Strategy Hall Of Fame

Fund Minimums, Hold Times & Fees

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.

Fund Availability?  It Depends.

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.

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.

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!

The Prudent Investor

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.

Stocks vs. Sectors & Asset Classes

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.

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

Foreign Stocks

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.

Inverse / Shorted Funds

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.

Ultra / Leveraged Funds

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.