Note: This Web page is not shown in the Menu of this site. It is accessible by people to whom I, Leland Hevner, President of the National Association of Online Investors (NAOI), have contacted directly via email or a LinkedIn message. I have created this page to expand on the information provided in that communication.
Overview - Using ETFs to Change the Fundamental Way We Invest Today
Exchange Traded Funds (ETFs) are one of the most important developments in the investing world during the last 50 years. Yet, today, most of the investing public has never heard of them. They are not "mainstream" investments. Advisors don't recommend them because commissions are higher on mutual funds and the buy-and-hold portfolios designed for public today use are not structured to take advantage of the unique benefits of ETFs. As a result, this unique investment type is nowhere close to realizing its full usage or sales potential. This needs to change and it does with the introduction of Dynamic Investment Theory and NAOI Dynamic Investments as explained on this Web page and in more depth on this entire Web site.
Rarely does an opportunity arise for a financial organization to dramatically improve the fundamental way we invest today. On this page you will learn about just such an opportunity and how to take advantage of it by using ETFs in a revolutionary, outside-the-box, manner. You are about to read how your organization can separate itself in a crowded field and take a leadership role in defining the future of investing.
The State of the ETF Industry Today: Stuck!
As I scan the financial media on a daily basis I read a lot about the problems faced by the Exchange Traded Fund (ETF) industry today. These problems exit because the evolution of the ETF industry has ground to a screeching halt. It needs to start moving forward again, not by creating ever more ETFs but by changing how ETFs are used. On this page I will show how the use of ETFs in a simple "dynamic" investment type all of these problems go away and the world of ETFs can evolve and expand as it should and must.
A Few Problems Faced by the ETF Industry Today
As alluded to just above, the ETF industry is facing multiple serious problems in today's investing environment. Here are just a few of the problems that have stalled the expansion, use and evolution of Exchange Traded Funds:
ETF Development is Hitting a Wall. The ETF space is getting crowded. All of the major and most of the minor market indexes have at least one ETF that tracks them and many are covered by multiple ETFs. It is becoming increasingly difficult for developers to find a unique ETF product that is profitable for the creator. This results in the design of ETFs that are increasingly more narrowly focused and thus more volatile as well as ETFs that are so exotic that financial advisors will not, or can not, recommend them to their clients. Thus, in today's investing world, ETF developers are hitting a dead end and this is a big problem. Refer to my blog post about this issue by clicking here.
Standard Portfolio Design Methods and the ETF Volatility Problem. As mentioned above, new ETFs are being forced to become increasingly narrow in focus and thus more volatile; subject to violent price swings. The problem is that the universal design for portfolios today is based on Modern Portfolio Theory (MPT), an approach that embraces a buy-and-hold management style. In such a portfolio there is no room for volatile ETFs that pose the risk of significant price drops in very short time periods. As a result, many ETFs that are being created today are not suitable for client portfolios and advisors will not recommend them. For this reason a record number of ETFs are being pulled from the market due to lack of sales. Volatile ETFs are simply not compatible with today's "static" portfolio designs.
The "Me Too" Problem. There are a limited number of market indexes that an ETF can track that are acceptable for inclusion in today's MPT portfolios as mentioned just above. All of the major indexes and most of the minor indexes are already tracked by one or more ETFs, forcing developers to create a host of "me too" ETFs for the same index. When an index such as the S&P 500 is tracked by multiple ETFs, the "winners" will be the major ETF developers such as Vanguard, State Street and Black Rock that have significant marketing clout and offer low ETF expenses. Most "me-too" ETFs will eventually be forced to close. This dynamic will result in only a few major companies dominating the ETF market and the resultant lack of competition does not bode well for the much needed evolution of the ETF industry.
ETFs Are Not a Mainstream Investment Today. In my position as the President of the National Association of Online Investors, I interact with the investing public almost daily and have for years. I can state with confidence that most average investors don't have any idea what an ETF is; it is not a mainstream investment type. This should not be surprising as advisors don't recommend them to their clients primarily due to the fact that mutual funds provide much higher sales commissions. And since today's standard portfolio is designed to be a buy and hold investment, the ease of trading benefit of ETFs is simply not an advantage. Thus, ETFs are seen by the public as little more than "quirky" mutual funds and public demand for them is minimal to nonexistent.
The Keys to ETF Evolution
ETFs will only realize their full usage and sales potential when a new approach to investing is developed that fully exploits their unique advantages. Such an approach must utilize a buy-and-sell methodology that better copes with today's dynamic markets than today's MPT-based, buy-and-hold portfolios.
My company, the National Association of Online Investors (NAOI), has understood this need for years and has devoted significant time and expense to developing the dynamic approach needed to exploit the full power of ETFs. After 5+ years of research we found the revolutionary approach needed. We call it Dynamic Investment Theory (DIT). DIT creates Dynamic Investments (DIs) that automatically change the equity they hold in response to market trends. We released the result of our research in mid-2016 via a book entitled The Dynamic Investment Bible.
Dynamic Investments are a clearly superior approach to investing that produces significantly better performance in modern, volatile markets than do the static MPT-based portfolios that the public is forced to live with today. And the perfect equity type for powering Dynamic Investments is the ETF. As a result, DIT and DIs are the catalysts that will "kick-start" the evolution of the ETF industry and catapult ETFs to mainstream status virtually overnight. Below I show how.
The Seeds of ETF Evolution
The need for a better approach to investing became clear to me in late 2008 while teaching a college course in personal investing. I was showing students how to build asset-allocation portfolios based on an approach defined by Modern Portfolio Theory (MPT). When the market crashed so did these portfolios. At that point I had to realize that MPT, which was originally introduced in 1952 was dangerously out of date.
I saw that while markets had evolved tremendously since the early 1950's, portfolio design methods had barely changed at all. In 2008, and still today, the financial services industry gives clients static, MPT-based portfolios to cope with modern dynamic markets - and they simply don't worked.
I cancelled all further classes until the NAOI could find a better approach to investing. After 5 + years of exhaustive R&D and testing we found it in the form of Dynamic Investment Theory (DIT) which is summarized below
Introducing NAOI Dynamic Investment Theory
When the NAOI started its research we vowed that any new approach to investing would be based on scientific methods and trading activity would be triggered by objective empirical market observations as opposed to subjective human judgments as they are today. We were determined to eliminate as much of the human error factor as possible.
So we started with the ONLY fact that is known about equities markets without question, that being as follows: assets, markets and market segments are cyclical. They move up and down in price over time. And they move up and down at different times - e.g. when stocks go up, bonds go down. This led to the hypothesis that there exist at all times, in any economic condition, positive returns somewhere in the market. Our goal then became to design a new investment type that was capable of finding and capturing this positive return while avoiding areas of the market that were trending down. We succeeded in meeting this goal with the NAOI Dynamic Investment type; a development that will define the future of investing. I describe DIs next.
Introducing NAOI Dynamic Investments
DIT defines the logic and the rules for the creation of a next-generation investment type called Dynamic Investments (DIs). DIs automatically change the equity they hold based on a periodic sampling of market trends. The DI structure was created to capture the positive returns potential that exists somewhere in the market at all times and to do so based on objective market observations, not on subjective human analysis and judgments. As we tested various DI designs, they produced returns that astounded even us.
Early in our development process we saw that ETFs would be the perfect equity type to power this amazing investment due to its ease of trading and the fact that their exists an ETF for virtually any asset type and market segment where we wanted to be able to search for positive returns.
A DI has three components as illustrated in the figure at right and explained below:
- The Dynamic ETF Pool or DEP: This component of the DI holds from 2 to 10 ETFs that are candidates for purchase by the DI which only owns one ETF at a time.
- The Review Period: This component specifies how often the DI reviews the DEP to determine which ETF to buy hold for the next period. At time of review the DEP is ranked by the Trade Signal, explained just below, to identify the ETF in the DEP that is trending up most strongly.
- The Trade Signal: This is a simple indicator that measures the direction and strength of the price trend for each ETF in the DEP. Only the one that is trending up most strongly at time of review is purchased, or held, until the next review.
Once defined for a Dynamic Investment these variables do not change. However, the ETF held does change depending on market conditions. Thus, a DI is a passively managed, active investment providing the best elements of each approach. This is unique in the world of investing. You can see that while design decisions are made based on human judgment, actual trades are signaled by empirical observation of market movements. And experience has shown us that the market is a whole lot smarter than any one or group of analysts.
ETFs are the equity type that makes Dynamic Investments work efficiently. When NAOI Dynamic Investments become the investment type of choice in the market, and based on historical performance we are confident that they will, the use and sales of ETFs will explode and they will finally take their rightful place as a mainstream investment at least as popular as mutual funds are today and probably more so. For more information on how Dynamic Investments are designed and how they work go to this link.
How Do Dynamic Investments Perform?
In Dynamic Investments the NAOI development team now had an investment type that was sensitive to market movements and the built in intelligence to find and capture positive market returns. The concept was great, but does it work? That now became the focus of our research.
Of course the performance of a specific DI depends on the skill of its designer. Se for testing purposes we used one of the simplest DIs possible has only 3 ETFs in its DEP. We were astounded by how well this DI performed when backtested over a significant number of years. Below are the performance results of this simple DI for the 10 years from the start of 2007 to the end of 2016 - a period that saw both a significant stock market crash, a sustained bull market and years that were essentially flat, in other words a statistically significant number of years with a full variety of economic conditions.
Backtest Period Performance - The tables below show the average annual returns of the DI for the backtest period as compared to a generic MPT portfolio with a 60% allocation to stocks and 40% allocation to bonds. Also shown is the Sharpe Ratio which is a risk measure that shows the amount of return received for each unit of risk taken. Any number greater than 1.0 is a superior investment.
Summary Table for the period from the start of 2007 to the end of 2016:
Annual returns for each investment type for each year during the period.
These DI return numbers are simply astounding. Today's "experts" would say they are impossible. And they are when we are constrained by MPT portfolio design rules. But with the introduction of an investing approach that is dynamic, returns like this are not only possible but probable! And the Sharpe Ratio for the period shown in the first table shows that these returns did not come with excessive risk!
Why does this ultra-simple NAOI designed Dynamic Investment work so well? Here are just a few of the reasons:
- The DI includes company diversification through the use of ETFs and asset diversification by having multiple ETFs in its DEP. But it adds another factor in the form of "time-diversification" which does not exist in today's MPT portfolios. And while company and asset diversification only reduce risk, time diversification reduces risk
AND enhances performance!
- The DI is designed to ONLY buy into asset types / market segments that are moving up in price at time of purchase. Odds are good that the trend will continue for at least another quarter. It is also designed to sell or avoid areas of the market that are trending down in price. A good example is 2008 when this DI automatically switched from stocks to bonds and earned +57% while the stock market was losing about the same amount!
- The buy-and-sell management strategy used by DIs enables this investment type to nimbly move between assets and markets based on market trends. In other words, it is sensitive to market movements and has the built in intelligence to take advantage of them - without the need for human intervention. Market sensitivity is not present in the buy-and-hold, MPT portfolios that virtually all investors own today.
- Once designed, a DI makes trades based on market movements, not based-on human judgments. As a result it is immune to incorrect market analysis, sales bias, inappropriate advice and even scams that are prevalent in the market today.
Dynamic Investments are finally the investment type that the investing public needs to both take advantage of market uptrends and to avoid market down trends and in doing so to achieve high returns with low risk and absolute protection from market crashes. This is the approach that the NAOI began looking for in 2008 and it exceeded all of our very high expectations for a better way to invest.
How Do Dynamic Investments Solve Today's ETF Problems?
Let's look back at the problems that ETFs are facing in today's MPT-based world of investing as mentioned at the start of this page and see how they simply go away in the future's DIT-based world of investing.
A Vast New World for New Product Development: Dynamic Investments are a new investment type, not known to the investing world before the release of the NAOI Dynamic Investment Bible. As such, it opens up a vast, virgin territory for the development and creation of an unlimited number of unique DI products. And, as discussed above, by simply combining existing ETFs, these are very easy products to create. They only require a designer to define a Dynamic ETF Pool of ETF investing candidates, a Review Period and a trend-detecting Trading Signal. With the introduction of Dynamic Investment Theory the current "dead end" that ETF developers are now facing disappears.
Taming Volatility and Reviving Dying ETFs: The high volatility of narrowly focused ETFs is the reason that many very valuable ETFs are being withdrawn from the market today. Volatile investments simply don't work in an MPT, buy-and-hold portfolio. Dynamic Investments solve this problem as a volatile ETF can simply be placed in a DI's DEP where it will only be purchased when it is trending more strongly than any other ETF during a review event. And then it will only be held until the next review period, a span of time that is typically 1-3 months depending on the design. If/when the volatile ETF starts to trend down it will be "stopped out" or sold before significant losses are incurred. This structure and management approach brings back to life some very useful ETFs such as PEK, an ETF that tracks China stocks and many others that can serve a very valuable function in a well-designed DI. Go about half way down on this page to see how this works.
Unleashing Hidden Value in Existing ETF Product Line: Many companies have extensive product lines of proprietary ETFs. Yet these product lines currently have massive value that is lying dormant. This is value that can be unleashed by combining these existing ETFs into the Dynamic ETF Pool of newly created Dynamic Investments. And each newly created DI will perform exponentially better than any of the standalone ETFs that it has in its DEP. Through the use of DIs, an existing product line's value can be multiplied many times over and virtually overnight. Go to this link for more information on this topic.
Making ETFs Mainstream Investments: As mentioned above, much, if not most, of the investing public does not know what an ETF is. The reason is that they provide no advantage over mutual funds in a standard MPT, buy and hold portfolio. As a result, advisors don't recommend them to clients. However, when the public learns about the higher returns, lower risk and wealth protection features of Dynamic Investments, they will demand them. And since ETFs are the equity type that powers DIs, sales of ETFs are on the verge of soaring and will eventually surpass sales of mutual funds. Dynamic Investments are the vehicle that will catapult ETFs from today's investing "backwaters" to the mainstream of the investing world.
The World of Investing Is About to Change
Dynamic Investments are so obviously superior to today's MPT portfolios that they will change the future of investing in virtually all areas. Many of the astonishing ways that DIs will change the world of investing are presented at this link.
Let's look at the effects that the introduction of Dynamic Investments will have for specific groups in the investing arena:
- For Individuals - When available, individual investors will demand Dynamic Investments for these reasons: they provide investors with high returns with low risk, they are simple to implement and manage, they protect portfolios from market crashes and they put up barriers against investing scams, schemes and fraud. The introduction of DIs will bring millions of average investors back into the market who are currently sitting on the sidelines in fear of losing money. DIs will finally provide individuals with the investment vehicle that enables them to take advantage of the wealth generation power of equity markets with confidence. And DIs will empower individuals to take more personal charge of their portfolios, severing the current unhealthy dependency of the public on advisors, who are also salespeople, to safeguard their financial futures.
- For the Financial Services Industry - While change is never easy for an industry that is making money hand over fist today, the financial services industry should welcome and embrace Dynamic Investments. Why? Because this simple yet powerful investment type will bring millions of new customers into the market as discussed in the point just above. In addition, DIs open a vast new field of new investing product development. Not only will DIs generate revenue streams in the form of management fees, they will also enable companies to create assets in the form of proprietary DI designs - much like index creators do today.
- For Financial Advisors - Advisors should welcome DIs with open arms. This is an investment type that is easy to explain and provides levels of return that are impossible when using MPT portfolios. And they provide the wealth protection features that will encourage clients to invest. Plus, DIs don't care about the risk tolerance of any investor - so the need for advisors to try to guess at the risk tolerance of each client goes away. This frees up time for advisors to concentrate on other important aspects of wealth creation such as financial planning. Go to this link for more information.
- For Developers - DIs open a vast new world of product development opportunities. There are an unlimited number of DIs that can be created for different goals and an unlimited number of ways that DIs can be configured in a Dynamic Portfolio. Go to this link for more information.
- For Portfolio and Asset Managers - DIs give portfolio and asset managers a extensive new set of tools to use to meet the performance goals of the assets under their management. Using DIs managers can create portfolios with far higher returns with less risk than the outdated MPT portfolio models they are using today. Go to this link for more information.
- For 401k Sellers and Managers - DIs completely revolutionize the world of 401k and other retirement plans. Today's 401k portfolios are typical MPT, buy-and-hold portfolios. As such they are low return, high risk investments because they use a buy-and-hold management style. As such, MPT portfolios DO NOT take full advantage of the tax deferral benefits provided by retirement plans. DIs take full advantage of this benefit by using a buy-and-sell management approach which, as you have seen on this page, produces significantly higher returns than static, MPT portfolios. Go here for more information.
The future of investing will not be like the past or even the present. It will be exponentially better for all involved through the use of NAOI Dynamic Investments. And ETFs will be at the heart of this brave new world.
NAOI Support Resources
The concept of Dynamic Investments is simple. The implementation of it takes some work. The NAOI stands ready to work with any organization who wants to take advantage of the benefits of this new approach to investing as described on this page. Here are just a few of the services we offer:
Powerful Dynamic Investments: The NAOI can provide to you the design of multiple Dynamic Investments that you or your clients can use beginning immediately. This will come as part of a Consulting Contract listed below under which we will not only give you the design and management specifications for these DI's but also show you how to integrate them into your current product line without disrupting existing revenue streams.
Seminars: A presentation on all aspects of Dynamic Investment Theory. See more at this link.
Classes: Offering structured coursework in areas such as optimal Dynamic Investment Design. See more at this link.
Consulting: Working with your organization to integrate Dynamic Investments into your existing product line and defining a transition plan from where you are now to the dynamic future of investing. See more at this link.
Partnerships: The NAOI realizes that we have just scratched the surface of the benefits made possible by Dynamic Investment Theory. We are willing to share our research with your R&D staff. This effort will enable you design, create and use the Dynamic Investments we have already designed and also empower you to create your own proprietary DIs and DI configurations.
Summary - Let's Go!
I began this Web page by commenting on all of the problems that ETFs seem to be encountering today. People are complaining that the ETF space is getting too crowded, that all of the "good" indexes are already covered by multiple ETFs and that just a few companies are dominating the ETF world. Others bemoan the fact that too many ETFs simply cannot attract the volume needed to stay viable and are being pulled form the market in record numbers.
The complaining needs to stop. I have shown to you on this page how ETFs can be catapulted virtually overnight to the primary investment type in the world of investing - surpassing even MPT portfolios that have been in use for decades. I have opened the doors for the development of an unlimited number of ETF-based Dynamic Investments that will outperform any stand-alone ETF or even MPT portfolio in existence today.
If you work with ETFs in any manner it is time to take action. ETFs can either languish as second-class investments as they are today or they can be catapulted to the top of the investment type list immediately through the use of Dynamic Investments. The solution is easy - I showed it to you on this page.
There are no more excuses. It is time to take ETFs mainstream and change the world of investing forever. The NAOI can show you how, today!
Contact the NAOI or Leland Hevner Personally
Contact the NAOI using the information on the Contact Page of this site or contact me directly at LHevner@naoi.org. Also sign up for the DIT Update Alerts Email List at the bottom of this page to immediately receive notice of new DIT developments as they occur.