upside potential while avoiding their downside risk.

More Information

For additional discussion of this topic go to the Taking ETFs Mainstream page of this site.

NAOI Consulting

The NAOI is available to consult with and train ETF creators and vendors to fully exploit the potential of their ETF product lines using Dynamic Investments. Click here for more information.