KFAC Commentary – Background & Rationale for Recent Trades

Nicholas Coppola, CFA

 July 11, 2018 

As you have likely seen in your trade confirmations, we are reducing our over-weight exposure to mid-cap ETFs and raising our exposure to small cap ETFs.  This transaction moves us closer to a similar mix of market caps and styles as the broader market, as well as provides several tactical/strategic benefits.  Note that simply based on their size, small cap companies tend to be more domestically focused, which translates to less concern regarding trade wars and an outsized benefit from tax reform.  The United States also continues to be a bright spot in the world economy, and our shift towards a greater exposure to small cap companies takes advantage of this trend.   

We are also adding a small position in the DoubleLine Shiller Enhanced CAPE fund.  This is a somewhat unique fund that creates value through two sources, including a US sector rotation strategy and a fixed income portfolio.  The sector rotation strategy is achieved through an equity index swap that receives the returns of the sectors believed to be ‘cheapest’.  Sector selection is based on a version of the Cyclically Adjusted Price to Earnings (CAPE) ratio developed by Dr. Robert Shiller, a Professor of Economics at Yale University and a Nobel laureate.  So how are these sectors selected?  At a high-level, sectors of the large cap equity market are evaluated by price relative to earnings over the prior ten years.  While many investors commonly look at price to earnings ratios over the trailing twelve months, this ten-year view aims to better approximate earnings over a full market cycle.  To take this a step further, the fund then calculates a Relative CAPE ratio for each sector, which compares the current ratio to prior history.  Importantly, this step helps to ensure that the fund doesn’t simply invest in historically ‘cheap’ sectors that may then proceed to remain ‘cheap’ well into the future (i.e., utilities).  The fixed income portion of the fund is then managed by DoubleLine and provides diversification with the goal of trying to outperform cash.  While there are surely a number of risks involved in this strategy (i.e., environments where both equities and fixed income perform poorly), we believe that the methodology is sensible and consistent with our value investing philosophy.  

Thank you again for your continued support.  And as always, please let us know if you have any questions about recent trades or your broader portfolio.

Sincerely,

 

Nick Coppola, CFA

 

Nicholas Coppola, is a Senior Portfolio Manager at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at ncoppola@scottkays.com.

 

This report and Mr. Coppola’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any investment and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned here in.