Innovative index-based investing strategies continue to emerge, and advisors can use them to incorporate lower-cost alternatives to mutual funds into clients’ portfolios. But experts warn that it’s critical for clients to be aware of the risks.

AlphaPro Management Inc. is set to launch a new exchange-traded fund in early February that is based on the S&P/TSX 60 130/30 Strategy Index. The index is designed to give additional weighting to top performing constituents and decreased position to the weakest performing stocks in the index, which provides the possibility that the index will outperform the benchmark.

“The whole notion behind this strategy is to provide an alternative to index investing that delivers similar risk profile with enhanced risk management and enhanced performance,” explains Ken McCord, president of AlphaPro Management.

Horizons AlphaPro S&P/TSX 60 130/30 Strategy ETF will be one of several actively managed ETFs that AlphaPro Management has launched in recent months, including the Seasonal Rotation ETF and the Income Plus Fund. McCord says investors are drawn to the funds since they offer attractive fees, and the prospect of higher returns than standard index ETFs.

“It’s still keeping the investor within certain parameters — it’s not allowing them to go too far beyond what the actual index looks like — but it still affords them the opportunity to beat the index,” he explains.

Under the 130/30 strategy, Standard & Poor’s assesses such factors as stocks’ capitalization rates, earnings quality and equity analyst recommendations. The stocks determined to be the 10 top performers in the index each have their respective weights increased by 3% relative to the S&P/TSX 60, while the 10 weakest performing stocks each have their weights decreased by 3%.

The new product marks the first time that this type of 130/30 strategy will be accessible to retail investors in an ETF form in Canada, and industry watchers are eager to see whether it catches on among retail investors. In the U.S., 130/30 strategies have become very popular among institutional and private client investors, but less so among retail investors.

“It’s very hedge-fund like, because there is a shorting and leveraging aspect to it,” says Dan Hallett, vice president and director of HighView Financial Group.

Hallett says it will likely take time for this type of strategy to gain traction in the retail market, since hedge fund strategies are still foreign to many retail investors.

“The complexity of these strategies is enough to scare a lot of retail investors,” he says.

But Hallett points out that other products utilizing leverage and shorting strategies, such as the Bull and Bear Plus ETFs offered by Horizons BetaPro, have been very popular. Designed to offer double the daily performance of their underlying index, or double the daily performance opposite that of the underlying index, Hallett says these funds involve a considerable amount of more risk and complexity than the 130/30 strategy.

“Those are probably more adventurous,” he says. “If you look at what they’ve done with those products, probably they’re going to find an appetite for this.”

McCord says the 130/30 strategy ETF could be used as part of a core Canadian equity portion of a client’s portfolio.

“This is really designed to always deliver a net 100% exposure to the TSX 60, and in that respect, represents an ideal core Canadian equity position,” he says.

Hallett agrees that this type of fund could be used as a core holding. But he warns that it involves more risk than passive ETFs.

“It’s possible to lose significantly more in a product like this, compared to your straight, standard, plain-vanilla index fund,” he says.

It’s important for advisors to ensure clients are familiar with these risks. But any investor comfortable investing in equities, Hallett says, would likely be willing to take on the additional risk for the prospect of higher returns.

IE