On a dark and stormy night, a beacon can raise the hopes of lost travelers. As Howard Present tells it, something like this happened for F-Squared Investments in 2008. The S&P 500 plummeted 37%, while his firm's flagship AlphaSector Premium strategy lost less than 2%. That got investors' attention, he says, but not many sales for the firm.
Then in 2009, the strategy bested the S&P again, this time gaining 32% to the index's 27%. The happy result was that F-Squared pulled in some $1.3 billion in 2010, and by the end of 2011 was approaching the $6 billion mark in assets under management.
The 2008-09 performance put F-Squared's investment philosophy in relief. "Wealthy people don't want to lose money," says Present. "When they think about investing, they're very happy with relative outperformance in positive markets, and in down markets, they're interested in an absolute return orientation."
Present and his colleagues at F-Squared in Newton, Mass., put risk in terms that matter for clients. "One, how much money can an individual investor lose in a short period of time? Two, how much daily volatility is the individual investor absorbing?" he asks.
F-Squared offers several investment products, but according to Present, they are all philosophically similar to AlphaSector Premium.
The U.S. equity strategy invests in up to nine State Street Global Sector SPDR exchange-traded funds that reflect the primary sectors of the S&P 500. A 10th ETF, used only in bear markets, tracks short-term Treasurys.
The firm's investment process is entirely quantitative: There are no fundamental or qualitative inputs. Once a week, the investment team evaluates the nine equity sectors to determine whether any one has a higher probability of producing a positive or negative return.
If the analytics show that a particular ETF is going to make money, it remains in the portfolio. If one is going to lose money, it's eliminated entirely. This isn't a trading strategy, however. The engine tends to have an intermediate horizon. In bull markets, the average holding period for an ETF is more than a year.
The ETFs in the portfolio are always equal weighted. When all nine are in, each one receives an 11.1% allocation. Whenever a sector is dropped, a reallocation occurs in order to maintain the equal weighting. In December 2011, says Present, the strategy had five ETFs, each with 20% of assets.
The portfolio can go down to four ETFs, weighted at 25% each, without adding cash, he says. "When we drop the next sector, that's when we trigger a top-down call that says we're heading into a bear market. Our goal is to aggressively protect on the downside, so we start adding cash to the portfolio."