Spectrum Investments has launched a new fund. I know, you’re thinking to yourself “not another fund”, but this one really has some unique characteristics. So many new fund launches are not innovative. Rather, they are simply copies of other funds to keep up in a competitive environment. For example, I remember when every company was launching a new technology, internet, B2B or e-commerce fund.

For Spectrum, they have launched the new Tactonics Fund, a fund I consider being very unique.

What is Tactonics mean?

According to Spectrum Investments, Tactonics is a new, innovative and powerful method for allocating assets on a global basis, and represents a significant advance in modern investment theory.

Karen Bleasby, lead manager of the Tactonics Fund, says “Tactonics uses a sophisticated proprietary computer model designed to pinpoint and capture winning trends in today’s complex global economy.”

Step 1: Tactical Asset allocation – Spectrum calls it “Winners Persistence”. The model uses quantitative data to determine the momentum of different markets and indices looking for persistent winners and persistent losers. Essentially, the Winners Persistence evaluates the “Buy” side of the equation identifying the best markets, sectors, and management styles.

Markets – geographic regions like the US, Japan, Canada, Europe, etc.

Sectors – industry sectors like Financials, Resources, Technology, etc.

Styles – Different management styles like growth, value, momentum, etc.

In this step, they look at 26 different markets, sectors and management styles to try to determine the 12 best areas to invest in. Once this is determined, the fund allocates 9.5% of the fund to the top 6 winners and 7.2% to the next 6 winners.

The models are run daily (mostly to invest daily cashflow) but portfolio model changes are made once a month. The model is very active. In fact, Bleasby estimates that the portfolio turnover will be about 100% per year meaning that the portfolio will completely change over a 12-month period.

It is important to understand that the Winners Persistence is a relative comparison. This means the computer looks at the 26 different possibilities and tries to determine the best 12. For example, in a bear market where all 26 sectors might be losing money, the computer simply tries to distinguish which investments will perform best relative to each other.

Exchange-Traded Funds (ETFs)

The investments of choice are Exchange Traded Funds (ETFs). These investments have become very popular indexing tools because they provide a low-cost advantage to mainstream mutual funds. ETFs allow Bleasby to gain the broadest possible exposure to industries, sectors and investment styles around the world. With such an active style of management, ETFs allow for swift trading.

Step 2: Risk Metrics – From what I can glean, risk metrics partly determines the sell side of the equation. If the industry, country or style demonstrates too much risk, it will be eliminated from the portfolio. So what you may have is a winning sector but the sector has appreciated to the point of having too much risk, risk metrics would signal a sell for that sector. Once a sector becomes too risky, a sell is signaled.

For example, from their backtesting, in August of 1997, just prior to the Asian crisis, the Risk Metrics determined that 5 of the 12 winning sectors were too risky. As a result, the fund moved to 40% cash. According to Bleasby, the fund could move to 100% cash but, this is very unlikely.

Currently, the fund is 100% invested and is very far from having risk metrics move the fund into cash.

The objective of the fund

For Bleasby, the goal is simple “We want to provide superior returns with less risk.” The fund is benchmarked against the MSCI World Index.

A new fund but some backtesting data

One of the biggest risks of investing in a new fund is the fact that it is unproven. For Bleasby, they did a tremendous amount of backtesting of the computer model.

Firstly, the model was backtested in the Canadian Market back to the early ’60s. The model was then backtested against the world markets back to the early 1970s. Finally, the model was backtested to Jan of 1994 using all of the current markets, industries and investment style investments.

Karen shared with me some interesting stats.

• According to the backtesting, the model would have started investing in the NASDAQ in Oct 1998 because of the winner’s persistence.
• In December 1999, the winner’s persistence continued on the NASDAQ but risk metrics signaled a complete sell. The NASDAQ reached its peak in March of 2000.
• Currently, Winners Persistence does not recognize the NASDAQ as a winning sector.
• Since 1994, the backtesting showed that the model would have outperformed the MSCI index in 6 of 7 calendar years. The only year the model underperformed was 1994.
• Since 1994 the worst 12-month return was -5.36% for the period ending March 2001. At this time, the MSCI World index was -18.54%
• The best 12-month return was 41.98% for the period ending March 31, 1998. At this time, the MSCI World index was 35.27%.
• The model had experienced negative returns only 4 times since January 1994 (Jan 1995, Dec 2000, Mar 2001, April 2001).

My two cents

I am a quantitative nut when it comes to funding analysis so a quantitative fund model intrigues me. Just like any other innovation, the jury will be out until it can prove the model really works. The test of a good investment is not how well it does in good times but rather how well it does in bad times.

Spectrum is promoting this fund as a core holding. While I think it has tremendous merits, remember the risk of the unknown. Take a good look at this fund to see how it fits into your investment portfolio but I would suggest that you start with a reasonable allocation. Increase the allocation in the future as the fund develops a track record.

Pros:

• Well diversified across geographic regions, sectors and management styles
• Risk managed by using EFTs and maximum index exposures
• Utilization of index management
• Active management – tries to predict market momentum and trends
• Quantitative based discipline – a logical thought process that eliminated unnecessary emotion and bias
• An index fund with active management

Cons

• Unproven proprietary model designed by Spectrum
• Low-cost ETFs are not reflected in the MER of the fund. You might justify the fee with the active management component.
• May not be tax efficient for non-RRSP portfolios
• I would have loved to see the potential for fixed income holdings to mitigate risk. Having this asset category would enhance the product even further.

Buy with caution! It is a global equity fund with broad mandates making it a potential core holding. The element of the unknown would call for a reduced exposure that can be built into a core holding given time. The fully invested fund makes it a great fund to buy.

Jim Yih is author of Mutual Fundamentals, an advisor with Kofin Financial Group and account representative of Manulife Securities International Ltd. Please send questions or comments to Jim at fax 780-436-3226 or email [email protected], For more information about Jim, visit www.fundfilter.com.

The information contained in this article was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. The views expressed are those of the author and not necessarily those of Manulife Securities International Ltd.

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