A Barbell to Balance Risk and Reward

Snapshot

As uncertainty and volatility linger in the market, Brian Belski offers a barbell strategy with two BMO ETFs to balance risk and reward in the months ahead.

Outlook

Earnings are once again surprising to the upside, part of a secular trend from corporate America of ​“under-promising and over-delivering” with respect to quarterly results. However, macro uncertainties and fears over a potential recession, coupled with continued price gains in the overall market, are confounding most investors. For our part, we are not seeing the disintegration of macro data points, including but not limited to corporate earnings and consumer spending that many analysts and macro observers have been predicting for several quarters. As such, we believe the path to our bull case scenario for the S&P 500 to reach 5,050 by year-end is becoming increasingly likely. 

Details

• BMO U.S. Equity Value MFR Fund ETF Series (Ticker: ZUVE)
• BMO U.S. Equity Growth MFR Fund ETF Series (Ticker: ZUGE)

Benefits

• Selection of Holdings: Based on fundamental factors, which allow the portfolios to be forward-looking, as opposed to indices that attribute weight based on past performance. 
• Balanced Approach: Using ZUGE and ZUVE, investors can balance growth versus risk.
• Equal Weight: Both ZUGE and ZUVE distribute equally between 50 companies scoring the highest on a multi-factor ranking (MFR) system. 

Trade idea: A growth and value barbell strategy

Growth has had a huge rebound this year, but over the last two months, Value has outperformed. Why is this? We find the run-up in equity markets has collided with a broader trend toward interest rate normalization, and investors needed to adjust to the current environment. In particular, two primary stumbling blocks, the low 200-day price volatility (200DPV) and FY1 earnings revision (FY1REVR), came in abnormally low relative to their historical 12-month averages, which increase the probability of an uptick moving forward. Overall, the market appears to be bottoming out and, as a result, we are expecting more normal price performance environments in Q3 and Q4. 

That being said, macro risks remain at the forefront of investors’ concerns. As such, investors looking to mitigate risks while also staying invested in this environment may consider a ​“barbell strategy” by owning both Growth and Value. Keep the focus on moderation — for example, by splitting your equity exposure 50/50 between the BMO U.S. Equity Growth MFR Fund ETF Series (Ticker: ZUGE) and the BMO U.S. Equity Value MFR Fund ETF Series (Ticker: ZUVE). While ZUGE provides continued exposure to high-growth names, ZUVE delivers a price performance-conscious counterweight that reduces risk without necessarily lowering upside potential. 

Both ETFs use a proprietary model that goes beyond traditional Growth and Value indices. Conventional indices base their composition on past performance, which often results in high turnover, whereas we focus on fundamentals in order to optimize risk-adjusted returns. This is evidenced by our strategies’ Sharpe ratios relative to their respective benchmark indices:

Value MFR model performance summary

Growth MFR model performance summary

In both instances, our model allows us to diverge from the index and select companies on the basis of a multi-factor ranking score. The model conducts rigorous analysis of key factors to arrive at a formula that yields 50 holdings we can believe in — and then we allocate to them evenly. The equal weight approach is critical; it eliminates bias in the portfolio and creates a meritocracy where we take profits from the best holdings to finance those that are trading at a discount.