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A New Twist on an Old Strategy

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Although we’ve experienced a recovery in the equity markets this year, investors remain gun-shy about jumping back into the markets full throttle. This is quite understandable, of course, since many investors are still reeling from three years of losses. To help coax investors back into the equity markets, investment firms are increasingly offering mutual funds that include alternative investments, also called asset allocation funds, which provide a cushion when the markets head south.

Two such firms that recently launched asset allocation funds are Hartford, Connecticut-based Phoenix Investment Partners, the asset management subsidiary of The Phoenix Companies, Inc., and Kauser Management, LLC, in Boulder, Colorado. Phoenix is offering two new funds, The Phoenix Partner Select Wealth Builder and Wealth Guardian, which are both modeled after institutional portfolios and include allocations to seven Phoenix mutual funds offering traditional and alternative strategies. Wealth Builder is a capital appreciation fund that has an 80/20 allocation to equities and bonds, while Wealth Guardian, a current income and capital appreciation fund, has a 60/40 allocation to equities and bonds. Both funds also include a 15% exposure to alternative investments on the equity side–10% in the Phoenix-Duff and Phelps Real Estate Securities Fund and 5% in the Phoenix Market Neutral Fund, which employs a long/short strategy. Both funds, launched in early August, are offered in A and C shares, and require a $500 minimum investment. The A shares charge a 5.75% front-end sales load.

Kauser Management’s Technical Chart Fund is a first-of-its-kind long/short asset allocation fund that bases all of its investment decisions on technical chart analysis. “There’s no fundamental analysis,” says Matthew Rich, the fund’s portfolio manager. Technical chart analysis, an investment style that has primarily been available to wealthy individuals able to invest in hedge funds, “is a strategic investment style that basically analyzes different chart patterns that stocks trade in based on price and particular volume trends,” Rich explains. After analyzing those “chart patterns that happened over the past 10 to 15 years, we try to accurately predict the future stock movement, based either on the upside or the downside.”

So unlike fundamental analysis, which is based on the financial position of a particular company, technical chart analysis assesses a security’s price trends over a period of time. Rich, who previously managed a hedge fund, says the fund’s primary objective, like other asset allocation funds, “is to protect clients’ assets in poor market conditions” by outperforming in down and sideways markets.

The Technical Fund, launched September 2, is a no-load fund with a 2% expense ratio. The fund has a $5,000 minimum investment, or a $1,000 minimum investment if used in retirement accounts. Charles Schwab and Wachovia are the two primary channels of distribution for the fund.

Plusses and Minuses

Unlike the asset allocation funds of yore that used just stocks, bonds, and maybe cash, the new breed of asset allocation funds are “responding to a more sophisticated market, more sophisticated financial advisors, and more sophisticated clients looking for strategies that are more similar to [those used by] institutional clients,” says Steve Gresham, chief sales and marketing officer for The Phoenix Companies. The “more advanced” versions of asset allocation funds, he says, now mix stocks and bonds with international stocks, high-yield bonds, and alternative investments that offer low correlations to traditional asset classes. “The beauty of asset allocation, at least in the modern history of the markets, has been [that it also serves as] a risk reduction strategy,” Gresham says.

The downside to these types of asset allocation funds, though, is that they tend to lag when the markets do well. “Since I’m always going to have some short positions in the [Technical Chart] fund, [which can be short up to 50%], if the market continues to go up at a rapid pace, I’ll probably underperform somewhat,” Rich says. Gresham concurs. “Asset allocation funds are spread across a number of different parts of the market, so in a roaring bull market, they’re going to lag unless they are allocated to the roaring stocks,” he says. “The downside for advisors using asset allocation funds is that in a rip-roaring bull market, certain clients will say I’m in something that’s too boring.”

A Mixed Performance Record

Chris Davis, a mutual fund analyst at Morningstar, says the majority of mutual funds that employ market neutral strategies “haven’t been particularly successful,” except for the Calamos Market Neutral Fund. The Calamos fund, which is now closed to new investors, gained 8% in 2001 and nearly 7% in 2002, Davis says. And over the past five years, it gained 10% annually, he says. “That’s pretty much what you’re promised with these kinds of funds–that you’re going to be making money in any kind of environment.” Davis issues this cautionary note to investors: “Any class of funds being launched en masse by all types of different fund companies is a reason to be skeptical.”

Given the equity market’s recent rally, you’d think that firms starting up an asset allocation fund now would be late to the game. But Rich believes “this is the beginning of the trend toward asset allocation funds.” Why? Because most mutual fund companies, he says, are starting to give their existing mutual funds the flexibility to short stocks. While Rich has seen signs of this already, he says, in some cases, it may not be such a good thing. “Some of the funds that are already out there that can short stocks are not very good investment choices for individuals because the people who are managing these funds have no experience in shorting stock,” he says. Most mutual fund managers have never worked in the hedge fund world, he says, where shorting stocks is common practice. Rich predicts the Technical Chart Fund will likely perform better than other funds that use shorting strategies because of his previous life as a hedge fund manager, and because the fund uses technical chart analysis. “Shorting stocks based on fundamental values rarely works,” he says. “You can’t short stocks based on fundamental analysis, because shorting stocks is basically a timing issue. Technical chart analysis helps you analyze money flow in and out of stocks and in and out of industries. That’s why we’re able to have success on the long and short side.”

Edwin Friderici, VP of marketing and product manager at Phoenix Investment Partners, agrees with Rich that asset allocation funds will remain in vogue because investors’ appetite for risk has shifted to more conservative funds. Friderici cites recent data compiled by the mutual fund research and consulting firm Strategic Insight, which found that year-to-date as of June 30, 29%, or $10.7 billion, of net new flows to domestic equity funds went to asset allocation funds, which includes the two Morningstar fund categories “conservative allocation” and “moderate allocation.” The conservative allocation strategy funds attracted $7.5 billion during this period, Friderici notes, while moderate allocation strategies attracted $3.2 billion. In June alone, $3.9 billion–or 21%–of net new flows to domestic equity funds went to moderate ($2.1 billion) and conservative ($1.8 billion) funds. Over the past three years, he says, “investors and advisors have become more concerned about risk.”

Only the Long-Term Need Apply

Unlike pension funds and endowments, retail investors usually chase hot stocks, and therefore “tend to be concentrated in a certain style or capitalization, so there’s a lack of diversification,” Friderici says. A recent Dalbar report found that the average total return of the average equity investor between 1984 and 2002 was a measly 2.57% compared to 12.22% for the Standard & Poor’s 500. So investors aren’t even beating inflation, Friderici notes.

When compared to other asset allocation funds, Friderici says, Phoenix’s new funds offer from 30% to 70% less risk than their peers. Because they invest in alternative financial products, he says, Phoenix’s funds “are giving retail investors the chance to invest like institutions.” Institutional investors have been successful over the years, he says, because “they have a process; they identify their goal based on their needs, and once they have that goal, they develop an investment policy statement. They also have a rigorous process whereby they select diversified managers for their portfolios, and then they have a system of monitoring and rebalancing as appropriate.”

The Phoenix funds are geared toward “long-term investors,” Friderici says, “so they’re perfect for IRAs or IRA rollovers.” The seven underlying strategies within each Partner Select Fund are managed by six of Phoenix’s independent investment managers. Phoenix owns 11 investment partners across the country, and “they all have different styles of managing, so you don’t get group-think here,” he says. “They’re not drinking from the same research pool, so it’s diversified managers with multiple styles.” And instead of monitoring and measuring 50 to 70 funds for their clients, he says, advisors can use one Phoenix fund and “focus their attention on the client.”

Washington Bureau Chief Melanie Waddell can be reached at [email protected]