Structuring and Implementing Portfolio

Presented by QQQTM
Strategies Using Exchange-Traded Funds (ETFs)

O R A N G E PA P E R S E R I E S

Also inside:
3 Using ETFs as an investment tool
4 Core/satellite strategies: combining
passive and active fund management
5  Sector rotation: views of market cycles
8  Diversifying a portfolio to potentially
reduce volatility
11 Commodity risks to consider
12 Investing strategies using currency ETFs
13 Unpredictable risks
14 Conclusion
Structuring and Implementing
Portfolio Strategies Using
Exchange-Traded Funds
O R A N G E PA P E R S E R I E S
For years, institutional and individual investors who have wanted to structure
their portfolios with greater precision and control have used exchange-traded
funds (ETFs) as an integral component of their investment strategy. In this
paper, we outline how ETFs can be used for many purposes, offering investors
transparency and flexibility in structuring portfolio strategies, including:
• Core/satellite strategies that combine passive and active
fund management.
• Sector/sector rotation, which aims to overweight strong sectors of the
economy and underweight weaker ones.
• Using complementary asset classes to diversify a portfolio to potentially
reduce volatility.
• Implementing cash equitization to maintain liquidity needs or
target allocations.
As we discuss in this paper, ETFs may provide the complementary pieces
needed to participate in global economic growth, to hedge against inflation
and to allocate a portfolio.
2
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Benefits of using ETFs
First introduced in 1993, ETFs offer broad exposure
to market segments in a single investment, making
them well-suited as components of an asset allocation
program. ETFs offer the following benefits:
Flexibility — ETFs allow investors to use advanced
trading techniques, such as purchasing on margin and
short selling (even on a downtick, unlike stocks), and to
place limit and stop orders.
Transparency4 — ETFs report their holdings on a daily
basis, so investors know which underlying securities they
are buying.
Tax efficiency4 — ETFs have a unique ability to manage
the associated capital gains through in-kind exchanges.
Many ETFs have never made a capital gains distribution
to current shareholders.
Loss harvesting4 — The sale of an underperforming
security coupled with the purchase of an ETF that holds
the sold security may allow for the realization of capital
losses while maintaining similar investment exposure.
Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S
Using ETFs as an investment tool
Many investors set their investment policy by using a strategic asset allocation
model suited to their individual needs, such as a 60% to 40% stock-bond portfolio.
An ETF is an innovative investment tool that combines some of the features of
mutual funds with some of the features of individual stocks. Like a mutual fund, an
ETF gives investors access to a group of securities through a single transaction. Like
a stock, ETF shares are traded on exchanges at market-determined prices.
Portfolio strategies can be devised to meet a broad range of requirements, including
the following:
• C
 ore/satellite strategies — Designed to minimize volatility, tax liabilities and
costs while providing the investor with an opportunity to outperform the
market, core/satellite strategies combine passive investments that track
equity1 and fixed-income indexes (the core) along with additional actively
managed positions that seek to generate alpha (satellites).2
• S
 ector/sector rotation — These are alpha-seeking strategies that aim to
overweight strong sectors of the economy and underweight weaker sectors.3
• C
 omplementary asset classes — This strategy seeks to reduce portfolio
volatility by adding non-correlated or weakly correlated asset classes
(such as commodities, currencies and real estate holdings) to a core asset
allocation structure.5
1
Source: Eugene F. Fama and Kenneth R. French, “The Cross-Section of Expected Stock Returns,”
The Journal of Finance, Vol. XLVII, No. 2, June 1992, most current available
2
 ome investors will devote a portion of the strategic allocation to alternative investments and cash; others
S
may consider alpha-seeking, risk-hedging or tax-reducing overlays through ETFs.
3
 ource: “PDP: Case Study in Adaptability,” Systematic Relative Strength: The Official Blog of Dorsey,
S
Wright & Associates Money Management, April 28, 2011, most current available
4
 TFs disclose their full portfolio holdings daily. Invesco PowerShares does not offer tax advice. Investors
E
should consult their own tax advisers for information regarding their own tax situations. While it is not
Invesco PowerShares’ intention, there is no guarantee that the Funds will not distribute capital gains to
their shareholders.
5
 ource: “CNBC Diversified Global Core Model Portfolio: 3 Experts Share Insights,” Seeking Alpha (website),
S
June 21, 2010, most current available
3
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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

ETFs can be used as core and/or satellite • C

investments in virtually unlimited ways
to precisely ‘dial in’ unique attributes of
certain asset classes.
 ash equitization — This strategy primarily applies to portfolio managers
whose performance is measured against a benchmark but who must
maintain cash levels to meet liquidity requirements (such as in a pension
fund). Since lower available yields from cash investments (the so-called cash
drag6) can pose a threat to the portfolio’s overall benchmarked return, fund
managers can use equitization through highly liquid ETFs7 that mirror the
portfolio’s investment benchmark. Investors may also wish to consider cash
equitization to maintain target allocations or liquidity needs without sacrificing
performance.8

Core/satellite strategies: combining passive and active

fund management

A core/satellite strategy begins with selection of equity and fixed-income

investments that meet an investor’s specific needs and risk-return objectives (see
Figure 1 below). Typically, the core is invested in passive, index-based funds or
ETFs that seek to capture the average returns generated by the major asset classes,
such as the S&P 500® Index, a broad measure of US stock performance, or the
Barclays U.S. Aggregate Bond Index, which tracks US investment-grade bonds.
Some investors focus the core on indexes that allow them to pursue a particular
investment bias (i.e., growth over value, corporate bonds over government-backed
securities, or international markets over domestic markets).9

FIGURE 1
Large-Cap
Core/satellite strategies typically combine a passively ETF Small-Cap
indexed core portfolio supplemented by active Inflation ETF
satellites that the investor believes will improve the Protected Bonds
quality of the portfolio’s return. ETF International
ETF
Note: Illustration is provided to show the concept of
Core
core/satellite investing. It should not be construed as Portfolio
investment advice. Global Bonds
Source: Asset Communications, May 2011, based on ETF Emerging
1992 Fama/French article cited on page 3.
Market
Currency ETF
Real Estate
ETF ETF

6
 ash drag relates to the amount of cash an investor holds over a given time period. Over time, being
C
out of the market can result in cash drag — a performance gap between the index return and
portfolio performance.

7
 hares are not individually redeemable and owners of the shares may acquire those shares from the Fund
S
and tender those shares for redemption to the Fund in Creation Unit aggregations only, typically consisting
of 50,000, 75,000, 100,000 or 200,000 shares.

8
 ource: Gus Sauter, “Reducing the Performance Drag of Cash Through Equitization,” White Paper
S
Published by Vanguard, 2006, most current available

9
Source: Asset Communications, May 2011, most current available

4
FOR US INSTITUTIONAL INVESTOR USE ONLY - NOT FOR USE WITH THE PUBLIC

Foreign securities have additional risks,
including exchange-rate changes, decreased
market liquidity, political instability and
taxation by foreign governments. Investment
in securities in emerging market countries
involves risks not associated with investments
in securities in developed countries. The
economies of the countries in the Asia Pacific
region are largely intertwined; if an economic
recession is experienced by any of these
countries, it will likely adversely impact the
economic performance of other countries in
the region.
One way to implement a sector strategy is
to pick a business cycle or a calendar period
and invest in industries that are anticipated to
benefit from it.
Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S
The satellite portion of the portfolio is generally considered the investor’s actively
managed component. Satellites are used to capture the performance of specific
market segments that the investor believes will enhance the portfolio’s overall
performance, either through lower correlation of asset classes, or through attempts
to reduce volatility. ETFs can be used as core and/or satellite investments in virtually
unlimited ways to precisely “dial in” unique attributes of certain asset classes. For
example, if the investor believes emerging markets and small-cap equities will be
strong performers, he or she could allocate a portion of the portfolio to ETFs that
track these market segments.
Key considerations
In a core/satellite strategy, the percentage of the total portfolio allocated to satellite
investments and weightings of those ETF satellite allocations is at the discretion
of the investor. Of course, trading costs should be carefully considered before
implementing any investment strategy. As individual sector returns can be more or
less volatile than the core portfolio, investors should regularly monitor performance
and make adjustments consistent with their objectives.
Sector rotation: views of market cycles
Not all sectors of the economy behave the same way at the same time. In a sector
rotation strategy, investors can use one or more individual sector funds to attempt
to profit from their view of market direction or economic cycles.
Investors who are inclined to manage a sector rotation strategy on their own can
initiate the process by dividing the type of risks they want to take between broad
market ETFs (i.e., their core portfolio) and sector ETFs. That way, if their sector
strategy does not play out, sector-driven losses may be mitigated by core holdings.
Investors can take long-only, short positions, or simultaneous long and short
positions in sector ETFs that they believe will outperform or underperform the
broad market.
There are many other ways that investors can use sector rotation to diversify a
portfolio using major themes in the market. One way to implement a sector strategy
is to pick a business cycle or a calendar period and invest in industries that are
anticipated to benefit from it. For example, back-to-school periods may favor retailers,
while summertime may favor travel-related businesses such as hotels, airlines and
oil refineries. Periods of low interest rates may boost shares of financial companies.
Investors have a wide array of industry ETFs that they may use to express these views.
Another methodology to consider might be based on geography: As economic growth
in the US slows, it may be picking up in Europe or Asia. Investors may use regional
ETFs to capitalize on global economic forces that are benefiting countries with
higher-than-average growth rates. It is, of course, possible to combine sector rotation
strategies — overweighting a country or regional ETF, for example, while incorporating
economic analysis of the industries that are most likely to benefit in that locale.
5
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Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Given the more than 1,457 index-based and actively managed ETFs available
today,10 the range of potential sector rotation strategies are limited only by the
investor’s imagination. Nevertheless, most strategies follow a rules-based
approach that seeks to:

• Identify and respond to changing currents in the markets.11

• Buy sectors during their down periods and sell when prices peak.
• Hold more than one sector at any given time.
• Keep losses low by understanding the risks.
Concentration risk Stock selection risk
Liquidity risk in thinly traded ETFs Correlation risk

• Hold the better performers in the portfolio.

Investors who do not have strong views on market cycles, or who are not inclined to
manage a sector rotation strategy on their own, may prefer to select a sector-rotation
portfolio. Sector-rotation portfolios incorporate rules-based models to attempt to predict
inflection points when sectors become relatively stronger or weaker.

One approach developed by Dorsey, Wright & Associates, LLC, a supplier of technical
research services to the financial services industry and individual investors, seeks to
automatically manage exposure to sectors controlled by demand and eliminates exposure
to sectors controlled by supply using relative-strength *pricing models. Of course,
there can be no assurance that any sector-rotation strategy will correctly predict sector
movements or economic cycles.

Another way in which investors can use technical analysis to build their core portfolios is in
the area of managing market capitalization. Investors in the past largely added small-cap
holdings at specific times of an economic cycle — usually at the beginning of expansions,
when small-cap stocks tend to outperform.

Dorsey, Wright, working with Invesco PowerShares, introduced fixed models based on a
proprietary technical analysis that may allow investors who seek to reduce a core portfolio’s
exposure to large-cap companies to efficiently modify the allocation. So, for example, a
portfolio that is 80% weighted in large-cap stocks could be modified to include a 20% small-
cap allocation by selling 25% of the large-cap holdings and buying small-cap ETFs.

Note that smaller companies offer the potential to grow quickly, but can be more volatile
than larger-company stocks, particularly over the short term.

10
Sources: Bloomberg L.P., as of Oct. 31, 2014

11
 ource: Sam Stovall, “How to Buy the Right Stock in the Right Industry at the Right Time,” Standard
S
&Poor’s-McGraw Hill, 1996, The McGraw-Hill Companies, Inc.

* The relative strength strategy is NOT a guarantee. There may be times where all investments and
strategies are unfavorable and depreciate in value. Relative strength is a measure of price momentum based
on historical price activity. Relative strength is not predictive and there is no assurance that forecasts based
on relative strength can be relied upon.

6
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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Key considerations
The primary challenge for the investor implementing a sector rotation strategy is
picking inflection points when one sector becomes relatively more attractive
than another (see Figure 2 below).

For example, we can see from S&P’s Sector Rotation chart how moving into a given
sector too early may result in poor performance or losses, and how getting in too
late may cause investors to lose much of the upside potential in that cycle.

The market cycle

Prices of financial assets tend to move up and down just like the broader economy.
However, it is important to recognize that the market cycle usually runs several
quarters ahead of the economic cycle. Consider how market cycles tend to move in
four sequential stages (as illustrated in Figure 2 below).

• Market bottom — This stage begins with rapidly dropping prices, culminating
in a long-term low.

• Bull market — This stage begins when the market rallies from the bottom.

• Market top — A market top occurs when the bull market inevitably flattens out.

• B
 ear market — This stage begins when the market heads toward the
next bottom.

FIGURE 2 Technology Basic Industry Staples Utilities

Cyclicals Industrial Energy Services Finance
Sector Rotation Model

Source: Sam Stovall, “How to Buy the Right

Stock in the Right Industry at the Right Time,”
Standard & Poor’s-McGraw Hill, 1996,
The McGraw-Hill Companies, Inc.

Full Recession Early Recovery Full Recovery Early Recession

Market Bottom Bull Market Market Top Bear Market
Market Cycle Economic Cycle Copyright StockCharts.com Website

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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

The economic cycle

FIGURE 3 Empirical research has shown that market cycles are fairly accurate harbingers of
Sector Profitability Cycles movements in the broader economy. Most of the time, changes in market valuations
Stage of Economic Conditions Historically of financial assets predict the next economic cycle, anywhere from three to six
Economic Cycle Profitable Sectors months or more into the future. For example, most investors will observe that
Full Recession •  iminishing growth
D Cyclicals and
(GDP) transportation,
when the economy is in the throes of a recession, the market begins to look ahead
• Falling interest technology and to recovery.
rates industrials
• Weak consumer

confidence
Although past performance does not predict future performance, Stovall’s research
Early Recovery • Improving Industrials, basic
consumer materials, energy cited in Figure 3 (at left) suggests that this forward-looking characteristic of the
confidence
• Rising production market often occurs toward the tail end of a recession, when markets can have
• Bottoming interest

rates
very positive performance. Furthermore, certain industries are widely recognized to
• Steepening yield
outperform at different stages of the economic cycle.
curve
Full Recovery •  apidly rising
R Energy, consumer
interest rates staples, services
• Flattening yield Diversifying a portfolio to potentially reduce volatility
curve
Early Recession •  conomy weakens
E Services, utilities,
• Consumer cyclicals and Portfolio diversification is a cornerstone of most investment policy. Recent history
expectations about transportation
the economy are shows us that the conventional approach to diversifying portfolios across stocks,
weak
• Industrial
bonds and cash — even geographies — does not always result in reduced risk for
production falls off
• Interest rates peak
investors. The investment toolkit may need to be expanded through broad exposure
• Flat or inverted to different asset classes and sectors. Certain commodity and currency ETFs may
yield curve
provide the complementary pieces needed to participate in global economic growth,
Source: Sam Stovall, “How to Buy the Right Stock
to hedge against inflation and to allocate a portfolio.12
in the Right Industry at the Right Time,” Standard
& Poor’s-McGraw Hill, 1996, The McGraw-Hill
Companies, Inc., most current available In periods of extremely high volatility in the equity and fixed-income markets, asset-
specific risks tend to become more correlated than returns. This means that returns
of certain asset classes usually considered to be uncorrelated tend to begin to move
more in lockstep.

FIGURE 4 In the downturn of 2008 to 2009, for example, nearly every area of the equities
Index Performance During March 2008 – December
market finished lower at the end of the period. We believe moving money around
2009 Market Downturn different market caps, geographies or style boxes did not achieve adequate
Total Return Index Performance downside protection diversification, and most investors lost money during this
Cumulative Annualized period (see Figure 4). However, when stocks recovered in 2010, their correlations
Barclays U.S. 3.2% 1.7% with other asset classes once again began to diverge appreciably, which re-
Treasury 20+
S&P 500 Index -12.4% -7.0% established the importance of holding lower or negatively correlated sources of
Russell 2000® Index -5.9% -3.3% return for those same investors.13
NASDAQ-100 Index 7.8% 4.2%
DJ U.S. Real Estate -18.4% -10.5%
DJ U.S. Financials -34.1% -20.4%
MSCI EAFE -17.4% -9.9%
MSCI Emerging Market -9.6% -5.4%
Index
12
 urrency and commodity funds are speculative and involve a high degree of risk. An investor may lose all
C
DJ UBS Commodity Index -35.4% -21.2% or substantially all of an investment in funds. These commodities and currencies generally are volatile and
are not suitable for all investors.
Sources: Barclays U.S. Treasury 20+ Return
per Zephyr Style Advisor. All other returns per 13
Source: “Outlook 2011,” Barron’s, December 20, 2010
Bloomberg L.P.
Past performance is not indicative of future results. Certain funds and portfolios, particularly the PowerShares ETFs, in and of themselves do not qualify as
Index returns do not reflect any fees, expenses or sales diversified investment strategies.
charges and do not represent Fund returns.
An investor cannot invest directly in an index.
8
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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Compelling sources of return

Portfolio diversification may be achieved when lower or negatively correlated assets
are added to a portfolio. There are times when tactically weighting a portfolio with
such assets makes sense, and others when their weighting should be reduced.
Two compelling sources of non-correlated return that can be added to a traditional
stock and bond portfolio are commodities and currencies (see Figure 5).

• C
 ommodity ETFs14 may allow investors to participate in global growth,
hedge their portfolios against inflation, and may serve as a powerful
portfolio diversifier.

• C
 urrency ETFs14 may help mitigate portfolio volatility. Investors may profit
from the rise or fall of foreign exchange rates by owning ETFs that take long
or short positions in one currency versus another.

As is true with any portfolio, it’s important to note that asset allocation or
diversification does not guarantee a profit or eliminate the risk of loss.

FIGURE 5 0.15
One-Year Period
S&P Goldman Sachs
0.84 Three-Year Period
Commodity Index
Asset-Class Betas versus S&P 500 Index 0.86 Five-Year Period

0.44
Sources: Zephyr Style Advisor and Bloomberg,
MSCI EAFE Index 1.17
as of June 30, 2014
1.13
Low betas are not necessarily indicative of low
0.79
correlation. For instance, an index regressed
Dow Jones 0.92
against the S&P 500 Index could have high US Select REIT Index
correlation to said index but have a low beta 1.00

because it has a much lower magnitude of 0.00

BofA ML
returns than does the S&P 500 Index. US Treasury Bills 0.00
0-3 Mos. Index 0.00

0.74
Dow Jones
Credit Suisse -0.11
Managed Futures 0.07

0.36
Dow Jones
Credit Suisse 0.47
Long/Short Index 0.39

-0.06
Barclays US
Aggregate -0.06
Bond Index -0.05

1.00

S&P 500 Index 1.00

1.00

-0.05 0.0 0.5 1.0 1.5

Betas are presented for each asset class over one-, three- and five-year periods. There may be significant differences in beta calculations
over differing time periods.
Betas are presented for each asset class over three-, five- and ten-year periods. There may be significant differences
in beta calculations over differing time periods.

14
 ommodities, currencies and futures generally are volatile and are not suitable for all investors. Foreign
C
securities have additional risks, including exchange-rate changes, decreased market liquidity, political
instability and taxation by foreign governments.

9
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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Commodity ETFs
In the past, investors could only access commodities through futures contracts
on limited exchanges; today, they can get commodities access through an ETF.
Commodities have historically produced very low correlation with stocks
and bonds (see Figure 6).14
FIGURE 6 Average Correlation of Returns in Rolling 10-Year Periods

S&P
Dow Jones Dow Jones
Correlation Matrix Goldman Dow Jones Citigroup Barclays U.S.
MSCI EAFE Credit Suisse Credit Suisse S&P 500
January 2004 - June 2014 Sachs US Select US T-bill Aggregate
Index Managed Long/Short Index
Commodity REIT 3-month Bond Index
Futures Index
Index
Source: Zephyr Style Advisor, as of
June 30, 2014 S&P
Goldman Sachs 1 0.49 0.24 -0.05 0.11 0.40 -0.03 0.41
Commodity Index

MSCI EAFE Index* 0.49 1 0.68 -0.13 0.06 0.64 0.12 0.89

Dow Jones US 0.24 0.68 1 0.05 0.03 0.37 0.22 0.74

Select REIT
BofA ML US -0.05 -0.13 0.05 1 -0.03 -0.05 0.08 -0.08
T-bill 3-month
Dow Jones Credit
Suisse Managed 0.11 0.06 0.03 -0.03 1 0.32 0.07 -0.01
Futures
Dow Jones Credit
Suisse Long/ 0.40 0.64 0.37 -0.05 0.32 1 0.01 0.59
Short Index
Barclays U.S.
Aggregate Bond -0.03 0.12 0.22 0.08 0.07 0.01 1 0.04
Index

S&P 500 Index 0.41 0.89 0.74 -0.08 -0.01 0.59 0.04 1

*MSCI Emerging Market return correlations represent a price return and not a total return where dividends are reinvested.
All other indexes represent total returns. Index returns do not reflect any fees, expenses or sales charges and do not represent
Fund returns. An investor cannot invest directly in an index.

In addition, commodities historically have been weakly linked to blended stock/

bond portfolios. The reason for this low correlation is fairly straightforward: prices of
tangible goods such as agricultural products or petroleum are affected by different
supply-demand factors than the prices of stocks and bonds. Of course, this does not
mean prices of stocks, bonds and commodities cannot go down at the same time.
What it does mean, however, is that if prices all drop simultaneously, it could be for
different reasons.

Take, for example, the S&P Goldman Sachs Commodity Index (GSCI), which, since its
introduction in 1991, has become a widely followed commodity index. There have
been only two years since the GSCI’s inception that stock and commodity prices
tracked by the index were down in the same year (2001 and 2008).15

15
Source: Bloomberg L.P., as of December 2014

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Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Commodity risks to consider

Because prices of raw materials and borrowing costs have historically risen quickly
in response to rising inflation, commodities can be used to partly hedge inflation risk
in stocks and bonds — especially the risk of unexpected inflation as was experienced
in the mid- to late-1970s.

Key considerations
In addition to exhibiting greater volatility than stocks and bonds, commodities are
subject to the following specific risks that investors need to consider carefully
before investing:

• M
 arket cycle risk — Commodities as an asset class tend to experience
longer periods of modest performance, with returns slightly below inflation,
followed by strongly positive periods driven by price spikes in the underlying
commodity. Volatility levels can rise unexpectedly, especially in the wake of
interruptions in supply.

• R
 oll-yield risk — Commodities are generally traded in futures contracts
based on the current cash price (the “spot” price) that fluctuates daily for
a given commodity. A positive roll yield can arise if the investor can buy
a futures contract lower than the spot price for a particular commodity (a
market condition referred to as “backwardation”). However, a less favorable
outcome may also result from negative roll yields when the spot price
is lower than the futures contract (the opposite of backwardation, referred to
as “contango”). When markets are in backwardation, investors make money
selling their higher-priced expiring contracts to purchase lower-priced ones
for later delivery.

On the other hand, when markets are in contango, investors will lose money
on their roll because they must sell lower-priced expiring contracts to move
into higher-priced near-term contracts.

• P
 erformance differentials — The types of commodities represented by a
particular index may have performance characteristics that affect returns
in unexpected ways. For example, the cost to extract industrial metals or
precious metals may be high enough to discourage future extraction of those
minerals. The incentives to drill for oil involve a different set of economic and
political constraints that impact supply.

On the other hand, commodities based on agricultural production (corn,

soybeans and wheat) are relatively easy to produce and supply at the
margin. It is important to understand the composition of a specific
commodities index before investing in an ETF based on that index.

11
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 Structuring and Implementing Portfolio Strategies
Using Exchange-Traded Funds
O R A N G E PA P E R S E R I E S

Investing strategies using currency ETFs

Commodity-price fluctuations can impact portfolio performance. For this reason, investors
should consider commodity pricing trends before adding complementary ETF strategies to
their portfolios. Fortunately, a number of robust relative-strength* pricing tools that can
help are available. Dorsey, Wright & Associates, LLC developed rules-based commodity
models, with input from Invesco PowerShares, to identify areas of the commodity market
that exhibit relative strength versus other commodity-based alternatives. For investors
who seek broad exposure to commodities without the work of allocating among the
commodity complexes, a broadly-based commodity ETF portfolio is also an option.

Currency ETFs
Another way to add diversity to a portfolio is to invest in currencies.14

Currency values move in cycles, and they can be very volatile. And, unlike commodities,
which represent an absolute value for a product, currencies represent relative value. The
basic strategy for investing in currency includes buying or selling units of foreign exchange
based on the value of those currencies relative to the dollar, as follows (see Figure 7):

• S
 trengthening dollar — During periods when the US dollar is strengthening relative
to foreign currencies, investors may decide to sell units of foreign currency (i.e.,
through a currency ETF) to potentially profit from that movement.
125

DXY
weakening

100
FIGURE 7
DXY
strengthening
U.S. Dollar Index (DXY),
June 1998 - June 2014 75
Index level

Source: Factset, as of June 30, 2014

The US Dollar Index is a market-
weighted basket of six foreign currencies
50
that is commonly used to track price
movements in foreign currencies.
Utilizing exchange rates expressed in
units of foreign currency per US dollar,
the six currencies include the euro, 25
Japanese yen, British pound sterling,
Canadian dollar, Swedish krona and
Swiss franc.
0
Jun. 30 Jun. 30 Jun. 30 Jun. 29 Jun. 28 Jun. 30 Jun. 30 Jun. 30 Jun. 30 Jun. 29 Jun. 30 Jun. 30 Jun. 30 Jun. 30 Jun. 29 Jun. 30 Jun. 30
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Currencies and futures generally are volatile and are not suitable for all investors. Investment in foreign-exchange-related products is
subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and
foreign interest rates, and investors’ expectations concerning interest rates, currency exchange rates, and global or regional economic
or financial events and situations.

* The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies
are unfavorable and depreciate in value. Relative strength is a measure of price momentum based on historical
price activity. Relative strength is not predictive and there is no assurance that forecasts based on relative
strength can be relied upon.

12
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• W
 eakening dollar — During periods when the US dollar is weakening relative
to foreign currencies, investors may decide to buy a currency ETF to take
advantage of the valuation differential.

Whether to meet strategic or tactical portfolio objectives, adding a currency ETF

position to a portfolio may provide three major advantages. First, it may help
improve asset allocation and allow investors to gain broader market exposure.
Second, we believe currency exposure may help manage portfolio-level risk.
For example, taking a long or short position in a specific currency (or basket of
currencies) may help soften the currency effect on international stock and bond
returns. Finally, we believe, a currency position may potentially generate short-term
profits from changes in exchange rates.16

Key considerations
As noted above, investing in commodities and currencies can be more volatile than
other asset classes, and there are risks that investors need to consider. National
debt levels and trade deficits, which frequently result from decisions made by
often-opaque political entities, may increase the volatility of foreign exchange-linked
products. Interest rate changes may be sudden and unpredictable. And investors’
expectations of potential adverse political, economic or financial events can
have a negative impact on relative values between currencies — even when these
expectations are not always based on economic realities.

Unpredictable risks

Cash equitization is a concept that applies primarily to portfolio managers who are
being measured against a benchmark. Equitizing cash with one or more ETFs that
precisely track the manager’s benchmark reduces the likelihood of underperforming
the benchmark. ETFs seek to provide effective, near-constant equity exposure to
reduce or eliminate cash drag and can help the manager get closer to meeting
portfolio objectives.

Sometimes excess cash comes into a portfolio as a result of an unexpected

inheritance, retirement plan distribution, consolidation of assets, or capital gains.
A secondary use of cash equitization comes into play when an investor is waiting
to transition assets or implement a complex portfolio allocation strategy. As with
the primary fund management strategy described above, the investor can use ETFs
to achieve precise market or benchmark exposure during portfolio transition. As
with any investment that uses ETFs, investors considering cash equitization should
consider ETFs’ associated trading costs16 (trading spreads, transaction amounts
and commissions), tax implications14 (especially in nonretirement accounts), and
constraints imposed by the investor’s time horizon or risk tolerance that may offset
their cost advantages.

16
 ince ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity
S
may increase the cost of ETFs.

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Conclusion

When added to a core portfolio strategy to act on an investor’s economic or

market viewpoint, ETFs may provide a number of ways to seek returns in a cost-
effective manner, fine tune asset allocation and hedge certain types of risk. We
feel ETFs offer flexibility to investors who seek to implement specific portfolio
strategies, including core/satellite, sector rotation, adding complementary pieces
or cash equitization.

Note that there are certain risks that investors need to consider, and decisions
about portfolio allocations are left to the discretion of the investor. Investors should
monitor their ETFs’ performance and make adjustments that are consistent with
their objectives.

Ultimately, an ETF may provide a convenient and easy-to-monitor investment

vehicle for those who seek to manage their portfolios with a higher degree of
precision and control while potentially achieving a lower overall cost.

Of course, there is no assurance that the strategies discussed here will achieve their
objectives or provide the benefit of risk mitigation in adverse markets.

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About risk
There are risks involved with investing in ETFs, including possible loss of money. Index-based
ETFs are not actively managed. Actively managed ETFs do not necessarily seek to replicate the
performance of a specified index. Both index-based and actively managed ETFs are subject to
risks similar to stocks, including those related to short selling and margin maintenance. Ordinary
brokerage commissions apply.

The information provided here is for educational purposes only and is not to be construed as
investment advice, research or a recommendation of a particular strategy or product.

Alternative products typically hold more non-traditional investments and employ more complex
trading strategies, including hedging and leveraging through derivatives, short selling and
opportunistic strategies that change with market conditions. Investors considering alternatives
should be aware of their unique characteristics and additional risks from the strategies they use. Like
all investments, performance will fluctuate. You can lose money.

Equity risk is the risk that the value of equity securities, including common stocks, may fall due to
both changes in general economic and political conditions that impact the market as a whole, as well
as factors that directly relate to a specific company or its industry.

Funds focusing on a particular industry are subject to greater risk, and are more greatly impacted by
market volatility than more diversified investments.

Dorsey, Wright & Associates, LLC is compensated for providing consultation regarding the Dorsey
Wright PowerShares ETF Models. Neither Invesco PowerShares Capital Management LLC nor ALPS
Distributors, Inc. are affiliated with any Dorsey Wright company.

PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC. Invesco

PowerShares Capital Management LLC (Invesco PowerShares) and Invesco Distributors, Inc. are
indirect, wholly owned subsidiaries of Invesco Ltd. All data provided by Invesco PowerShares Capital
Management LLC unless otherwise noted.

Invesco Distributors, Inc. is the distributor of the PowerShares Exchange-Traded

Fund Trust, the PowerShares Exchange-Traded Fund Trust II, the PowerShares India
Exchange-Traded Fund Trust and the PowerShares Actively Managed Exchange-
Traded Fund Trust.

ALPS Distributors, Inc. is the distributor of PowerShares QQQ, a Unit Investment

Trust. Invesco Distributors, Inc. and ALPS Distributors, Inc. are not affiliated.

Before investing, investors should carefully read the prospectus/summary

prospectus and carefully consider the investment objectives, risks, charges and
expenses. For this and more complete information about the Funds call 800 983 0903
or visit invescopowershares.com for prospectus/summary prospectus.

© 2014 Invesco PowerShares Capital Management LLC

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