One of the site's resources-what Lydon calls its "ETF Analyzer"-reflects Fabian's influence. The analyzer is a listing of all ETFs with at least $50 million and their 200-day moving averages, which are the basis for Lydon's investment discipline.
"We found in designing it that if you're trying to manage your portfolio and you have core holdings-but are looking to find areas that might show new trends to the upside-the analyzer is a great way to do it," he says. "You can look at an ETF's 200-day moving average and see what areas might be developing a new uptrend. This is what we do for our own client portfolios ... we only own ETFs above their 200-day moving average trend line."
But wouldn't this imply that ETFs that drop below their trend line are then sold? "Not necessarily," says Lydon. "We sell when the ETF either goes below its 200-day moving average or when it drops 8% off its high-whichever happens first."
Lydon offers as an example how emerging markets like China were 30%-35% above their moving averages in 2007. "If we'd stuck to using just the moving average trend line and no 8% stop-loss discipline, we would have given back 35%," he explains. "And since ETFs are traded on the exchanges, we can buy and sell in the same day if we want to. So we really believe that, for advisors wanting to implement their own strategic or tactical allocation model, ETFs really are the answer."
According to a 2009 study of active and passive investment strategies by Winans International-an investment management and research house-from 1988 to 2008 a 200-day moving average strategy produced average annualized returns of 13% while a buy-and-hold strategy returned only 4%. Of course, the 2008-2009 stock market by itself provides the perfect testing ground for Lydon's moving-average strategy. Did it protect his clients?
"We dodged a bullet," he says. "As of February 28, 2009, we were down 2.6% year to date, while the S&P was down over 18%. In 2001 and 2002, we were down by single digits when the market was down considerably more. So in the last ten years it's been difficult to make money, but since the end of 2000, we're up 2.9% annualized, net of fees, while the S&P is down to the tune of 7% per year."
In spite of the fact his clients earned just short of 3% a year, they're nonetheless enjoying a considerable alpha effect from Lydon's strategy. It isn't just the sell discipline that has helped, he says, but "by having all asset classes, sectors, commodities and currencies available to us via ETFs, we've been able to reduce risk and provide opportunities to clients when trends develop."
And that's happened during a very tough, challenging time in the market when even some money market vehicles have seen share values sink below $1. Lydon's common sense told him to move clients from diversified money market funds to U.S. government money market funds in early 2008. "We're barely getting 1% interest, but the clients feel that even if a money market is paying zero percent and their money is safe, they're OK with that."
Lydon recently co-authored the book iMoney: Profitable ETF Strategies for Every Investor, published in the summer of 2008 by FT Press. He sees an even brighter future for ETFs, including the introduction of new indexes and asset classes. For example, new "sShare" ETFs from Pax World Management will target companies with strong environmental and social governance criteria and equal sector-weighted ETFs have been introduced by companies like Alps Holdings.
Where will the money come from to buy these new ETFs? Says Lydon, "We know that there's three to five trillion dollars on the sidelines now, and at some point in time this money will come back to the market. When it does come back, the average individual investor-and advisors too-will be better educated about the benefits of ETFs. When you see big names like PIMCO and Schwab entering the ETF marketplace, it's clear to me that ETFs are the most innovative investment vehicle we've seen in the last 50 years."