Toward the end of 2008, for example, the firm concluded that the global credit contraction would work to the benefit of short-term Treasurys and the treasuries of foreign currencies. Based on that conclusion, the firm overweighted U.S. Treasurys, Japanese yen and gold ETFs. Positive results in those categories, along with the tax efficiencies inherent in ETF investing, allowed the firm to limit its losses, Cucchiaro says.
Kim Arthur, president of Main Management LLC in San Francisco, says he was able to save his clients about 300 basis points in losses through the aggressive use of covered calls on his ETF positions.
He uses ETFs for this strategy is because their prices typically are less volatile than those of mutual funds and single stocks-which proved to be advantageous when the market collapsed in late 2008. "You get more liquidity and diversification with an ETF, so price drops are not going to be dramatic," he says.
Research has also shown that a systematic covered-call-writing strategy on the S&P 500 will deliver a return similar to the S&P 500's return, but with lower volatility, he says.
Arthur was a single-stock investor until 2002, when he decided that ETFs offered the advantages of liquidity, transparency and diversification, along with lower costs and tax efficiencies. He also lost faith in active managers, noting that two-thirds of them usually underperform their categories. "When you're doing ETFs and index-based investing, all you care about is asset allocation and finding the right index to represent your buckets," he says.
At the firm, where the average client account is $6 million, investments are limited to a pool of 15 ETFs from a variety of sources, including iShares, PowerShares, State Street and Wisdom Tree, he says.
Naismith says his firm Sarasota Capital Strategies finished the fourth quarter of 2008 in the low single digits by actively managing its indexes-in the form of ETFs-and by hedging long positions with inverse ETFs.
He notes that inverse ETFs are not for the faint of heart. The products are rebalanced daily and are designed for active traders, he says, adding they can backfire as long-term investments. "We literally had to adjust these things daily for them to work," he says.
The firm uses technical analysis to evaluate each of its sectors and the overall market, which in 2008 led it to manage more defensively, he says. One move involved taking long positions in two sectors the firm considered defensive plays-consumer staples and health care-and matching the investments one-to-one with inverse S&P 500 ETFs.
The firm has also started 2009 with long positions in currency ETFs, including the Swiss franc and the U.S., Canadian and Australian dollars. "Managers really have to pay attention to trends and volatility," Naismith says.
Thomas Mench has been investing in nothing but ETFs since the SPDR S&P 500 first became available in 1993. During that time, he has seen the industry grow to the point where he can use a 24-box matrix of ETFs to achieve the diversification he wants for client portfolios.