The original thinking behind the development of the
SmartGrowth ETF Lipper Optimal Growth Index Fund (LPGAX) was to create a viable alternative to traditional asset allocation models.
In practice, however, the fund has emerged as a viable alternative to the current domestic-equity market turmoil.
From its June 4 inception through Thursday, the fund gained 8.1%, compared with an 11.6% decline by the Standard & Poor's 500 stock index over the same period.
Kevin Mahn, chief investment officer at
Hennion & Walsh Asset Management Inc. of Parsippany, N.J., doesn't subscribe to the notion that the portfolio of a 60-year-old investor should automatically be allocated to 60% bonds and 40% stocks.
Thus, two years ago, he began tinkering with a relatively simple quantitative asset allocation technique that uses broad and flexible diversification to balance risk and return inside a portfolio.
"The main reason this fund works is the same reason some target maturity funds don't work," said Mr. Mahn.
A driving force behind the creation of the fund was that he was watching many of his clients struggle to catch up with their retirement savings goals under traditional models that would have them become more conservative as they got older.
"Investors wanted to get more aggressive, so we wanted to see if we could deliver better risk-adjusted returns using ETFs," Mr. Mahn said.
Once the idea was born, he said, he "handed over the keys to the engine" to
Lipper Inc. in New York, where the model was used to create a series of five global market indexes that range from conservative to aggressive.
Hennion & Walsh, a financial advisory firm with $2 billion in assets, entered the mutual fund business by licensing three of the five new indexes and registering them as mutual funds.
Even with the Lipper brand attached, the fledgling fund group has so far grown to just $16 million — $11 million of which is invested in the most aggressive of the three funds.
An important aspect of the strategy is the flexibility to gain global market exposure across multiple asset classes, according to Andrew Clark, head of research for the Americas at Lipper.
"I think something like this works because the ETF universe is now big enough that it is beginning to span a complete market," he said.
Mr. Clark readily admitted that the strategy behind the indexes is not rocket science. "It's nothing complex," he said. "Until recently, we were running it on a laptop computer."
But it seems to work.
The process, which is entirely backward-looking, seeks to identify the smallest number of ETFs that are representative of the performance of a larger ETF category.
The entire universe of more than 600 ETFs is boiled down through a four-step process that starts by selecting those funds with at least a six-month history, at least $1 million in daily trading volume, below-average expense ratios and a high correlation to the underlying index.
That initial screening process typically leaves less than 250 ETFs with which to construct each index.
The continuing analysis considers six months' worth of daily returns for each ETF, which lead to the quarterly adjustments to the index.
In terms of what might end up inside a given index, the field is wide open, and the number of ETFs could range from two to 600, according to Mr. Mahn.
The vast and growing universe of ETFs makes it possible for the portfolio to have highly concentrated exposure to everything from currencies and commodities to single countries or any equity category in a transparent format.
"The idea is that keep the indexes within a certain band of standard deviation," Mr. Mahn said. "We don't care what's in the portfolio as long as it stays within the set bands."
The indexes have so far averaged between six and 15 underlying ETFs in any given quarter, according to Mr. Mahn.
Even though he has downplayed the relative complexity of the strategy, Mr. Clark admitted that the general concept is pushing the limits of conventional portfolio construction thinking.
"For some people, the indexes would be counterintuitive," he said. "If you read the academic literature, it will say you need more ETFs for true diversification."
The
SmartGrowth ETF Lipper Optimal Growth Index Fund currently has a 40.9% allocation to the iShares Lehman 3-7 Year Treasury Bond (IEI).
The second-largest holding, at 8.9%, is the iShares MSCI Taiwan Index (EWT), followed by a 7.3% weighting in UltraShort S&P 500 ProShares (SDS).
Questions? Observations? Stock tips? E-mail Jeff Benjamin at [email protected].
