Minimizing the risks in equity markets

With mutual funds and exchange-traded funds (ETFs) crossing into each other’s territory, Toronto-based AGF Investments Inc. has introduced a sector-allocation mutual fund that uses ETFs rather than individual security selection to manage the fund’s exposure to various U.S. equities sectors.

The goal of AGF U.S. AlphaSector Class Fund is to achieve healthy returns and preserve capital by reducing exposure in market sectors when they show signs of losing value. The fund invests in nine equities-based ETFs based on various sectors of the S&P 500 composite index, plus one short-term U.S. treasury bond ETF to provide exposure to cash. Increased focus is placed on sectors showing signs of strength in an effort to ensure participation in rising markets.

AGF’s product follows on the heels of Toronto-based ETF-provider BlackRock Asset Management Canada Ltd.‘s recent launch of mutual funds that contain fixed mixes of iShares ETFs.

“We are seeing a rotation into equities, with the U.S. leading the rest of the world,” says Blake Goldring, AGF’s chairman and CEO. “But many people are wary of being burned – they want to participate in equities markets but avoid the major risks. We are bringing on an innovative product that allows [such investors] to participate in the market with state-of-the-art tools [to] minimize downside risk.”

The new AGF fund’s sector allocation is evaluated once a month by Boston-based F-Squared Investments Inc. using quantitative screens that measure factors such as price momentum and volatility. Indicated sectors are then wholly or partially omitted from the portfolio, then the assets are allocated equally to the remaining sectors.

If all nine equities sectors are held, the asset allocation would be 11.1% each, but if only seven sectors are held, the allocation would be 14.3% each. The maximum weighting in any one sector is 25%. If three or fewer sectors are indicated, the portfolio then begins to turn to cash and can hold up to 100% cash.

F-Squared president Howard Present says his firm has been able to capture 85% of the rise in the U.S. equities market since 2008 by using its program to focus on healthy sectors and eliminate exposure to declining sectors, yet has experienced only 15% of the downside in periods in which the market has dropped.