There has been myriad research and speculation that sector outperformance in the markets may have as much to do with the time of year as it does with fundamentals. Now Horizons AlphaPro has created a new actively managed exchange traded fund that will try to capitalize on seasonal proclivities of investors.
The advent of sector tracking ETFs has mitigated seasonal risk. Investors may be aware of the outperformance of small caps in January — the so-called “January effect” — but without sector-wide exposure, they face individual stock risk.
Don Vialoux and Brooke Thackray are seasoned market technicians who will manage the underlying portfolio of the recently launched Horizons AlphPro Seasonal Rotation ETF. It will be the first managed fund in North American to employ a seasonal market strategy.
Thackray has published four books on seasonal investing and says the advent of ETFs has allowed him and Vialoux to cleanly exercise their tactical strategy, which will overweight and underweight broad-based market exposure to the fund’s core positions in the S&P 500 index and the S&P/TSX Composite Index versus investments in sectors within those broader markets.
Most investment managers use fundamental analysis to pick individual securities. Thackray will emply technical analysis to identify seasonal trends in markets. The fund’s sector allocations are not based on price, but timing.
Thackray says seasonal investment patterns are verified by more than 60 years of market data. For example, the broad market’s largest gains usually occur between the end of October and May, while returns tend to be flat or declining in the following six months. During that slower period certain sectors — such as oil — have tended to outperform.
“Seasonal investing is broken down into two markets: One portion is the broad market sectors, such as the TSX/Composite index, and the other are different sectors within that market. Historically different sectors outperform during different times in the year,” Thackray says. “Broad markets tends to do better during the six months from October to the beginning May. Our core strategy is going to be investing in the S&P 500 and the TSX Composite. If there were no sectors during that period set to outperform, then we would be only invested in those two ETFs. When there are sectors we think will outperform, we take the money out of the two broad-based indexes, and put them in different sectors. At times almost all of the funds assets will be will be put in the different sectors.”
During broad market underperformance Thackray says money not invested in certain sectors may invest in a money market fund instead of being kept in the broad-based core positions.
“My favorite trend is in the oil sector. The oil sector has two seasonal trends where it will outperform the market twice a year on average. The big one runs, on average, from February 25 until May 25. Why does oil go up over that time period? That’s because the refineries tend to be shut down for maintenance and are switching over from winter gas to summer gas [demand],” Thackray says. “All of sudden they come back online, they have a large demand for oil. At the same time you have investors saying the driving season is coming up, I’ve got to get to the oil stock. That has driven the outperformance of that sector over the last 26 years; it’s gone up 24 times which is an incredible frequency rate. Over the same 26 years, the oil trade has beaten the S&P 500 23 times. That’s a solid seasonal trade we look for.”
Even in the two down years, Thackray says this seasonal trade was only marginally lower, at 1% or less. On average over the two and half months of the trend, the oil sector has outperformed the S&P 500 8.9%.
A concern for investors is that these trades become well-known and opportunity is priced out. Thackray says he monitors movement in a sector when the trend begins. He and Vialoux look for an entry time before the trend begins and get out before it has taken hold. The most noteworthy example of this is the earlier shifting of start dates of the January Effect, which Thackray can now start as early as December 19.
“The seasonal trade that has actually been talked about the most — with the most media attention and research — is the January Effect, which is when stocks are sold in September, which drives down the price. Investors are more likely to sell small caps during this period for tax-loss selling and creating a good value. In January those sold asset classes tend to go up,” he says. “What’s happened in that trade, the date has moved to get into small caps to Dec. 19, because managers are actually trying to anticipate that. We just use the technicals to shift the date so we have a solid date to enter that market if it’s an applicable seasonal event for that year.”
He adds, “The use of seasonal analysis has so much more room to grow. We’re not worried about other people [crowding the trades]. We actually get in before the majority of the market. Everybody is rushing to get the oil out in April, so you’re in that trade before May.”
Ken McCord, president of Horizons AlphaPro, says the new ETF is part of an expanding line-up of actively managed ETFs, and is was compelling because the process is predictable and the research suggests it works.
“I’m trying to build a family of ETFs that will rival any mutual fund company. The ETF wrapper provides for better tax-efficiency, lower cost and better liquidity than the traditional mutual funds,” he says. “I’m always looking for traditional strategies that could steal share from the incumbent mutual fund companies, such as dividend funds and core Canadian equity. I also want to come out with unique, never-before-seen strategies. The research that was presented to us by Don and Brooke was just so compelling,”
McCord says the active strategy fits well with the transparency of ETF investing, because investors are always going to have a sense of where the fund is positioned at certain times of the year.
“I know in every October they are going to be long in the broad market. I know in the start of May they are going to sell it. I know they are going to get into gold towards the end of the year and sell it before the new year starts,” he says. “I know they are going to be in technology shares in October, November and so on just before the big trade show in Vegas. It gives me as an investor a lot more comfort in knowing what’s going on with my money.”
(12/09/09)