This article about investing in the Donald Trump era is by former hedge fund manager turned author Lars Kroijer, an occasional contributor to Monevator. He also wrote Investing Demystified.

New US President Donald Trump is making headlines on an hourly basis. Our social media accounts are going crazy with comments about his presidency being a de facto coup or a one-way route to the apocalypse.

You may well be asking whether you should change your investment strategy as a result?

In short, the answer is perhaps – but probably not how you think.

In previous articles I have outlined how I consider it highly unlikely that the vast majority of investors can beat the markets – whether through active stock selection, market timing, or via picking the one out of ten actively investment funds that may manage to do so over a ten-year period.

I’ve also argued that for your equity exposure you should pick the broadest and cheapest index tracking exposure you can get your hands on, namely a world equity index tracker fund.

‘Just’ because Donald Trump is now President of the United States, that is no less true. You most likely couldn’t beat the markets before 9 November 2016. You still can’t. That hasn’t changed.

But what also hasn’t changed is that you can still expect to make returns of perhaps 4-5% above inflation. This estimate is based on over 200 years of history of equity returns in many states of the world.

However these average long-term expected returns will be volatile over the short-run. You can expect much higher returns some years, and terrible losses in others. And you can reasonably expect to be compensated in higher risk periods with commensurate higher expected returns, though there are no guarantees of this.

Okay, so even if in a Trump world we haven’t found a crystal ball, what can we do?

In my view, there are two main things we should focus on:

1. Evaluate whether the risk of the markets has changed enough that we should re-evaluate the risk levels of our portfolio.

2. Consider if the sudden change in the political landscape has changed our overall economic life enough that our risk profile should change as a result.

For the rest of this article I’ll explain how to do both things.

Market risk under President Donald Trump

You’ll find below a graph of the expected future risk of the US stock market. Without being too technical, it measures the expected standard deviation six months into the future. Since the index value is based on the implied volatility of equity options, it is a market price.

If you think you know the future volatility of the market better than this chart then you can get rich trading it. (Many try!)

Source: CBOE.com

There are many issues with this kind of chart, such as that the value itself is very volatile (so the risk changes a lot), the volatility doesn’t capture ‘fat tails’ ¹, and it only looks six months into the future. All that said, it does give a good idea of future expected risk.

Look at the very volatile 2008/09 period circled in red, and compare it to the more recent period, also circled. What this tells us is that as momentous as the election of Trump was politically, in terms of market risk it hardly made a dent.

Because the election of Trump was a genuine surprise – Betfair had the probability of Trump becoming president at about 15% on election day – we can get a good sense of how much things shifted as a direct result of Trump’s election. (If Trump had been expected to win, then the impact of his presidency would already have been built into the market price.)

As things turned out, the equity market risk hardly moved.

Confused? Don’t be.

Just know that the expected risk of the stock market in the future did not change as a result of Trump, and so this factor alone should probably not cause you to change the risk profile of your portfolio.

Your risk with Trump as President

While the market risk has not changed as a result of the election, your personal risk might have. The overall market did not move hugely after the Trump election, but there are clearly some sectors and geographies that could be hugely impacted by his election.

You therefore need to understand how Trump’s election might affect your overall life.

For example, if you work at a Mexican company that exports most its products to the US, then a Hilary Clinton victory would clearly have been better news.

Similarly, imagine a scenario where you work in mid-level management at a BMW factory in the United States. You’re so confident in the company, you’ve previously invested most of your savings in BMW stock, your pension is guaranteed by BMW, and most people in the town you live in are also employed by BMW.

Now imagine Trump goes on one of his 3am Twitter rants:

“BMW are a bunch of foreign losers. Time to kick them out”.

Then imagine some hours later after Trump has slept a bit and had his morning coffee he tweets:

“I meant it. We are shutting them down”.

All hell breaks loose. BMW is down 50% and people start talking about the need to close the US operations. There’s a discussion about the risk of the BMW corporation defaulting on its debts.

Your whole economic life has been turned upside down because of Trump getting out of the wrong side of bed. To say you are overexposed to BMW would be a massive understatement. Your job, pension, savings, and house all correlate to the BMW corporation. You were guilty of putting all your eggs in the BMW basket and are now paying for it.

Very nasty – but less extreme versions of this example are equally worth avoiding.

Is Trump fighting for you or gunning for you?

So how do you know if sectors you are exposed to might be helped or hurt by Trump? Or by Brexit, incidentally, or any other big event?

Again, because Trump’s victory was a surprise we can see the market impact right after the election. If Trump’s hypothetical BMW Twitter rant had taken place before the election then you would expect BMW stock to be down a lot right after the election. That’s how you know.

It was not a surprise to see the Mexican Peso decline after Trump’s surprise win.

My advice? Sniff around. Understand your economic exposure and see how those sectors fared in the market’s mind after the election. Then look at how much Trump’s various statements and Tweets impact on how these things move.

Maybe it’s time for a change

If your investment portfolio consists of a world equity tracker combined with super low-risk government bonds, you will have broadly diversified away a lot of the sector and company-specific Trump risk.

But as illustrated by the BMW employee example we just saw, your individual non-portfolio exposures may still lead you to change the risk you feel you can afford to take in your investment portfolio.

For example, you may previously have felt quite relaxed about stock market risk, and employed a fairly bullish 75%/25% split between equities and bonds.

But after assessing your Trump-adjusted risk, you may feel a 50%/50% risk is appropriate.

This would not be because the markets have gone down in value, or up in terms of risk. Rather it would be because the sectors or geographies you are otherwise exposed to has changed your overall risk profile under Trump.

Deciding how a Trump presidency might impact your overall economic life is far from a science. We don’t really know and can’t expect to be precise about it.

But you shouldn’t ignore the issue. The Trump presidency has the potential to be very consequential on your economic life.

There will be other shocks in the future, too. If you’re uncertain as to how much risk you should be taking in your portfolio, perhaps consider using a financial advisor to help you think through your exposures.

When hiring someone, make sure you don’t start paying them to actively outperform the market. Just as you probably can’t do that for yourself, they are likewise extremely unlikely to be able to outperform.

But they should be able to help you understand your overall economic life, how your risk profile may have changed – or even how you can protect yourself from being the mid-level BMW manager in the example above.

President Trump and you

I know it may feel odd that something can dominate the news like the Trump presidency and yet we are still not able to justify having a different perspective to that of the overall market.

However do think about how Trump might impact your job, sector, house, pension, insurance policies, and other things that contribute to your overall economic welfare – and then perhaps re-consider the risk of your portfolio as a result.

Below you’ll find a video that recaps the things I’ve discussed in this article. (You will find some other investing videos on my YouTube channel).

Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating all his profits from his book to medical research. He also wrote Confessions of a Hedge Fund Manager.

1. The fact that unlikely events happen far more than predicted by the normal distribution assumption of the standard deviation.[↩]

Good reads from around the Web.

Well here we are, one month into the year of the people Taking Back Control. Isn’t it going well everyone?

In the UK the people have Taken Back Control and given it to a handful of Tory MPs. This right-wing minority of a centre-right party will now unilaterally establish how this country trades, regulates, and protects its citizens for generations.

What could possibly go wrong for the provincial masses ¹ who voted for Brexit?

Of course, MPs have been told they’ll get a vote on the final terms of our departure from the EU. And as this week has shown they’ll be called traitors and enemies of the people if they don’t simply wave it through.

What part of democracy don’t I understand? That’s what Brexiteers have been shouting all week, as they lambasted anyone who questioned giving the government the right to pull us out of Europe before we’d reached any sort of national consensus on what Brexit should and should not entail.

An admittedly Herculean task, given the flat-out contradictory hopes and motivations of Leave voters, but that’s on a Leave voter’s conscience, not mine.

No, we voted out, that’s the litmus test for all routes forward. That’s the constant refrain. It’s like going to the doctor because you have an ingrown toenail and seeing your leg amputated. “Yes, but we’ve dealt with the toenail!”

Top trumped

Meanwhile in the US the people have Taken Back Control and given it to a thin-skinned autocrat who seems to be deliberately probing the system for its weakest links. He’s also openly scornful of the international institutions and alliances assembled in the past 70 years to keep the great powers in check and stave off total war, and the globalization that has helped take a billion people out of poverty in the past 20 years.

And he is not wasting any time in sorting out America’s problems!

On Friday he announced his administration would tear into the post-financial crisis regulations to get banks to lending again.

He literally – I shit you not – stated that he has “friends” who can’t borrow.

But let’s cut him some slack; you can see the lack of lending pretty clearly in this chart from the US Federal Reserve:

Source: St Louis Fed

I mean, I know it looks like total US commercial and industrial loans are now running about 30% higher than before the financial crisis.

But that’s just a fact!

You’ve get to get hip to alternative facts. You know, bogus funding claims written on buses, massacres that didn’t happen, nonsense theories that sound right but that are flatly wrong about the impact of immigration, trade, and so forth.

These distortions might all make for good sport in a world without nuclear weapons.

Unfortunately we don’t live in such a world. As with all his predecessors, a man follows the new President around day and night with the nuclear codes that enable him to begin World War 3 in about the time it takes to compose a Tweet.

Died in the wool

I would like to think those reasonable people who voted us out of Europe for reasons of sovereignty or even economics would at least now acknowledge the downsides of the alliance they made with nationalists, racists, and fascists to push them over the 50% mark.

Social media suggest they won’t. People are getting more entrenched, not less. There’s every chance it could get worse before it gets better.

I also don’t know if there are any Barry Blimps still reading Monevator. But there should be fewer than there were just through the natural attrition of the Leave voting cohort.

Here’s some – not to be taken hugely seriously – maths I shared with friends this week:

I’ve just been looking at Office for National Statistics data on deaths. I estimate at least 300,000 UK citizens have died since the Referendum.

Around 64% of over 65-year olds voted Leave, compared to just 29% of 18-24-year olds. Very few people die before 55, which is around the age that people started to favour Leave. Mostly the oldest Leave-ist voters die. Voter turnout was 72%.

Consider older people were more likely to turnout, assume people don’t change their vote as they get older, squint a bit, and I guestimate about 22,000 Leave voters are dying every month.

Brexit won by 1.2m votes. Within about five years Leave’s existing margin of victory will probably be dead, leaving us to lump it.

But wait – what about the new young? If we assume 70% or so would vote Remain and constant turnout, then Remain might win a Referendum within three years.

No wonder they want to trigger Article 50 and get us out in two.

(Caveat: All sums done in my head, your mileage may vary.)

Of course you can quibble with my assumptions.

For instance it’s possible young people are looking at the cabal of Conservative ministers heading off to Brussels to decide the future of the UK for themselves, at Nigel Farage chilling with Donald Trump, at the US refusing entry to its own legal residents for a period on a presidential whim and they’re thinking: “Hey, I don’t know what that guy is smoking but I want some of it!”

What do I know? I’m just a liberal elite snowflake.

[continue reading…]

1. Yes, I understand not every Leave voter was a member of the provincial masses. Perhaps you weren’t. But they are the ones I am talking about here. See how it works? Maybe I’ll write about another kind of Brexit voter later on. Who can tell![↩]

Most of us are comfortable with the idea of diversifying across geography. We’re all too aware that countries can rise and fall through the league of nations, that the Chinese Dragon can catch a cold or the Land of the Free can turn into the Land of the Hideously Over-Valued.

Diversifying across the sources of investment return is a road less travelled.

Academics have isolated the main factors that drive equity returns. And we can invest in them just as with countries or continents – piggybacking their unique properties to hopefully reinforce our portfolios whichever way the wind blows.

The easiest way of doing this is with a multi-factor exchange traded fund (ETF). These combine factors like value, size and momentum into one handy package.

In a previous thrilling installment, we stared into the multi-factored eye of iShares FactorSelect MSCI World ETF. Now we’re gonna sidle up to a couple of ETFs that follow the Scientific Beta Developed Multi-Beta Multi-Strategy index.

That’s right. You asked for it!

Okay, maybe you didn’t but I’m gonna tell you anyway because multi-factor exposure offers:

• A chance of outperforming the broad market over time.

• Better risk-adjusted returns through exposure to less correlated equity asset classes.

Two very nice outcomes, even if the majority of passive investors might rather just be woken up in 20 years time when their vanilla portfolio has finished rising in the oven of compound interest. (Which is absolutely fine by us, of course).

Welcome to my laboratory

The Scientific Beta ETFs are a potent potion of value, size, momentum, and low volatility.

These factors should mix well together because correlations have been historically low between:

• Value and momentum
• Size and momentum
• Size and low volatility
• Low volatility and momentum

The Scientific Beta Developed Multi-Beta Multi-Strategy index – apart from being stuffed with more keywords than a pornography website page circa 1999 – tracks 1,600 equities that tilt towards the above factors across the developed world.

You can check its diversification chops for yourself on the factsheet.

Two ETFs currently track variations on this index:

1. Fundlogic Morgan Stanley Scientific Beta Global Equity Factors ETF (GEF) tracks the equal weighted (EW) version of the index.

This means the index is evenly divided between the factors, so its fortunes are less likely to be swayed by any particular one of them.

2. Amundi ETF Global Equity Multi Smart Allocation Scientific Beta ETF (SMRU) tracks the equal risk contribution (ERC) version of the index. This mechanism is designed to minimise tracking error regret – the malaise that makes investors want to sell up when their factor tilt underperforms the broad market.

Scientific Beta’s backtesting suggests that the equal risk index sacrifices a performance smidge (0.3% per year between 2003 and 2013) in exchange for less volatility (1% less per year between 2003 and 2013) in comparison to its equal weight cuz. Since they’ve gone live, there’s scarcely a whisker between them.

Now, our multi-factor pair may have longer names than a Welsh village, but luckily they don’t charge by the word. Their Ongoing Charge Figures (OCFs) are comparatively modest at 0.4%.

You’d pay 0.5% for iShares FactorSelect ETF, by comparison – but the cheapest, plain, developed world ETF is less than half as dear at 0.15%.

Will you get what you pay for?

So are these multi-factor ETFs worth it?

Sadly, there’s too little data to go on to answer that question.

However an early comparison of their holdings versus plain, developed world rivals does reveal a slant away from the consensus.

The difference they can make is confirmed by this Trustnet performance chart that matches the last 24-months worth of results from our multi-factor ETFs (A and B) versus two plain, developed world ETFs from HSBC (C) and Vanguard (D).

Ignore the graph if you like, and drop your gaze to the numbers below.

A year ago our multi-factor upstarts had just put in a 12-month stint of slamming their no-frills rivals. They’d beaten HSBC’s ETF by over 3% and Vanguard’s by well over 2% over the period. Albeit the year was no great shakes – even the multi-factor ETFs barely broke even.

But 12-months later and the vanilla crew reigned supreme – beating the Smart Beta duo by over 4%.

What does this tell us? Only that the the Scientific Beta formula does actually create products with returns that differ from regular ol’ world ETFs. They should therefore add some diversification to your equity mix.

What we absolutely cannot infer from 24 months worth of data (no matter how tempting) is which of these products will turn in the best results over the long-term.

And we can’t tell how they might perform under different economic conditions, either.

Good signs

The factor metrics used by Scientific Beta to select its index holdings are straightforward and supported by independent research. This gives me more confidence that they haven’t just sent their data miners into the bowels of history to pluck out some shiny backtests that won’t be replicated in real life.

You can read all about how the indexes are constructed on Scientific Beta’s website.

In fact, Scientific Beta go to greater lengths than most to strip their indexes bare for all the world to see. Indexes should be see-through like chiffon, so this is another encouraging sign, especially as I’ve been unable to find dissenting voices picking the methodology apart.

The equities in the index are not cap weighted but strained through more filters than sewage. Initially they are equal-weighted, then they’re deconcentrated, decorrelated, risk-weighted and risk-adjusted to keep your portfolio smelling sweet.

I’m poking fun because the methodology is a jargon fest and I have no way to unravel it. In Scientific Beta’s defence they’ve documented each stage in detail. The gist is that the process is designed to increase the diversification effect.

Scientific Beta’s own pitch for why you’d invest boils down to:

Such a Multi-Strategy Index is suitable for investors who do not hold a strong view on what is the best strategy over the relevant investment horizon and wish to protect themselves against uncertainty by i) diversifying strategy specific risks and ii) smoothing their outperformance across distinct market conditions.

The Investor’s Field Guide wrote a great piece on why investors looking for outperformance should take a strong position in defiance of the market consensus.

While true, this requires you to do three things that are tough:

• Take a contrarian view.

• Be right.

• Stay the course for as long as it takes to become right. That could mean spending years grappling with the consequences of being wrong.

The Scientific Beta ETFs do not offer concentrated contrarianism. They allow you to wander off the beaten track ever so slightly. It’s a detour to grandma’s house that shouldn’t take you too deep into the forest. (That’s what the big bad wolf of stockpicking is for.)

We can see evidence of Scientific Beta’s pitch in the chart above. The multi-factor ETFs move in tandem with the performance of the plain developed world product, but they’re offset enough to make your portfolio a little different, hopefully in a positive direction over time.

So why wouldn’t you?

Aside from adding considerable complexity to your investing life, there’s a couple of particulars about these ETFs that may give passive investors pause.

Firstly, both are synthetic ETFs. They don’t physically hold the equities in the Scientific Beta index. Instead they use a financial contract known as a total return swap to match the index return.

Personally, synthetic ETFs don’t worry me. They do others. Either way, you should know the risks you’re exposed to.

In particular, financial regulators have warned of the potential for conflicts of interest when ETF providers and their total return swapping counter-parties are arms leading from the same financial octopus. (We’ve written more about such risks, if you’re keen).

It appears to be the case that Morgan Stanley is the counter-party to the Morgan Stanley ETF. See pages 172, 384 and 393 of the annual report.

And there’s another eyebrow raiser on page 39 of the ETF’s prospectus.

Morgan Stanley states:

When Morgan Stanley acts as broker, dealer, agent, lender or advisor or in other commercial capacities in relation to the Fund, Morgan Stanley may take commercial steps in its own interests, which may have an adverse effect on the Funds.

Also…

It is anticipated that the commissions, mark-ups, mark-downs, financial advisory fees, underwriting and placement fees, sales fees, financing and commitment fees, brokerage fees, other fees, compensation or profits, rates, terms and conditions charged by Morgan Stanley will be in its view commercially reasonable, although Morgan Stanley, including its sales personnel, will have an interest in obtaining fees and other amounts that are favourable to Morgan Stanley and such sales personnel.

It’s as well to be aware of the bargain you’re making when investing in any product.

Amundi is backed by the French bank Credit Agricole and the counterparty of their Scientific Beta ETF is BNP Paribas. The ETF is domiciled in France which means you’ll be exposed to withholding tax if it distributes dividends.

According to the dividend policy, the fund manager is at liberty to decide whether dividends are paid out or reinvested in the ETF. It doesn’t say on what basis the manager will make this decision.

The final point to note, if you’re interested in what other investors think, is that the Amundi Scientific Beta ETF has been the most successful in attracting paying customers.

As of January 2017 it has acquired $536 million in assets, compared to $246 million for Morgan Stanley’s version and $270 million to iShares FactorSelect ETF.

Over to you

Ultimately, these are complicated investment products that require much due diligence before they can comfortably slot into anyone’s portfolio.

Every investor needs to decide whether the underlying principles of factor investing make sense to them and whether the available investment products are likely to do a good job.

All I can do is lay out some of the issues worth thinking about and link to further research that may help.

Personally, I do invest across the factors. I do this as much in the hope of diversifying my portfolio as in squeezing any more performance from the financial toothpaste tube.

The greatest argument against this move is simplicity. If you’re an exponent of the art of KISS then… as you were.

Take it steady,

The Accumulator