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Under the Hood of Tactical Allocation Funds
analysis, asset allocation, mutual fundanalysis, Leuthold, mutual fund, tactical allocation

An article from The Wall Street Journal describes a new wave of “tactical allocation” mutual funds:

There are 41 mutual funds with “tactical” in their names that are tracked by investment-research firm Morningstar Inc., including 18 that were launched since the beginning of 2012. Total assets in this fund category have risen to $4.92 billion from $1.10 billion in December 2007, according to Morningstar.

Successors to the so-called market-timing funds of the past, tactical allocation funds attempt to shift between asset classes

…with the idea of exploiting the stock market’s strong points and dodging its weaker corners over time.

One of such funds mentioned in the article is Leuthold Core Investment Fund (LCORX):

Douglas Ramsey, one of the managers of the Leuthold Core Investment Fund, says the fund’s goal is to match the performance of the stock market over the full cycle with substantially less risk, which it has done.

The fund can shift its stock exposure from 30% to 70%, and now holds 60%, Mr. Ramsey says. While it was originally conceived as a core portfolio holding, it’s now often used by registered investment advisers as a part of their alternatives allocation, Mr. Ramsey says.

Let’s take a look at the fund’s performance from the Alpholio™ perspective. The cumulative RealAlpha™ chart shows that the fund did not add value on a truly risk-adjusted basis, i.e. vs. a dynamic reference portfolio of exchange-traded products (ETPs): The fund’s statistics demonstrate that despite a low TrueBeta™, the volatility of the fund’s returns was higher than that of the reference portfolio, and the annualized RealAlpha™ was negative: The reference weights chart depicts how the fund’s asset allocation changed over time: An equivalent fixed-income position of the fund is represented by the iShares 1-3 Year Treasury Bond ETF (SHY). In 2008, this position was insufficient to cushion equity declines and, as a result, the fund returned about -27.4%. From mid-2009 to mid-2010, in an attempt to capitalize on the stock market’s rebound, the fund started to decrease this position. However, the decrease was too gradual and ultimately reversed in the second half of 2010. Consequently, in 2010 the fund returned only 3.5% compared to about 12% of its peers. This illustrates the difficulties tactical allocation managers have with market timing. and global/international funds 

The situation was similar in fixed income: Average Investor Return
analysis, mutual fundanalysis, Fidelity, investor return, mutual fund

An article in InvestmentNews discusses how “average investors” in some of the top ten large-cap mutual funds failed to beat the market over a recent five-year period due to market timing:

Over the five-year period ended Aug. 31, which includes the collapse of Lehman Brothers Holdings Inc. in 2008, the S&P 500’s 42% free fall to the bear market’s bottom and its subsequent 130% rally, five of the 10 biggest large-cap-stock funds posted better annualized returns than the benchmark.

These five funds are:

According to the article

The average investor return, which takes into account buying and selling behavior, for all but one of the funds was much lower because investors were busy selling, according to Morningstar Inc.
Only investors in the T. Rowe Price Growth Fund enjoyed the full market cycle’s outperformance. The average investor return over the past five years in the fund was 8.85%, beating the fund’s 8.63% return.

So, what’s wrong with the article’s thesis? First, a simplified proposition of looking at just the fund’s returns without taking the fund’s risk into account. Second, the use of a single performance benchmark (the S&P 500® index, a proxy for “the market”) that cannot fully adjust for that risk. Third, a notion that there exists an “average investor” whose investments into and withdrawals from the fund precisely mimicked the inflows and outflows generated by all of the fund’s investors in both time and relative scale (for one, there is no proof that these same investors who cashed out later reinvested into the fund). Fourth, a surprising indication that market timing may actually work in some cases (e.g. PRGFX). Fifth, looking at just one specific time period for a very small number of funds to derive the following speculation:

After all, five years from now, it may be funds such as the American Funds Growth Fund of America (AGTHX) or the American Funds Investment Co. of America Fund (AIVSX) that are sporting the best 10-year annualized returns, even though both have underperformed these past five years.

How would a truly risk-adjusted performance of the five funds look like over an extended period of time, which includes the interval used in the article? Here is one example, as a continuation of a previous Alpholio post on Fidelity® Contrafund®: The chart clearly shows that on a cumulative RealAlpha™ basis, the fund started to underperform its reference portfolio in late 2007, i.e. well before the onset of the financial crisis. Therefore, the following five-year period was largely irrelevant to those investors who practiced “market timing” based on the above information. 

According to the Bloomerg article: Calamos Active ETF
exchange-traded fundactive management, Calamos, ETF

Calamos Investments recently filed a registration statement for an actively-managed Select Growth ETF. Should investors care? To answer that, let’s take a closer look at the Principal Investment Strategies section of the statement:

The Fund invests primarily in equity securities issued by U.S. companies. Under normal market conditions, the Fund invests primarily in companies with market capitalizations of greater than $1 billion that the Adviser believes offer the best opportunities for growth. The Fund may invest up to 25% of its net assets in foreign securities.

When buying and selling growth-oriented securities, the Adviser focuses on the company’s growth potential coupled with financial strength and stability. When selecting specific growth-oriented securities, the Adviser incorporates the firm’s top-down macro-economic views and focuses on individual security selections (referred to as a “bottom-up approach”) based on qualitative and quantitative research.

In seeking to meet the Fund’s investment objective, the Fund’s investment Adviser utilizes a disciplined investment process designed to help enhance investment returns while managing risk. As part of these strategies, an in-depth proprietary analysis is employed on an issuing company and its securities. At the portfolio level, risk management tools are also used, such as diversification across companies, sectors and industries to achieve a risk-reward profile suitable for the Fund’s objectives.

For comparison purposes, here are Principal Investment Strategies in the summary prospectus of the Calamos Growth Fund:

The Fund invests primarily in equity securities issued by U.S. companies. The Fund currently anticipates that substantially all of its portfolio will consist of securities of companies with large and mid-sized market capitalizations. The Fund’s investment adviser generally defines a large cap company to have a market capitalization in excess of $25 billion and a mid-sized company to have a market capitalization greater than $1 billion, up to $25 billion. The Fund may invest up to 25% of its net assets in foreign securities.

In pursuing its investment objective, the Fund seeks out securities that, in the investment adviser’s opinion, offer the best opportunities for growth. The Fund’s investment adviser typically considers the company’s financial soundness, earnings and cash flow forecast and quality of management. The Fund’s investment adviser seeks to lower the risks of investing in stocks by using a “top-down approach” of diversification by company, industry, sector, country and currency and focusing on macro-level investment themes.

In addition, these documents show the same nine managers for both funds. Therefore, it would be reasonable to assume that both funds will pursue very similar investment strategies, although the “select” in the ETF’s name would suggest a more concentrated portfolio than that of the Growth Fund.

To get an idea of what the performance of the upcoming ETF may look like, let’s review the historical performance of the Growth Fund: Since early 2005, the fund exhibited a decisively downward trend in its cumulative RealAlpha™. This is further demonstrated by performance statistics: Unless the forthcoming active ETF adopts a drastically different investment strategy, the historical risk-adjusted performance of its sibling mutual fund does not bode well for the future of this new product. Analysis of Invesco Balanced-Risk Retirement Fund
analysis, mutual fundanalysis, Invesco, mutual fund

An article in The Wall Street Journal discusses the recent performance of Invesco Balanced-Risk Retirement 2030 Fund (TNAAX, class A shares). In the fall of 2009, the fund started adopted a risk parity investment strategy, which distributes the risk evenly between stocks, bonds and commodities. To increase bonds’ contribution to the overall risk, the fund uses leverage. Consequently, when interest rates started to rise in May 2013, the fund’s performance took a hit: Nevertheless, the chart shows that from the beginning of 2010 through August 2013, the total return of the fund was still higher than that of its average peer in the Target Date 2026-2030 category. Morningstar also reports a three-year (to August 31, 2013) Sharpe Ratio of 1.14 and 0.97 for the fund and its category, respectively. While the return of the fund was lower than the category’s average, its volatility was even more so thanks to the relatively high bond position.

Let’s take a look at the fund’s performance from Alpholio™’s perspective. First, the cumulative RealAlpha™ chart: The chart shows three distinct periods in the fund’s performance:

Therefore, the switch to a risk parity strategy generally benefited the fund’s shareholders, esp. when compared to the first two years of operation. The next chart shows the reference portfolio weights for the fund: Currently, the fund has top three equivalent positions in iShares Core Total U.S. Bond Market ETF (AGG; 46.4%), PowerShares QQQ™ ETF (QQQ; 24.5%), and iShares MSCI Singapore ETF (EWS; 12.8%).

As a previous Alpholio post indicated, when interest rates rise, correlations among stock, bond and commodity returns increase; hence, risk parity strategies tend to underperform. This negatively affected the fund in mid-2013. However, longer-term performance of the fund since its adoption of the risk parity approach is moderately encouraging. As depicted above, the study also found that Are ETF Fees Increasing?
exchange-traded productETF, expense ratio

An article in Forbes indicates that an average expense ratio (ER) of exchange-traded products (ETPs) increased from 0.61% to 0.62% over the 12 months to June 2013. The emphasis should be on average, as opposed to asset-weighted. That is because

Driving the fee increase is the cost of newly issued funds. Since 2010, the average net ER of a newly issued fund is 0.70%, according to Morningstar data.

Not surprisingly, as the ETP space becomes more crowded and basic indexing is increasingly well covered, more niche products with a small amount of assets under management (AUM) and, consequently, higher ERs are introduced. However, a straight ER average is less indicative of what a typical investor would pay compared to an asset-weighted average.

So, was there also an increase in asset-weighted fees? The 2012 and 2013 Lipper’s Quick Guides to OE [open-ended] Fund Expenses provide at least a partial answer. Here are the average asset-weighted fees for ETFs with “institutional” load types:

For all ETF types, the ER decreased or stayed the same between 2011 and 2012, with an overall decline by about 7.3%. Therefore, on an asset-weighted basis, ETF fees exhibited an opposite trend to that on a straight average basis. That is great news for both ETF investors and Alpholio™, as the fund expense component of the (negative) excess return became smaller.