How The Trend Can Be Your ETF Friend

February 25, 2016

[This interview appears in our upcoming issue of ETF Report.]

Pacer Financial, based outside of Philadelphia, launched its first ETFs in the middle of last year. The firm has quickly attracted $500 million in assets to its "Trendpilot" funds, which the company says are designed to provide a selection of strategy-driven ETFs that aim to serve as long-term investments as part of a diversified portfolio. However, Pacer is not new to the ETF industry. The company at one time was the wholesaling operation for RevenueShares when it first launched. And if the "Trendpilot" strategy sounds familiar, it's because Pacer worked with Royal Bank of Scotland and its exchange-traded note platform developing products with the name before RBS decided to exit the ETN market in addition to all its other kind of noncore bank businesses globally.

ETF Report caught up with Pacer Director Sean O'Hara to discuss the unique strategy of the company's ETFs and where he sees them fitting into a diversified portfolio.

ETF Report: Let's talk about your "Trendpilot" ETFs that launched last year and the strategy behind them, which some would say is smart beta. What are the differences between the three: the Pacer Trendpilot 750 (PTLC | D-50), the Pacer Trendpilot 450 (PTMC | F-1) and the Pacer Trendpilot 100 (PTNQ | F-55)?

Sean O'Hara: We would categorize ourselves as strategy-driven, not smart beta; not that we have any problem with that. I read on your website that smart beta is going to attract $100 billion this year. So if we can hang around in that crowd, great, but what we think we do is strategy-driven.

We use a trend-following approach. The "750" is a reference to the Wilshire US Large Cap Index, which holds the 750 largest stocks in their Wilshire 5000. The "450" is a reference to the Wilshire US Mid-Cap Index. And then the "100" is the Nasdaq-100.

The rules are very simple. What we want to do is to be fully exposed to those underlying equity indexes when the trend is positive. And the way we measure the trend being positive is by using the price of the index versus its 200-day moving average.

If the price of the index falls below its 200-day moving average for five-consecutive days, then the dynamic is changed; the trend—at least in the short run—has changed. So at that point, the index calls for us to take half the exposure and go to U.S. Treasury bills, moving away from risk.

We will then either stay in that 50/50 mode and go back to full equity mode, or go all the way out of the market based on whether or not the next risk signal triggers. The next risk signal is whether the moving average itself starts to go down instead of continuing to move up.

The simple idea is to be fully participating in the market when it's rising. When things get dicey or you get some volatility, it moves to a halfway-safe position. And then if the trend really changes by confirming both those signals, then move away from risk entirely.

We use a traffic light analogy—green, yellow, red. Green is fully invested; yellow is 50/50—that means caution; and red means stop altogether. We're trying to provide an alternative way for advisors and clients to include something in their portfolio that helps them manage the risk of being an equity investor without detracting from equity returns when the markets run.

ETF Report: So these funds are purely rules-based?

O'Hara: They are 100% rules-based. Take the midcap as an example: PTMC. It tracks the Wilshire U.S. Mid-Cap Index. On Aug. 24, it was completely out of the market, and it's been completely out of this market since then. Midcap stocks, if you measure them by a benchmark—the Wilshire midcap or the S&P 400 or the Russell 2000, whatever midcap benchmark you like—have fallen about 18% since then. Our midcap ETF is down 6% relative to that decline.

If you look at this over long periods of time, this very simple rules-based methodology will provide a vehicle where somebody can match or exceed equity returns with a whole lot less exposure to the downside, which is inevitable in the market; it's just the way it works.

The 200-day moving average as a way to manage the risk or the exposure to the markets has been a great indicator to move out of the way of that bear market cycle.

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