Beyond Big Tech: ETF managers look to international assets for diversification

Key Concepts

• Diversification: The strategy of spreading investments across various asset classes to reduce risk.
• Hard Assets: Physical assets with intrinsic value, such as commodities (gold, silver, copper, oil, gas, and agricultural products).
• Duration Risk: The sensitivity of a bond's price to changes in interest rates.
• "Higher for Longer": A macroeconomic environment where interest rates and inflation remain elevated for an extended period.
• Non-Correlated Assets: Investments that do not move in tandem with the broader market (e.g., the "Magnificent Seven" tech stocks).
• Managed Futures: A strategy that uses derivatives to go long or short on various asset classes, including commodities and interest rates.

1. Diversification Strategies Beyond Consensus Trades

The speakers argue that investors should look beyond the "consensus trade"—specifically the mega-cap tech, media, and telecom stocks (the "Magnificent Seven")—to find relative value.

• International Exposure: Paisley suggests looking abroad for diversification. The thesis is that as geopolitical risks (specifically in the Middle East) resolve, the U.S. Dollar—which acted as a safe-haven asset—will likely weaken. A weaker dollar historically provides a tailwind for international assets.
• Hard Assets: Commodities are identified as an underrepresented asset class that serves as a hedge against "sticky" (persistent) inflation.

2. Real-World Applications and Portfolio Examples

The speakers provide specific examples of how they are executing these strategies:

• Commodity Holdings: The portfolio includes Southern Copper, silver miners, and gold to create a "non-correlated sleeve."
• Growth Outside Tech: A notable example is Comfort Systems (FIX), a Texas-based HVAC company. Despite being an "old industry" firm, it demonstrates tech-like top-line growth. The speakers note that such companies benefit from the infrastructure needs of data centers, providing a way to gain exposure to the AI boom without relying solely on semiconductor or software stocks.

3. Methodologies: Managed Futures and Duration

The discussion highlights two distinct, yet complementary, approaches to portfolio management:

• Dynamic Managed Futures: Unlike static commodity funds, managed futures allow for "long/short" positioning. This provides flexibility to profit from energy, agricultural soft commodities, and interest rate fluctuations regardless of market direction.
• Adding Duration Risk: With the 10-year Treasury yield hovering between 4.3% and 4.5%, the speakers suggest that investors are currently underpricing the risk of falling rates. Adding duration (buying bonds) is presented as a hedge against potential economic softening or a decline in inflation, which would cause rates to drop.

4. Key Arguments and Perspectives

• The "Seesaw" Strategy: The speakers acknowledge a tension in their strategy: they are simultaneously betting on hard assets (which thrive in "higher for longer" inflationary environments) and duration/bonds (which thrive if inflation cools and rates fall). They view this as a balanced way to navigate market uncertainty.
• Challenging the "Mag Seven" Dominance: While acknowledging that thematic funds focused on semiconductors have performed exceptionally well, the speakers caution against "pressing bets" on these same names going into the new year. They argue that comparable growth can be found in uncorrelated sectors.

5. Notable Quotes

• "There are places, believe it or not, inside the economy that have tech-like growth, but are old industries essentially and totally uncorrelated." — Mike, regarding the investment case for companies like Comfort Systems.
• "[Adding duration] is a risk that many investors are underpricing the market right now... the ability to add duration or interest rate risk right now when it is much cheaper is another area the market we're starting to see flows." — Paisley, on the opportunity in the bond market.

6. Synthesis and Conclusion

The primary takeaway is a shift away from the concentrated "Magnificent Seven" trade toward a more diversified, multi-asset approach. The strategy relies on two pillars:

1. Inflation Protection: Utilizing hard assets and commodities to hedge against persistent inflation and a potentially weakening U.S. Dollar.
2. Risk Management: Utilizing managed futures and adding duration to portfolios to hedge against interest rate volatility and potential economic cooling.

By balancing these "two ends of a seesaw," investors can capture growth in non-traditional sectors (like HVAC/infrastructure) while maintaining a defensive posture against macroeconomic shifts.