About the Editor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's passive funds research team, where he covered alternative, dividend, and actively managed ETFs and performed quantitative modeling of ETF strategies.

Lee joined Morningstar in 2008 as a data analyst, where he evaluated ways to measure and improve the firm's data quality.

Lee holds a bachelor's degree in economics, with honors, from Grinnell College.


Investment Strategy
Morningstar ETFInvestor scans the globe for value and improving fundamentals across virtually all asset classes. Editor Samuel Lee draws upon academic and practitioner research — including Morningstar's sizeable bench of stock, bond and fund analysts — to find reliable drivers of outperformance.

Morningstar ETFInvestor features two real-money portfolios.

The ETF Income Portfolio assembles a high-quality collection of income-generating ETFs with the goal of earning 5% in excess of the 30-day T-bill rate over a full business cycle. The portfolio adheres to a benchmark-agnostic strategy in its search for absolute returns.

The ETF Global Asset Allocation Portfolio, on the other hand, is more benchmark sensitive. It seeks undervalued asset classes with improving fundamentals. The strategy seeks to beat the 60/40 MSCI ACWI/Barclays US Aggregate benchmark over a full business cycle, with the least risk possible.

 
 
Dec 20, 2014
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Samuel Lee,
Editor, Morningstar ETFInvestor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's
Featured Posts
Bear Market Plans
Last week I asked you for your bear-market plans. Your responses fell into four groups:

1) Do nothing; have enough cash and bonds beforehand to keep you sane in a market crash. This was the most common response. Stephen, who owns an aggressive portfolio of high-yield assets including equities, REITs, MLPs, and junk bonds, observes that his portfolio’s income is unlikely to fall as much as its market value, and so long as this holds he doesn’t have to do anything. Seeing financial assets this way leads to sensible long-term investing.

2) Buy. Charles writes: “I deliberately try to maintain a sizeable cash reserve just for market downturns or corrections.  I try to collect a list of sound investment opportunities that are less speculative and more long term to buy during one of these “episodes”.  Investments I would be glad to have in a good market.” I imagine most investors in good times believe this is what they’ll do, but such plans are often mutilated beyond recognition by bear markets. Even when a contrarian plan is executed, one might end up in a value trap, or worse. Bill Nygren of Oakmark OAKLX loaded up on Washington Mutual during the financial crisis, and the firm was seized by the government, placed into receivership, then sold to JPMorgan JPM at a cut rate. Ken Lewis of Bank of America BAC led the firm’s acquisition of mortgage-firm Countrywide Financial, a move initially hailed as both brilliant and brave, but it ended up costing the bank tens of billions of dollars in fines and has made many lawyers fat and happy with years of litigation. Charles mitigates this risk by making diversified bets.

Not many people have the wiring to pull off this strategy. My belief (based, admittedly, on conjecture) is that the best predictor of whether someone is capable of being contrarian is his behavior in past market crashes.

3) Sell. Bob uses the classic 10-month simple-moving average to time his moves in and out of various asset classes. Despite the terrible reputation trend-following has acquired, largely thanks to academics steeped in efficient-market dogma, it is remarkably robust when tested on virtually any financial time series. The evidence has become so overwhelming at least one top finance journal recently published a study demonstrating the strategy’s efficacy, though under the more palatable moniker “time-series momentum.”

Most investors do not invest with a plan to sell out. They think of themselves as in it for the long run. However, the pain eventually forces many of them to sell, probably near the bottom, setting them up for arguably the most costly psychological trap in investing: seeing the market recover while they’re still on the side lines in cash. Most investors find it tough to reenter the market after experiencing such severe trauma. Rather than swallow the loss, they hope the market collapses again to a lower price, at which point they intend to jump back in. Unfortunately, the market is pitiless and doesn’t care about the prices at which you bought or sold. Many who got out in 2008 or 2009 never got back in until much later, if at all. This is one of the worst things an investor can do. In light of this risk, I’ve become a bigger fan of mechanical rules that remove much of the emotion in buy and sell decisions. It is far better to acknowledge a low tolerance for pain and engage in systematic market-timing than to overestimate one’s pain tolerance and end up traumatized and poor.

4) No plan. At least one subscriber realized that a bear market would devastate his portfolio, prompting him to consider raising some cash. Good.

So what’s the ETFInvestor’s plan? My psychological makeup favors contrarian behavior; my instinct is to chase things that are falling. In April, a subscriber asked what I would have recommended during the financial crisis. I was but a lowly data analyst back then, but her query prompted me to look through my personal correspondences, online posts, and investment account activity to see what I was thinking, feeling and doing then. On Oct. 6, 2008, I wrote to a college friend, “Make sure your asset allocation is something you’re comfortable with, and stick with it.  If anything, I'd begin slightly increasing my contributions to take advantage of the lower prices caused by all this fear. You don't have to be as extreme as me, though: I'm putting 100% of my next paycheck into my 401(k).” According to my records I followed through by dumping $1,818.75 into my 401(k) on Nov. 3, 2008 (multiply that by 24 and you can calculate how much I was making each year back then). I found a message I had written on Feb. 23, 2009, in which I distastefully gloated, “I hope the stock market tanks another 40-90%. I wouldn't mind buying all the way down.” Of course, I was being a tad short-sighted, because if the market had collapsed another 90% I would’ve ended up a bum on the streets of post-apocalypse Chicago.

I’m aware that my bias is to buy things that have fallen. However, a deeper look at the historical record has disabused me of the wisdom of buying automatically into dips. It’s not uncommon for the market to fall for years at a time.  It’s also not uncommon for markets to trend up for years, too. Contrary to the received wisdom, prices do not follow a random walk.

Because I find it difficult to buy things that look expensive, I’ve allocated a portion of my personal portfolio to a momentum strategy. The rest of my portfolio, and the strategy I pursue in the ETFInvestor, is a slow-moving value and momentum strategy. I try to buy cheap things that are trending up, or, more often, I try not to sell out of expensive assets unless they’re trending down (the operative word is try—I still find it difficult to own expensive stocks).

U.S. stocks are expensive, with low expected returns, but I’m still holding on because momentum is strong. My intention is to cut my exposure once momentum cools off. I’m looking at measures like 12- and 10-month simple moving averages, 12-month total return, and aggregate earnings and dividend growth. I will never completely go to zero in U.S. stocks for two reasons: 1) tracking error, which can be huge in a trend-following strategy, and 2) model uncertainty, the possibility that trend-following measures won’t work in the future despite the strong evidence behind it. I don’t think anyone should apply a trend-following strategy to his entire portfolio.

Portfolio Update
I was very close to adding to our positions in PIMCO Dynamic Credit Income PCI this week, but I greedily waited for a wider discount. Sadly, the market rallied, and the discount is not so wide that I’m willing to add much more to our already substantial positions. At $21 a share, it’s still cheap and a good entry point for those who don’t have any exposure.

Regards,
Samuel Lee
Strategist
Editor, Morningstar ETFInvestor

P.S. The Morningstar ETFInvestor iPad app is now available for download.

Portfolio Holdings
Income Portfolio
ETF
YTD Ret %
Price $
4.9
108.8
CASH$
N/A
1.0
-4.0
55.9
1.0
62.2
-0.9
11.6
-13.5
20.9
14.1
32.7
4.5
40.4
12.9
24.7
Global Asset Allocation Portfolio
ETF
YTD Ret %
Price $
3.9
108.8
CASH$
N/A
1.0
-4.0
55.9
-8.1
20.9
10.5
32.7
4.5
40.4
-7.3
38.6
6.7
81.3
12.9
24.7
Most Popular ETFs
ETF Name
YTD Rtn %
3 Yr Rtn %
Trading Vol.
NASDAQ 100 Trust Shares
-10.76
1.45
125,000,944
SPDRs
-3.64
2.68
87,466,496
Semiconductor HOLDRs
-6.23
-11.66
26,838,700
iShares MSCI Japan Index
-6.59
7.18
17,256,500
iShares Russell 2000 Index
-7.46
6.43
16,210,700
Energy Select Sector SPDR
15.88
15.50
14,900,000
Financial Select Sector SPDR
-8.42
2.61
11,612,800
DIAMONDS Trust, Series 1
-3.75
2.21
7,350,600
Utilities Select Sector SPDR
6.84
6.82
3,848,200
Materials Select Sector SPDR
-4.31
8.50
2,179,300
 
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