The Sweet Simplicity Of Core & Explore

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The current Barron’s features an ETF roundtable where four panelists talked macro, how they use ETFs along with a few ETFs they each recommend. There was one comment in there that is worth exploring in a little more detail.

One of the participants talked about how he split his emerging market allocation between two funds. When asked why those two funds he replied;

We keep about half in funds that track our benchmark MSCI index, and the other half in an ETF that screens stocks for attractive traits—value, minimum volatility, and quality—which, we hope, can do a bit better than the benchmark.—Chris McGough, Stadion Money Management; Barron’s May 7th, 2016

This is of course a version of core and explore, in this case the asset manager was talking about two broad based funds; one market cap weighted which was the core and a factor fund which would be the explore.

In terms of portfolio construction this can go in several different but effective directions. Market cap weighted funds have their fair share of flaws (if you use cap weighted funds and don’t think they have flaws, take the time to research this) but might be the easiest way access a core position for their familiarity. The quote above refers to factor funds for explore but could also refer to smart beta (no argument from me for believing factor and smart beta are essentially the same thing) which are almost as broad based as market cap weighted. Similarly, a style fund (growth or value) could also be a broad based explore holding. Staying fairly broad based, a dividend oriented fund could also fit into the mix as well as one of the many currency hedged funds in a core/explore for foreign funds.

Also embedded in the quote is a belief in active management. Active management of course doesn’t have to refer to a type of fund, there are countless active strategies using passive funds. I would also bring up Cullen Roche’s opinion from way back that essentially says if you have a 60/40 portfolio that you have an active portfolio because the actual makeup of global assets is less than 50% equities, closer to 40% the last time I saw Cullen write about this idea.

Explore doesn’t need to be limited to some specialized, broad based fund of course. The article also includes ETF picks that are much narrower like country funds, sector funds and industry funds. The original core and explore was about using individual stocks which I believe in doing in moderation insomuch as you have the time to devote to individual stocks.

There is an additional layer to this idea in the context of using one core fund and one explore fund for a segment of the market like emerging markets as cited in the quote above as relates to taking defensive action. I am a believer in taking defensive action based on the 200 day moving average but there are many other valid trigger points, but am not a believer in going to 100% cash. Zero exposure is just as big of a bet as 100% exposure. Selling one fund, thus cutting exposure in half makes for easy implementation of defensive positioning.

There is nothing new about this but it can be simple and effective which is a good combination for a portfolio strategy.

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