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Money matters: More gain, less pain: New fund aims to draw gun-shy investors back to the stock market

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"Don't lose my money" is the proverbial concern for many investors, so it’s hardly a surprise many are fearful to wade back into the stock market, instead preferring the safety of bonds and balanced funds in recent years.

Fund firms have been trying to lure us back, in part because equity funds command higher fees, but also for our own good. Certainly, the risk of losing money in the equity market is a reality, but many investors seeking the safety of fixed-income or balanced funds -- half of which are comprised of bonds -- don't realize the fixed-income market has been on a 30-year bull run. Rock-bottom rates can't go on indefinitely, and when the interest rates rise, the bond market will fall.

Quick facts

AGF's U.S. AlphaSector Class fund at a glance:

-- This fund of funds is a portfolio that can invest in nine State Street SPDR exchange-traded funds that track major U.S. equity sectors: consumer discretionary, consumer staples, energy, financials, health care, industrials, materials, technology and utilities. It can also allocate funds to a short-term treasure ETF.

-- Sectors are evaluated on future performance on a monthly basis and capital is allocated into sectors based on the likelihood a sector will increase in value. Alternatively, the model divests in the sectors likely to decrease in value. Capital is spread evenly among ETFs that are expected to increase in value. For example, capital could be allocated in equal, 10 per cent portions across nine equity sectors and the cash ETF, or it could be invested evenly in four sectors--energy, financials, utilities and industrials -- at 25 per cent each. The investment can also move to a completely defensive position where all capital is allocated to the short-term cash ETF.

-- AGF U.S. AlphaSector Class fund is based on a strategy from Massachusetts-based firm F-Squared. The 10-year track record of this fund is 14.8 per cent per year with a cumulative return of more than 368 per cent since its inception in March 2001 compared to 76 per cent for the S&P 500.

-- Because the AGF fund is new, its management expense ratio (MER) is estimated to be no more than 2.65 per cent. The ETFs within the fund -- State Street's SPDR Select Sector funds--have MERs of about 0.18 per cent.

A different ETF strategy... from the Easy Chair:

U of T professor Eric Kirzner is best known for developing the Easy Chair Portfolio, a passive ETF strategy investing in Canadian and U.S. stocks, bonds and cash. He designed it originally for the Toronto Star in the 1990s to compete against other portfolio strategies using imaginary money. The main idea behind the portfolio is that periodic rebalancing so no one asset class is overrepresented would provide a return on investment on par with, if not better than, active-management strategies.

It's a cheap, DIY investment strategy that would have returned about seven per cent per year since its inception in 1997 and 2011, as stated in a 2012 article in the Toronto Star. Asset allocation is based on your appetite for risk, taking into account your retirement goals, but it always includes allocations for stocks, bonds and cash.

For example, a 40-year-old investor could have about 40 per cent invested in a Canadian equity ETF, 20 per cent invested in a U.S. equity ETF, 35 per cent in a blend of corporate and government fixed-income ETFs and five per cent in a money-market ETF.

As a rule, the portfolio is rebalanced twice a year to ensure no allocation strays too far from these percentages. So if the U.S. equity ETF accounted for 30 per cent of the portfolio while the Canadian equity ETF was down to 30 per cent, you'd sell some U.S. ETF units and buy more Canadian ETF units to restore the 40 per cent Canadian/20 per cent U.S. ratio.

This discipline helps guard against large losses, because investors can't chase returns and get caught in asset bubbles. During 2008, for example, the Easy Chair Portfolio lost only about seven per cent while the Canadian equity market was down 35 per cent.

"The great rotation hasn't occurred yet, but it certainly is gathering steam," says Blake Goldring, CEO of AGF Management. "So what do you do when you don't get much return from fixed income and you're faced with potential capital losses from these investments?"

No doubt, fund firms have been busy cooking up solutions, and AGF's U.S. AlphaSector Class fund is among the latest.

Focused on the growing U.S. stock market, it allows Canadians to invest across several industrial sectors from tech to financials to energy.

It also capitalizes on growing demand for low-fee exchange-traded funds (ETFs), investing in 10 funds that passively track nine S&P indices and one short-term cash index.

Still, these traits don't make AGF's offering all that different from other products rolled out in recent years. Nor does it set itself apart claiming to be "alpha" focused, pursuing returns while limiting devastating losses.

What makes AlphaSector Class stand out from the rest is its "secret sauce," Goldring says.

It's a successful proprietary strategy of a Massachusetts-based firm, F-Squared Investments, that allocates capital into sectors most likely to increase in value while moving money away from those likely to incur losses.

F-Squared's president, Howard Present, says at the heart of the strategy is a super-computer-driven model that employs quantitative analysis, the same mathematical acrobatics used in quantum physics. It's a numbers game too complex for most of us to wrap our heads around, but the long and the short of it is this:

"Each month, we have a quantitative evaluation tool that we run individually against all nine industrial sectors, asking the computer a green-light/red-light type of question," Present says.

The "green-light' answer -- a yes -- means a particular sector has a likelihood of increasing in value in the near future, so capital in the portfolio should remain in the ETF representing that sector, or be allotted to the ETF if no prior allocation exists.

"Alternatively, if our analysis shows that it (a sector) has a higher likelihood of losing money (red light), we remove that sector entirely."

All green-lighted ETFs in the portfolio are equally weighted, so the energy sector, for example, won't have a larger share than materials.

"We only drop sectors we identify as unhealthy, dangerous or even toxic," Present says. "For example, we dropped financials in July of 2007 and didn't own it again for almost two years."

Although the AGF offering is new, launched last month, the strategy it uses has been around for more than a decade -- though F-Squared has only used it for about half that span, having purchased it from a private-wealth firm, Present says.

The strategy's overall track record is remarkable, averaging almost 15 per cent per year compared to its benchmark, the S&P 500, of about eight per cent.

Present says the strategy isn't designed to pursue the highest returns possible. It's built to provide solid market gains without big market pains.

In a good year, when the market is up five to 15 per cent, the fund will be up by about the same amount.

"But when the market is up really big, like 25 to 40 per cent in a year, we're willing to lag," he says. "We're willing to leave money on the table to protect against huge losses."

Avoiding big losses by not pursuing big gains is exactly what the F-Squared strategy did between the peak of the market in May 2008 and its trough in March 2009 when it lost only 18 per cent of its value compared with the S&P 500, which lost about 51 per cent.

Goldring says AGF's U.S. AlphaSector Class fund offers the same formula that has attracted more than $15 billion to F-Squared's product line.


"This is ideal for people who have been anxious about being burned after 2008, allowing them to come back and dip their toes into the resurgent equity markets."

Yet a Canadian expert in low-cost ETF investment strategies isn't entirely convinced AGF's new fund targets the right audience.

"The way to get somebody into the market is to make sure they have some fixed income, some cash, a couple of simple (equity) ETFs and then build up from there," says Eric Kirzner, a professor of finance at the University of Toronto's Rotman School of Management.

"The last thing I would do is take a product that would have nine different ETFs in it that are being tactically rebalanced."

While an interesting offering that may well provide enhanced returns, Kirzner says it's also expensive for a portfolio of ETFs. The AGF's U.S. AlphaSector Class fund contains ETFs with annual management costs less than 0.2 per cent, but it is expected to have an overall management expense ratio (MER) of 2.65 per cent.

Goldring says the additional cost puts the fund on par with most actively managed U.S. equity funds in Canada. Furthermore, investors are paying for access to F-Squared's proprietary strategy that helps protect their money from substantial market losses -- unlike an unmanaged portfolio of ETFs.

Yet it's this computer-based, market-timing strategy that makes the fund likely more complicated and even riskier than the average investor wary of the stock market likely wants or needs, Kirzner says.

The product is likely better-suited for sophisticated investors and it shouldn't be a cornerstone holding in a portfolio, he says. "I would consider it opportunistic. If I was in the mood, I might put a couple of per cent of my portfolio into it."

Present agrees the fund isn't designed to be a primary portfolio holding.

"What we typically find for people who really understand it or embrace it is they'll take their U.S. equity or their global equity exposures -- let's say it's on average 40 per cent of their portfolio -- and they'll typically give us around 25 to 30 per cent of that."

But Goldring says he sees the AGF U.S. Alpha Sector Class a little differently. It could very well be a core product for individuals with several years to go before retiring and even be used as a complementary growth component for retirees' portfolio.

"To have this product, which provides downside protection while allowing investors to capture the upside of equity markets, is a really important feature."

Yes, it's more complex and costly than most ETF-based approaches, Goldring says, but the blend of "investment art and science" is worth it.

"The proof in the pudding is what F-Squared has done."

Republished from the Winnipeg Free Press print edition October 5, 2013 B12

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