NorthCoast Asset Management dialed back the equity exposure of its ETF portfolios in the second quarter, as markets continued to retreat from January highs.
The firm cut positions in high-yield municipal and corporate ETFs in favor of cash. NorthCoast also added a mortgage-backed bond ETF to its portfolio as part of a strategy to reduce credit risk.
"We saw macro and sentiment indicators in our model weakening," said Patrick Jamin, chief investment officer for NorthCoast. "That led us to increase our cash levels."
ETF Portfolios Go To Cash
NorthCoast shifted to cash as the top holding in each of its ETF portfolios in the second quarter. Portfolio cash positions ranged between 17% and 24%.
Duration risk, or the sensitivity of bond prices to changes in interest rates, was another factor in NorthCoast allocating more of its ETF holdings to cash. "Our duration model was telling us to underweight long-dated bonds and underweight duration," Jamin said.
"In this environment, we perceived that more rate hikes and more surprises of rate hikes were likely to occur and that we should be in more cash-like instruments," he added.
During the second quarter, NorthCoast decreased its stakes in VanEck High Yield Muni and iShares Interest Rate Hedged High Yield Bond. Shares of HYD and HYGH have fallen 15.1% and 7.3% so far this year.
"We decreased credit risk wherever it came from, whether it be from municipalities or the corporate world," Jamin said. "We looked at the risk of potential defaults as likely to be perceived to be higher than before. So riskier assets were likely to pull back."
Mortgage-Backed Bonds
Jamin sees promise in mortgage-backed bond funds. In recent weeks, NorthCoast has added to positions in iShares MBS.
"The credit risk is lower — based on implicit government guarantees — for mortgage-backed securities," Jamin said. "We were underweight MBB earlier this year, until June."
But that's changed and NorthCoast has reduced its underweight position. "After the pullback in a lot of the fixed-income securities, we thought this was one of the first places where we could begin increasing our allocation from cash and cash-like securities," he said. And, "With a steep rise in mortgage rates and the five-year Treasury yield, we think that most of the negative news in fixed-income is behind us."
ETF Portfolios: S&P 500 ETF Hits Headwinds
iShares Core S&P 500 ended the second quarter among the top equity ETF holdings for NorthCoast. However, the firm decreased its stakes in the fund during the quarter, as multiple indicators soured.
"We are looking at a sharper cooling of the housing sector," Jamin said. "We've seen some retail sales declining. Customer sentiments are starting to get depressed." IVV has declined 17.8% year-to-date.
Jamin added: "On the slightly positive side, equity valuations are becoming more attractive, but we need to see inflation cool off and show deceleration" before stocks will benefit.
NorthCoast is starting to see some upside in Chinese equities. The firm owns shares in iShares Core MSCI Emerging Markets, which has 30% of its holdings in Chinese companies.
"We are slightly overweight in Chinese equities," Jamin said. However, "we see that the Covid drag is starting to fade in China" and mobility is improving.
"We also expect that China has some room to stimulate its economy," he said. And he also says that some of the "technology regulatory pressures in the country have been starting to ease off."
