 Fund
Minimums, Hold Times & Fees
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Fund Classes: Clones w/ Fee Structure Differences
It's typical for mutual fund companies to create clones
of their funds that differ only in the fees charged. For
example, FELIX, FELCX, FELAX, FELTX, and FELBX, are all
clones of FSELX, Fidelity Select Electronics. The assets
of each are held and managed in common; just the fee
structures
 and
trade hold rules vary to better suit retail, advisor,
custodial and institutional markets.
Minimum Account Balance
Some companies, such as BlackRock, offer fund classes
requiring minimum purchases as high as $1Million, or
fund classes with fees on a sliding scale of the amount
invested.
Hold Time & Early Trade Fee
If we have this information, you can see it in
the Find-A-Fund popup and in the fund name when you put
the mouse pointer over a ticker symbol. Strategies with
fund hold times should use the
Trade
Automatic setting to abide by these limitations.
Funds with 30-day hold periods, such as Fidelity Sector
funds are no problem. Funds with holding periods beyond 60 days start to become problematic in a changing market
and should be avoided if possible.
Online brokers always provide hold time and early trade
fee information. Verify
that your funds reflect it properly.
Read more
HERE.
Brokerage Trading Fees (Commission)
1st Rule:
Commission-free trades for lame funds are never a good
deal. 2nd
Rule: $50 trading fees at a brokerage for
prominent mutual funds is excessive. Consider an account
at the mutual fund company.
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Fund
Availability? It Depends.
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Fund Classes: Clones for Retail,
Advisors, Custodians, and Institutions.
It's typical for mutual fund companies to create clones
of their funds that differ only in the fees charged.
While the assets
of each are held and managed in common; the fee
structures and
trade hold rules vary to better suit the retail, advisor,
custodial, and institutional markets.
Each fund
company has its own class codes, and each has its own
set of hold time and early trading fees associated with
each fund class. Whether you select a Strategy of funds
built by someone else or you select funds for
your own Strategy,
you must determine that each fund is actually available to
you based on the class of customer you
are. A name search
on Yahoo Finance can help identify fund clones.
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How to Determine Availability
Advisors and institutional investors are
professionals who already know which funds are
available to them.
Employer sponsored 401k, 403b,
and 457b, or like retirement plans, are managed by a plan
custodian, usually a financial services company, which
provides the employees with a fixed list typically
having 10
to 30 funds from which they may choose to invest their
retirement savings under the plan. Only from this fixed
list of funds can one build a corresponding Strategy to
manage the retirement savings. See examples
HERE.
If you
manage your own IRA or taxable account you
are classified as a retail investor. Generally (as
with Fidelity) within a retail investment account you are
allowed to purchase only the retail class funds.
However, at some brokerages, such as E*Trade, a retail
investor can mistakenly purchase advisor class funds,
although their
special trading rules and fees are always posted so they
can be easily found.
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The Bottom Line
Ideal fund terms include no initial sales
charge, no deferred sales charge, no minimum hold
period, and no early trading fee. Funds with these terms
exist, but generally impose a 90-day freeze on further
trading if you buy and sell them in less than 30 days
twice in a 90-day period. This isn't a problem for
month-end trading Strategies. Likewise, funds with 30-day hold periods and early trading fees are also not a
problem for month-end trading Strategies. Funds with
front or back end sales charges must always be avoided!
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The
Prudent Investor
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Background
The
Prudent Man Rule stems from the 1830 court decision
of Harvard College v. Amory instructing trustees to
"observe how men of prudence, discretion and
intelligence manage their own affairs, not in regard to
speculation, but in regard to the permanent disposition
of their funds, considering the probable income, as well
as the probable safety of the capital to be invested."
This is the basis of the 1994
Uniform
Prudent Investor Act. While the Act states
"prudent investing
ordinarily requires diversification," it
further states that
"there is no automatic rule for identifying how
much diversification is enough" as it
depends on the circumstances of wealth, age, taxes and
risk tolerance. Let's call it the
Diversification Uncertainty Rule.
Diversification Types: Horizontal, Vertical,
Serial
Armed with the wisdom
of the
Diversification Uncertainty Rule;
let's consider how the different types of
diversification can help an "ordinary investor" with
"ordinary circumstances," starting with type
definitions.
• Horizontal Diversification
is like a sector fund that invests in multiple companies
in a single market.
• Vertical Diversification
is like a balanced fund that invests in multiple markets
and/or asset classes.
• Serial Diversification
is like serial monogamy and is what SectorSurfer
Strategies do by sequentially owning the one, and only
one, best stock/fund of the Strategy's
companies, sectors, or asset classes.
Asset Class Fund Strategies
These Strategies, like most 401k Strategies, are
inherently well diversified and thus are sufficiently
prudent.
 Sector Rotation Strategies
Sector funds are diversified against pops and drops of
individual stocks and apply serial diversification to
reduce sector risk. These are also prudent.
Stocks & Commodities Strategies +
Post-Surfing Diversification
Individual stocks and commodities have daily volatility
risk as much as 3.5
times higher than the S&P500
and can suffer significant one day drops. A prudent
investor risks no more than 20% of his assets in any one
stock or commodity. Five Strategies produce useful
Post-Surfing Diversification.
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Stocks
vs. Sectors & Asset Classes
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Rotation
vs. Fitting
Rotation implies
something will be back time and time again, whereas
fitting implies it has more sporadic properties that
just
happen to meet the current need. SectorSurfer's
algorithm is agnostic as to which of these is really the
case and simply strives to select the one best
trending stock/fund of the Strategy. The question for
investors is: "Does
a superior past performance imply a superior future
performance?" The answer lies in whether
the performance was based on a rotational sequence or a
fitted sequence.
 • Sector Rotation occurs as the
economy cycles from boom to bust and back to boom again,
favoring different market sectors during different phases
of the cycle. These market sectors will still exist
decades from now regardless of the fortune or demise of
individual companies. The vast majority of investment
capital never sits on the sidelines in cash, but rather
continually sloshes from one favored sector to the next.
• Asset Class Rotation
is another dimensional slicing of the markets, typically
dividing its universe into large cap stocks, small cap
stocks, foreign stocks, bonds, and treasuries. Likewise,
asset classes will always exist regardless of the
fortune or demise of individual companies, each rotating
in and out of favor throughout the economic cycle.
•
Individual Stocks are constituent components of
sectors and asset classes, and thus inherently have a
rotation component to their performance. However, the
most successful growth companies typically have just one
historical period when they truly were
rising stars, doubling in value many times over a period
of years. Eventually market
saturation limits growth and they become a stodgy large
cap stock, or lose their way and fizzle.
Expecting a dozen
past rising stars to be future rising stars truly is
gold fever talking.
• Freshly Fit for Duty? Strategies built
from equities that primarily performed well in the past
because of sector or asset class rotation are inherently
fit for future duty. However, if rising star performance
is sought, the Strategy must be composed of stocks that
are current rising star candidates, not those that were
shining brightly
15 years ago. We recommend that you periodically
(annually) refresh the candidate list.
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ETF
Tax Surprise
ETFs Issuing Schedule K-1
While
taxes for most ETFs and ETNs are reported on Form 1099,
some commodity and currency ETFs are structured as limited partnerships and
thus issue Schedule K-1 to its investors to specify their
individual share of profits and losses. Currently they
include:
AGQ, ALT, BNO, BOIL, CANE, CMD, CORN, CPER, CRUD,
DBA, DBB, DBC, DBE, DBO, DBP, DBS, DBV, DGL, DNO, EUO,
FOL, FSA, FSE, FSG, FSU, GCC, GLL, GSG, KOLD, NAGS, SCO,
SOYB, SVXY, UCD, UCO, UDN, UGA, UGL, UHN, ULE, UNG, UNL,
USCI, USL, USO, UUP, UVXY, VIXM, VIXY, WEAT, YCL, YCS,
ZSL
Schedule K-1 Consequences
The
most obvious consequences for receiving Schedule K-1 is
that (a) it complicates your personal tax return, and
(b) that Schedule K-1 tends to be one of the last
documents provided to taxpayers, which may potentially
delay your tax
filing.
However, a more significant and
potentially disagreeable tax situation can occur when an
ETF is purchased near the end of one year and then sold
in the next year. If the limited partnership does well
in the year you purchased shares, it is possible that
significant taxes could be payable even though you have
not yet received any real financial benefits from
returns. In fact the published share price for what you
hold could even have gone down, but still the taxes will
be due and payable because there had been a recognized
profit or capital gain by the limited partnership
earlier in the same year.
The good news is that
when you later sell the ETF (or ETN) your taxes will be
adjusted by the formulas to compensate for what you had
previously paid in tax such that the net taxes over the
periods are adjusted to reflect the actual end-to-end
returns received.
Helpful Reference Articles
• What to Know About ETFs and Taxes -
Charles Schwab
• Beware The Tax Traps Of Commodity ETFs
- Daily Markets
• ETF Tax Tutorial: Complete List Of ETFs That
Issue K-1s - Seeking
Alpha
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Foreign
Stocks
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 Identifying
Foreign Stock Strategies
Our TopDog Strategies
page contains tabs for Strategies utilizing stocks
from Canada, Australia, England, and Germany, that trade
on the TSX,
ASX,
FTSE,
and DAX
exchanges respectively. The ticker symbols for the
stocks traded on these foreign stock exchanges end in
.T,
.A,
.L,
and .D
respectively for clear identification.
In the
upper-left portion of the Strategy chart shown on the
right, in addition to the
.T suffix on each ticker symbol,
the top bar contains a flag of the respective country
and a note indicating that you must have access to
trading stocks on a particular foreign stock exchange in
order to make practical use of the Strategy.
Some TopDog Strategies were designed for use by our
customers in foreign countries and thus require the
trading of stocks on the corresponding stock
exchanges in those countries. While some foreign stocks
are available in the U.S. as an
ADR (American Deposit Receipt), they are generally
thinly traded and often track their foreign counterparts
with poor granularity, and thus are not recommended
for use in U.S. SectorSurfer Strategies. Only very few
brokerages in the U.S., such as Interactive Brokers,
provides direct access to foreign stock exchanges.
Foreign Stocks Available in SectorSurfer
Foreign stocks are currently limited to the stocks of
the following indexes: TSX-60, ASX-100, FTSE-100 and the
DAX-30. A specific listing of stocks can be found on the TopDog Strategies
page under the particular tab for the corresponding
stock index.
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Inverse
/ Shorted
Funds
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Short Selling Background
When a stock or a fund is "sold short," it means that
you have sold something you don't have in your portfolio
in order to bet against it — generally because you
believe it is overpriced and will likely decline.
For example, if you think the company SickCo will go out of business, you may want to bet against
its stock by selling it short. Normally this means that
the brokerage would "borrow" shares of SickCo from
someone else's portfolio and leave them an IOU then sell
those shares for you. Later you would buy them
back at (hopefully) a cheaper price to book a net
profit, and then restore the shares back to the other
portfolio.
In order to prevent more shares being
sold than actually exist in the market, the brokerage is
required to limit short sales to the number of shares
their clients actually own. This rule is called the
naked short selling
rule.
Inverse and Short ETFs
To
make the process of short selling simple for an index or
basket of stocks, the financial industry has created
mutual funds and ETFs that are inherently "short" and
have the inverse
performance of their "long" brothers.
For example, if you buy the ETF called SH (ProShares
Short S&P 500), it will perform exactly the opposite of
the S&P 500 index. The ETF called PSQ (ProShares Short
QQQ) will perform exactly the opposite of the NASDAQ
index.
In IRA, 401K, or other retirement
accounts, you cannot directly short stocks and ETFs, but
you can purchase ETFs that are inherently shorted. Since
SectorSurfer normally protects a Strategy in
down-markets with StormGuard by going to $CASH, if you
wish to use inverse/short funds during down-markets, you
must enable them by adding
"/i" to the end of the Strategy
name as a signal to the algorithm to enable inverse
funds and disable StormGuard.
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Ultra
/ Leveraged
Funds
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Background
Leverage is used to buy more than $X worth of
investments with only $X of cash by taking out a loan to
pay for the excess amount purchased. For example, in a
typical home purchase, you might be required to put down
20% of the home value and then take a mortgage loan for
the remaining 80%. This would be 5:1 leverage since you
only have 20% skin in the game. In the stock market it
is called a margin loan. Margin is defined as the
portion that you actually own. For example, if you put
down $100K for $150K worth of stocks, you used 50%
leverage on your money and your margin (what you own) is
66.67% of the total.
Leverage Also Multiplies Risk
Leverage can be dangerous - witness MF Global, Lehman
Brothers and Washington Mutual. These banks/brokerages
were allowed to use over 30:1 leverage on various bonds
and mortgage-backed investments, which means they only
had 3% skin in the game. A drop of more than 3% in the
value would mean that their entire equity had been lost
and they had gone bust. Guess what happened? This is
also the reason why so many people who were allowed to
put down very little on their home purchases are now
under water and owe more than the home is currently
worth.
While you can’t directly apply leverage
to stocks or funds in a retirement account, you can own
inherently leveraged ETFs and mutual funds in a
retirement account. It is because inherently leveraged
funds actively adjust the margin back to a safe level
daily that you can never go bust.
When you make
use of 2x leveraged funds the daily volatility will be
magnified 2x and produce a much bumpier ride. However,
your long-term returns will be double ... hopefully to
your benefit.
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