Sterling Global Strategies is staking its future on building ETF-only portfolios. It may one day wrap some of its creations into separate listed ETFs, but not quite yet. For now, the challenge is to build the brand, Mark Eicker, chief investment officer of the Carlsbad, Calif.-based firm, told IndexUniverse Correspondent Cinthia Murphy.

The most surprising takeaway from their visit? Clients don’t mind their portfolios being allocated to cash—nor do they mind paying for it—if they feel the manager in charge of the portfolio is in control.

Murphy: Sterling Global Strategies has created one index and manages four model all-ETF asset allocation portfolios that rotate allocation between six or seven ETFs. Can you tell me a little bit about those?

Eicker: Every one of them is an ETF portfolio, and all of them are based on the same algorithm—the only difference being the asset classes that we are using. We are trying to overweight the asset classes that are in uptrends and stay away from the asset classes that are in downtrends. We always talk about efficient and inefficient markets, and during efficient markets, some asset classes are going up and some are going down—if you own everything, then you are going to smooth out the ride.

Basically what we’ve said is that there’s a way, by using a relative-strength moving-average model, to predict fairly consistently which asset classes are in uptrends, and we want to overweight those and stay away from everything else. In inefficient markets—those where we see broad market collapses like what happened in 2008—everything correlates and drops in unison.

In those times, we apply a moving average overlay to our relative-strength model that tells us whether the two asset classes that we are choosing are actually in uptrends or are just the two best-performing asset classes in a broad market collapse. In that case, we can move to a 100 percent cash allocation. It doesn’t happen very often—to have all tied to cash—but it can happen.

Murphy: You see cash as another asset class.

Eicker: Absolutely.

Murphy: Is that unusual?

Eicker: It is, but there are more and more of us out there that see it that way. It’s growing. But if you look back at the past 10 years of our index, we are only taking cash about 8 percent of the time. It’s not very often. And the highest position we’ve ever had in cash was 50 percent for one of our indexes, STRR.

Murphy: In what type of market environment does a sizable cash allocation make sense? In a down market?

Eicker: Exactly. I’ll give you an example. In the third quarter of last year, we were in cash and bonds two out of the three months, and during that period we were down 1 percent while the S&P 500 was down 13 percent in that quarter. By the end of the third quarter, we were 5.7 percent higher year-to-date while the S&P 500 was down 8.7 percent. It was a short bear market, but by the end of 2011, we had beaten the S&P 500 by something like 380 basis points, and all that with only 0.23 beta, or 23 percent of the volatility of the S&P 500. We really reduce investors’ exposure to volatility.

Murphy: Is this current market environment we are in—where stocks have been running up on a thin audience and everyone is talking about the possibility of inflation ahead—a good time to allocate to cash?

Eicker: We think so. If you talk to economists, when the debt levels get as high as they are now, volatility picks up in the stock market, so until the U.S. gets the house in order, the volatility is going to be there. Our goal is not to get cash; our goal is to buy the two asset classes that are performing the best. It’s key to have good risk management tools to be able to potentially protect your portfolio from broad stock market collapses.

Murphy: Is it hard to sell the idea of a cash allocation to your clients? I mean, how difficult is it to justify charging a fee just to park their investment in cash?

Eicker: It’s really not. We only go to cash when everything else is dropping, so as long as there’s leadership someplace, it’s OK. The whole idea is to rotate into the best-performing asset class, so the only time we’re going into cash is when everything is falling in unison. Our clients think it’s worth every penny.

Murphy: In July you launched an alternative bond portfolio. Do you see fixed income as the sweet spot right now?

Eicker: Let me say that we are a risk-averse shop. I love what our fixed-income portfolios provide because I think we’re going to see rising inflation, a rising interest rate environment, and if you are just sitting on an asset class and not rotating, you are going to get killed. But on our tactical bond portfolio, there are six things you can rotate between, like TIPS, high yield, emerging-market debt, sovereign debt, aggregate bond [and cash].

So we should perform well because we can rotate into things that are doing well at any given time. We have also added a 20-year inverse Treasury component to protect against rising rates. We can only take a 20 percent position in that, so when it gets to that, we allocate 40-40 between two out of the top three asset classes and 20 percent to inverse Treasurys. If interest rates rise, this is designed to smooth out the ride for bond investors. At the end of the day, we capped that position so that we don’t expose investors to undue risk.

Murphy: You have developed an index and ETF portfolios, the first being a tactical rotation one that came to market in December 2009. What’s the next step for the firm?

Eicker: We started managing live money in December 2009. We now have $135 million of assets under management and they're growing fast. The biggest thing for us right now is building up the selling agreements and having distribution space. I think the next part we have to tackle now is getting more feet on the ground. We are looking at hiring a wholesaling firm or hiring more wholesalers within.

Murphy: Given that you have designed the indexes yourself, why not launch your own ETFs like, say, AdvisorShares?

Eicker: We have actually talked to AdvisorShares, and there is definitely interest on both sides to eventually create an ETF, but we want to build up our brand first. We have also talked to mutual fund companies, which is to say we have a strong chance of launching something in the next 12 months.

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