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First Trust Advisors has partnered with Baltimore-based equity investment manager EquityCompass to launch the EquityCompass Risk Manager ETF (NYSE: ERM) and the EquityCompass Tactical Risk Manager ETF (NYSE: TERM), two actively managed funds seeking capital appreciation by primarily reducing volatility and avoiding large, prolonged market losses.
Both ETFs invest primarily in US equity securities but may switch a portion or the entirety of their holdings to cash, cash equivalents or short-term fixed income instruments if the portfolio managers believe the outlook for the US equity market is unfavourable. TERM goes a step further and is permitted to invest a significant portion of fund assets in securities designed to provide short exposure to broad US market indices.
Each ETF has a total expense ratio of 0.65%.
EquityCompass’ investment strategy is underpinned by the belief that avoiding the market’s worst down days is meaningfully more beneficial than the penalty that comes from missing the best up days as severe losses reduce future earnings power due to a smaller capital base – the gains required to fully recover from a loss need to be greater than the original loss. For example, a 20% loss requires a 25% gain for a full recovery, and a 10% loss requires an 11.1% gain to recover. Outsized losses can add years to the time it takes to recover capital.
“Following two devastating bear markets in the last 17 years, investors, especially those nearing or in retirement, recognize the vulnerability of equity markets and are seeking risk management solutions,” said Richard Cripps, chief investment officer at EquityCompass. “EquityCompass has been successfully utilizing active risk management in our portfolios since 2009. We are excited to collaborate with First Trust to offer investors a convenient and efficient method for incorporating this strategy into their portfolios.”
Ryan Issakainen, senior vice president, ETF strategist at First Trust, added: “We believe these ETFs will be useful tools for investment advisors seeking to manage risk in their clients’ portfolios, while maintaining exposure to US equities. As sub-advisor, EquityCompass brings a unique approach to risk-management, supported by years of rigorous empirical research.”
The funds are currently well diversified with 150 holdings each and a top constituent weight of just 0.75%. (Data as of 18 April 2017)