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ETF Core Strategies

Aim: To trend-trade general equity ETFs so as to ride rallies and buck busts in the Australian share market.

ETF Rotation Strategies

Aim: To back the local and foreign sector ETFs with the strongest price gains over both short and long terms.

What are the risks of market timing?

Using a proven medium to long-term trading system (called ‘market timing’ to distinguish it from daily or swing trading) based on non-discretionary indicators of market trend aims to significantly reduce volatility (i.e. market risk) while improving the reward to risk ratio of investing in Australian shares. Also using a widely diversified managed fund (e.g. an exchange traded index fund representing the top 50, 200 or 300 listed companies) to access the Australian share market should reduce the loss exposure to any one company (i.e. stock risk).

Nevertheless no investment system (other than keeping all your funds in short dated government Treasury bills) is completely risk free. Even a government guaranteed cash management account could suffer a delay in redemption of principal and a loss of interest if the deposit taking institution got into trouble.

The main risks with market timing an exchange traded fund (ETF) such as SPDR S&P/ASX 200 (share code STW) or Vanguard Australian Shares (share code VAS) are ranked by order of magnitude below:

  • High probability – The possibility of false timing signals due to ‘whipsawing’ of the share market. A whipsaw occurs when a sell signal is followed shortly afterwards by a buy signal at a higher price. Such whipsaws occur when the market undergoes a plunge, but then quickly rebounds (the full cycle occurring within 50 trading days). On such occasions our upgraded Conservative Strategy has produced an average sell/buy drawdown of -3.8% with a maximum one of -9.6% over the last 28 financial years back-tested. About 90% of sell/buy signals that occur within 50 days have been whipsaws. Also just as one can have successive wins one can also have successive losses. However, over an extended period, the gains from correct (i.e. winning) signals should far exceed those from false (i.e. losing) signals because a correct signal is allowed to run its full course whereas a false signal is quickly stopped in its tracks. By contrast, a set and forget approach to a share portfolio has no inbuilt safeguard to market busts. The costs of whipsawing should be viewed as an insurance premium for avoiding large market pullbacks which are typical in any year. Ordinary investors not familiar with market timing stop-losses tend to react to market swings by buying at the top (when euphoria reigns) and selling at the bottom (when despair sets in) with resultant massive losses.
  • High probability – The regular buying and selling of the ETF will trigger capital gains and losses with the net gain subject to full taxation in the year in which the transactions occur unless the gains accrue within a low tax superannuation fund or a tax free allocated pension fund. Of course any actively managed fund even if held permanently is subject to annual capital gains tax because its share portfolio will usually be turned over at least once a year. Only a passive index fund held in perpetuity chrysalises few capital gains.
  • Moderate probability – The spread between buy and sell prices on ETFs can widen when market activity is low. Market makers are meant to ensure little or no departure of an ETF from its underlying net asset value (e.g. the S&P/ASX 200 or 300 index), but in practice deviations of 0.5% are common and 1-2% occasionally happen. In the US, market arbitragers quickly close such gaps when they appear and it’s to be hoped that this will happen in Australia too as the ETF market grows and matures.
  • Moderate probability – There is always a possibility that the actual price at which an EFT is bought or sold proves much higher or lower than the closing price for the day on which the timing signal is based. Any change of signal is transmitted to clients as soon as possible after the close of the market at 4pm Australian Eastern Standard Time and no more than eight hours after the market has closed. Clients are then expected to act on the signal the next trading day. However, the price of the ETF used will fluctuate between a high and a low each day. To avoid the possibility of purchases or sales happening at these extremes some investors undertake their transactions in multiple lots during the day if their broker accepts this as one transaction for charging brokerage fees. For instance a client might instruct their broker to undertake one tranche at 10am, one at midday and one at 3pm so as to get a spread of the ETF’s prices during that day.
  • Moderate probability – Excess brokerage fees as a result of acting upon multiple timing signals during the year. On average MarketTiming’s Conservative strategy issues around 2 signals a year. This means for a client using a typical discount broker such as Comsec, brokerage fees (plus GST) of 0.12% per trade would typically total around 0.24% to 0.72% per annum on investible funds over $25,000 depending on the timing strategy used. The simulated annualised performance results of our strategies cited earlier are after 0.12% brokerage per trade has been deducted. Some online discount brokers (e.g. CMC Markets and Bell Direct) charge only a 0.10% brokerage rate per trade on volumes much lower than Comsec or E-Trade. On the other hand Australian equity ETFs have very low management fees (under 0.3%) so the total cost should still be less than buying and holding say an actively managed retail equity fund (whose entry fee is typically 4% to 5% of the initial investment and whose management expense ratio normally ranges from 1.5% to 2.5% of funds under management).
  • Moderate probability – An individual investor misses a market timing signal because they don’t check their emails or the MarketTiming website every day or two. Changes in MarketTiming’s signals will be posted on its website as soon as they occur and clients will be sent email alerts to draw their attention to such changes. When traveling a client should check their emails or our website at least every two days lest a signal changes. Being out of internet range can be a problem. In such cases you may formally request Market Timing Pty Ltd in advance of your journey to also email any signal changes to your broker or planner on the proviso that it may only be used for your purposes in accordance with your written instructions. An extra administrative fee is charged for this temporary service.
  • Low probability – The Company that manages the ETF becomes insolvent, though this should not affect the underlying value of the ETF’s assets because these are held are in a trust fund independent of the fund’s manager. Also ETF managers such as StateStreet and Vanguard have a long-standing reputation for being conservatively run which is reflected in their high credit ratings.
  • Low probability – The ASX closes down because of a breakdown of its IT systems, sabotage, natural disasters or war. If this happened all Australian shares would be affected. The ASX has security and back-up systems to minimise the probability of an interruption to its services.
  • Low probability – A client’s internet provider’s service ceases making it impossible to access either MarketTiming’s website or emails. In such cased clients should phone MarketTiming and ask for a phone alert until their internet connection is restored. An extra administrative fee is involved for this temporary service. An easier option is to have your ETF trading done automatically by a broker using our signals. See question 4b in the FAQ section of our menu for how to arrange such an auto-trade service at a deep discount to normal full service fees.
  • Low probability – A client’s computer malfunctions meaning MarketTiming’s website or emails can’t be read. To prevent such a possibility a client should have a fall-back remedy such as knowing where the closest internet café is located.
  • Low probability – The MarketTiming computer model malfunctions or breaks down causing a loss of signal capacity. MarketTiming has backup systems in place. Should one system go down (e.g. due to an electricity blackout) the other system will keep running. Should our website fail, MarketTiming would replace it with daily emails to subscribers until the system was up and running again. Our share price database is updated daily and the veracity of our models is checked continuously.

Trading unlisted managed equity funds has timing risks since there can be a few days delay between receiving a new buy or sell signal and having such a fund implement it by issuing units or redeeming cash.

A similar delay can occur with a super fund when you ask it to change your nominated strategy (from say a high growth to a cash option). Where delays up to three days occur with implementing signals use only the Conservative timing strategy and recognize that performance can be affected.

In the case of listed investment companies the main risk is that the market price of the shares may be at a premium or discount to their net asset backing. Also in both these cases unless the funds are indexed to the S&P50, 200 or 300 their price movements may differ from those of the general share market making MarketTiming’s signals less relevant.

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