December 2019 Model Updates

December 2019 Model Updates:

LSA will be completing our revisions to model portfolios that were not addressed in November.  This includes the ETF, SRI, and VA models that were postponed in November due to further review that was needed before release.  The full revision release schedule can be found below.

LSA will be making revisions to the following portfolios:

Posted Wednesday, December 11th: ETF, ETF Tactical, Transamerica, and SBL Advisor Design – targeted trade date – Wednesday, December 18th.

*The Mutual Fund and ETF revisions will impact the NTF models as well.

*LSA will be consolidating all NTF ETF models over the next six months now that the custodial platforms are offering commission free ETFs for all ETFs.

*LSA will not be making changes to the PC Tax Efficient or PC Income models until first quarter of 2020

*As a reminder, the Revision Explanation Presentation/Video is posted in the “Portfolio News,” section on each of the platform home pages and will be posted at the end of the business day on the targeted posted date.

Investment Rationale:

As communicated in our latest portfolio update presentation, the LSA Investment Policy Committee continues to believe that the probability of recession will continue to grow over the next 12 – 18 months.  With this as a high level thesis, the upcoming changes to models have been focused around two themes.  First, reducing risk…..this is the concept of taking down risk on the fringes of models to get a little more conservative, but not to restrict up-capture participation.  We believe that this reduction of risk will allow the models to continue to benefit from a “cautiously optimistic” stance on the markets.  Our intent is to start addressing market concerns with a focus on becoming more defensive.  The committee has also outlined a “part two” revision that is being defined as “hedging risk.”  This hedging risk movement is not expected to be implemented until 2020 and will be data dependent upon further deterioration of our recession indicators as outlined in our portfolio update presentation.  The hedging risk movement, down the road, has a more distinct focus on reducing correlations to the portfolios with the use of low or negative correlated investments to target alpha opportunities in a more prolonged correction, or recession.  Both phases of upcoming changes are addressing the simple stance on current market conditions that the IPC believes that there are greater downside risks at this point in the cycle, versus upside opportunity.  If you have not had a chance to review the monthly portfolio update video please do for greater details around potential headwinds that LSA is concerned with at this time.   (see website for replay)  The LSA IPC is identifying this round of revisions to focus on reducing some risk to the models in order to help address these growing concerns of potential recession as the current market cycle starts to wind down.  Although the committee continues to be cautiously optimistic over the next six to eight months, the focus of changes in this first round of revisions is to start the movement of getting more protection in the models.  The high level concepts that will be addressed can be found below.

There will be a focus on three general themes with this round of revisions:

  1. The LSA IPC will be reviewing every model, position by position, to make sure that we are achieving the spread profile that we target with each of the mutual fund, ETF, and subaccounts in the various models. What the committee is looking for is a manager’s ability to generate a positive spread between average up-captures and down-captures with an emphasis on down-captures.  This spread relationship is where we continue to believe real wealth accumulation comes from over time. During periods of market volatility, this spread can potentially help create a favorable return profile when markets begin to struggle. This review continues to support the LSA search process, but the IPC will focus on better down-capture characteristics at this time, to emphasize our focus on risk reduction.
  2. The IPC will be increasing some defensive posturing within the models. This translates to an average of about a 5% increase to fixed income.  This will begin to exercise the more conservative sides of the bands from a model perspective.  The increase in fixed income is focusing on higher quality asset classes as the committee continues to take down credit exposures to the models.  This movement includes the reduction, or removal, of bank loans in a number of the models and increasing more of our core bond position.  Please note that a more core bond position will increase our duration exposure. In doing so, this could create a greater correlation to the 10-year treasury.  That said, this increase in duration, could potentially provide a better risk-off buffer with our overall fixed income exposures.  As volatility concerns continue to grow, credit exposures become more correlated to the equity markets, and eliminate some of the risk posturing we often lean on out of our fixed income sleeve.
  3. The LSA IPC will also be looking to reduce some equity exposures to the models. This reduction will predominately be focused on international equities that have continued to struggle.  In addition, when appropriate, we will also reduce some domestic equity exposures where the committee identifies overextension in the models.  LSA continues to believe that valuations remain attractive with international equities but the developed world continues to struggle with little improvement of economic data.  On the domestic equity side we continue to stay focused on overweighting large cap versus small cap and maintain a neutral stance on value versus growth.

To recap….LSA continues to follow our high level thesis in which we believe that the US economy will be faced with a couple of difficult headwinds that have increased the probability of a recession taking place in the next 12-18 months. We experienced firsthand some of these headwinds in the fourth quarter of 2018.   These headwinds include, but are not limited to, concerns with an inverted yield curve, uneasy trade policy discussions with China, a softening in corporate earnings and a deficit that is rapidly growing.   Although our current recession indicators are not sounding the alarms just yet, we do have three of our seven indicators starting to raise flags.  The LSA IPC will be looking to slowly reduce risk from the portfolios with this round of model updates.  We believe such model changes could be particularly helpful during conditions of weakness for equities and/or other equity-correlated risk assets.

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