SMI Advisory Services (SMIAS) serves as the Advisor to three SMI mutual funds as well as Private Client, their separately managed account advisory business. Recently, SMIAS formed a new joint venture with a research firm named 3Fourteen Research. The new firm, 3Fourteen & SMI Advisory Services, serves as the Advisor to the recently launched SMI 3Fourteen Full-Cycle Trend ETF (FCTE).
Applying Upgrading principles to individual stocks
When SMI first learned about 3Fourteen’s Full-Cycle Trend (FCT) strategy, the immediate reaction was, “This is like Upgrading for individual stocks!” 3Fourteen’s quantitative, trend-following approach felt like a natural next step in the progression of SMI’s quantitative, momentum-driven strategies.
As this month’s cover article, Full-Cycle Trend: Upgrading for Individual Stocks, explains, the FCT model begins with an emphasis on Quality. SMI’s July article Understanding the Quality Factor noted that a significant body of research shows the performance benefit of focusing on Quality stocks. The Full-Cycle Trend model applies proprietary Quality screens, emphasizing downside volatility, to the S&P 500 Index stocks. These screens narrow the index to the 100 highest-
quality stocks.
FCT then ranks these 100 highest-quality stocks using 3Fourteen’s trend/momentum factors. Within this narrow pool of high-quality stocks, the process seeks strong long- and intermediate-term trends, but also looks to take advantage of short-term moves (“buying dips and selling rips”). The 20 stocks that rank highest after applying the trend overlay are purchased for that month and the portfolio is rebalanced so the holdings are equally weighted. This full process is repeated each month, typically resulting in 4-6 stocks being replaced.
Refining that initial universe of 100 high-quality stocks by applying this specific trend/momentum overlay has produced impressive results, both in 3Fourteen’s historical decades-long research results and in live results since they publicly began tracking FCT in November 2021.
(See Full-Cycle Trend: Upgrading for Individual Stocks for a detailed explanation of the Full-Cycle Trend strategy and its published results.)
Benefits of the ETF structure
Importantly, the exchange-traded fund structure offers several compelling benefits:
Significant tax benefits for taxable accounts.
ETFs can avoid realizing most capital gains that accrue to their underlying holdings. Unlike traditional mutual funds which are required to distribute these gains to shareholders periodically, or owning individual stocks directly which requires gains to be realized when positions are sold, ETFs are largely able to shield shareholders from gains realized when the portfolio sells stocks. Of course, ETF owners still must recognize any gains associated with an increase in the price of their ETF shares when they are sold. But the ability to avoid realizing most gains generated within the portfolio along the way allows tax deferral for as long as the ETF is held, a significant tax advantage. It’s such an important aspect that the “E” was included at the end of the ticker symbol (FCTE) as a reminder of the ETF’s tax efficiency in implementing this high turnover strategy.Diversification.
The ability to own a diversified portfolio of 20 stocks within FCTE is more than a convenience. While some personal accounts are large enough to handle trading a portfolio of 20 stocks, many are not, particularly if this “Upgrading with individual stocks” approach is just one of multiple strategies included within a portfolio (many investors have assets spread across various accounts, further complicating this task). The cost of certain stocks can also present challenges. For example, one stock holding might cost $2,800 per share, making it hard for an investor to get the correct weightings in a 20-stock portfolio. In contrast, FCTE can own the correct proportion of all 20 holdings, easily delivering the appropriate diversification to even the smallest accounts.Simplicity and ease of use.
Owning one ETF is significantly easier than trading a portfolio of 20 individual stocks! FCTE can be easily bought or sold from any brokerage account that allows ETF trading.Low contribution limits.
While buying even a single share of all 20 FCT stocks could cost several thousand dollars, a perfectly balanced FCT portfolio can be purchased with as little as ~$26, the recent price of a single share of FCTE.Giving opportunities.
Along with the tax benefits described in point #1, keeping most gains embedded in the ETF shares creates an opportunity for investors in taxable accounts to gift appreciated shares to charity, avoiding realization of long-term capital gains while fully deducting the security's market value.
Stock Upgrading now includes FCTE
Full-Cycle Trend is such a compelling and complementary strategy that it has been incorporated into SMI’s Stock Upgrading model. As such, the FCTE ETF is being included everywhere the Stock Upgrading model is utilized. See our August 2024 Fund Upgrading Update, the Upgrading Recommendations page, and An Upgrading Overview: Easy as 1-2-3 for specifics regarding the inclusion of FCTE within the SMI newsletter’s application of Stock Upgrading.
FCTE charges an expense ratio of 0.85%, which is in line with many other actively managed ETFs. To learn more about FCTE, visit 3FourteenSMI.com.