ETF Spotlight on DYLS

Posted on: 02/10/2017

John Koch iSectorsBy John Koch

Here at iSectors, one of the many names we have been given is that of “ETF strategist.” Morningstar calls our investment allocations “ETF Managed Portfolios.” Whichever name is given to us, it is obvious that we primarily use ETFs in our investment models. Notice the use of the word “primarily” in the previous sentence.

There are a few models we have where we need to reach into mutual funds or closed-end funds to gain exposure to certain things that are either brand new in the ETF space and lack a sufficient track record, are unattainable there altogether, or are less tax efficient in an ETF wrapper.

A prime example of this is in the iSectors Liquid Alternatives Allocation. When the model was created in 2009, there were some asset classes with no viable ETF choices at the time, such as long/short equity, market neutral, or merger arbitrage. Over the years we have slowly transitioned into using more ETFs in that model as they become available, but there were a few mutual funds that still remained in the Allocation until this year because a good enough case could not be made for selling.

WE recently transitioned out of a few mutual funds in Liquid Alternatives and added a few new ETFs. One of these is the WisdomTree Dynamic Long/Short Equity ETF (DYLS). DYLS is a long/short fund that is always 100% long and uses rules-based fundamental analysis to determine its amount of short exposure. It can only have 3 levels of short exposure: 0%, 50%, or 100%. We see this as a natural replacement for the fully active long/short equity mutual fund that we had been using, given our use of ETFs throughout all of our other strategies. This strategy can almost be seen as an extension of smart beta. It has taken rules-based analysis used in long only funds, and added it to the long/short space.

The long basket of DYLS has about 100 large and mid-cap names that are selected by fundamental factors, and it is weighted by inverse volatility, meaning that the least volatile stocks have the highest weightings. The short basket is more diverse with 500 stocks using standard market-cap weighting. The fund uses swaps to gain its short exposure in order to keep the fund’s expense ratio lower than most other ETFs or mutual funds of this type (48 basis points). There is also another version of this fund that is more bearish. The WisdomTree Dynamic Bearish U.S. Equity ETF (DYB) has a minimum 75% short exposure and can either be 100% long or 0% long depending on the fundamental factors. We were more inclined to choose DYLS because we wanted more of a true long/short equity fund as opposed to one with a bearish tilt.

There are still a few mutual funds and closed-end funds remaining in 4 of our models: the iSectors Liquid Alternatives Allocation, the iSectors Endowment Allocation, the iSectors Inflation Protection Allocation, and the iSectors Precious Metals Allocation. Implementing DYLS moves us one step closer to being 100% invested in ETFs, but unless there are some drastic changes in the tax rules, specifically in the precious metals market, we will be an ETF strategist that “only” uses about 95% ETFs.

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