A Contrarian ETF Portfolio For 2011 (UNG, GAZ, JJE, DXJ, DBU, LSC)

In Mebane Faber’s The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets he discusses a contrarian strategy that invests for a year after losing money in two or three consecutive years. He finds that for stocks:

“A down year two years in a row increases average returns about 4% but only happens about 10% of the time. Three negative years in a row result in median returns of about 30% a year…Extending the test to other assets classes shows similar results. When the past few years were negative, it is a good time to be in an asset class.”

Re-balancing is an easy way to gain exposure to under-performing asset classes. For example, if you have a target of 50% stocks and 50% bonds and stocks have recently underperformed causing your allocation to shift to 45% stocks and 55% bonds, re-balancing to your target weight of 50% stocks would require purchasing the under-performing asset class.

2010 and 2009 were great years for a wide variety of asset classes.  Thus, there are very few asset classes that have had 3 down years in a row. I examined the annual returns for hundreds of ETFs (non-leveraged/non-short) and was only able to find 3 ETFs with 3 consecutive down years:

  • ipath UBS Energy Sub Total Return ETN (NYSE:JJE)  [Visit our JJE category: HERE]
  • ipath UBS Natural Gas Sub Total Return ETN (NYSE:GAZ)  [Visit our GAZ category: HERE]
  • United States Natural Gas ETF (NYSE:UNG)  [Visit our UNG category: HERE]

There are additional considerations for these three ETFs.  The ipath UBS Energy Sub Total Return ETN (NYSE:JJE) is a relatively illiquid ETF which may make entry and exit difficult for investors.  The contango issues with the United States Natural Gas ETF (NYSE:UNG) and to an extent in the ipath UBS Natural Gas Sub Total Return ETN (NYSE:GAZ) have been well documented and it is difficult to say whether contango complicates a simple contrarian strategy like the one documented by Faber. It is reasonable to question whether ETFs with structural issues (liquidity and/or contango) belong in a true contrarian strategy, nevertheless, I will track the returns of the three ETFs above on the right hand side of Scott’s Investments throughout 2011.

For those looking for some additional contrarian picks, there are three additional ETFs which come close to meeting the above criteria and do not suffer from the some of the same structural issues as those above.  The two ETFs below were down two of the past three years with the up year returning less than 5%.  For this screen I excluded currency ETFs since the range of returns for currency ETFs tend to be tighter:

  • Wisdom Tree Japan Total Dividend ETF (NYSE:DXJ)  [Visit our DXJ category: HERE]
  • Wisdom Tree International Utilities ETF (NYSE:DBU)  [Visit our DBU category: HERE]

Finally, the ELEMENTS S&P Commodity Trends Indicator ETN (NYSE:LSC) has had two down years in a row. It began trading in June of 2008 and had positive returns for 2008; nevertheless, I will add it to the contrarian tracksheet on Scott’s Investments along with several other free portfolios I track on a regular basis.  [Visit our LSC category: HERE]

Written By Scott’s Investments   (No Positions)

Scott’s Investments focuses on several different ETF portfolio strategies ranging from Basic, Individual, Country, US Sector, and Global Sector ETF portfolios.

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