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Using a Country's Level of Economic Freedom as Investing Benchmark: Advisor David Marotta

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David John Marotta, founder and president of Marotta Wealth Management, left the teaching field to become an RIA to back up his father—both his parents were financial planners—and said that his lack of a U.S. bias stems from what he learned from them.

The elder Marotta, who earlier worked for the State Department and served as a senior research fellow at the Hoover Institution, “had an office down the hall from Norm Friedman” and other such luminaries, which the younger Marotta said was “a pretty great learning experience in high school and college. We’ve always had more of a global approach to our investing, and spend a little more time looking past the country bias of the U.S.”

While Marotta said in general he believes in “the efficient frontier and efficiency of the markets, and think index investing is the way to go,” there’s a hitch. “The difficulty is that there are 8,000 indexes.” Even if there’s a very small expense ratio involved, “you still have to decide how to craft the investment portfolio.”

While leaning toward the small in value can provide better returns, Marotta said that applies to foreign investing as well, “and foreign countries offer a different experience for the companies that are operating in them. Would you rather invest in companies in North Korea or South Korea?” That, he said, would make one recognize that “economic freedom matters: low debt and deficit are two components of economic freedom. The fertile soil of the country the company is operating in produces a better result.”

Marotta’s firm uses the Heritage Foundation’s index of economic freedom to choose the countries in which to invest, and uses country-specific ETFs and bond mutual funds to gain exposure to those countries. “iShares has the best country-specific ETFs,” said Marotta, “and we use a lot of those. Six in particular that we invest in … are Hong Kong, Singapore, Australia, Switzerland, New Zealand and Canada.”

He added that they use a “secondary tier, which includes Chile, and also emerging markets….” Other countries that he says are “low in debt and deficit” are Denmark, the Netherlands, Norway and Sweden, Germany and Austria. Emerging markets are “not particularly free, but have low labor costs.”

Marotta said he prefers to use ETFs rather than mutual funds because the latter “will kick off capital gains, but ETFs won’t.” Still, there are a “few things we use mutual funds for, because there are no good ETFs for them.” Among those are the aforementioned bond mutual funds, as well as the Vanguard Energy Fund and Vanguard Precious Metals Fund because, for the latter, “there’s no good index or ETF.” Marotta also cited the Vanguard Healthcare Fund and the Vanguard Energy Fund. “They have an ETF,” he said of the latter, “but it’s only in the U.S. The mutual fund is much more globally diversified.”

Regarding bonds, while they’re slightly more tilted toward U.S. bonds than foreign, “most of our foreign bonds are in emerging market bonds. The reason for that is three good reasons for emerging market bonds: they’re not dollars, they’re not euros and they’re not yen. All three of those are being devalued, while some emerging markets are holding their currency value better.” The firm also uses Australian and New Zealand bonds.

The firm uses six different asset categories, three for stability and three for appreciation. The stability categories are U.S. stocks, foreign stocks and resource stocks, and the latter are energy, REITs (both U.S. and foreign real estate—“anything with an underlying asset that should do well as an inflation hedge”) and precious metals/mining.

Amid age-appropriate allocations, the six asset categories and the other factors that go into making up a client portfolio, Marotta said, “it’s hard to talk about just U.S. and foreign in the midst of all that,” but it breaks down to about 53% foreign and 47% U.S. stocks. “If you were to do just investing like the global economy, we would probably do 60% foreign and 40% U.S. We’re underweighting foreign markets and don’t view that as a drastic movement, but I’ve talked to a number of others with 10–20% foreign and the rest in the U.S.—[that’s] country-specific bias.”

Although the U.S. market did better than foreign holdings in 2013, Marotta said that portfolio rebalancing means that now is the time to sell some of those U.S. holdings “and put it into categories that didn’t do as well as last year, such as REITs and emerging markets.”