Tactical Approach: Proactive Risk Management

We believe that long term investors generally benefit from being fully invested and this is why most of the FundX Upgrader Funds stay fully invested in all market conditions. But some investors prefer a strategy like our Tactical approach that proactively adjusts their portfolio’s risk based on current market conditions.

The Tactical strategy is used in two of the FundX Upgrader Funds: the FundX Tactical Upgrader Fund (TACTX) and the FundX Tactical Total Return Fund (TOTLX). The portfolios of these two funds are not always fully invested. Instead, these funds may hold considerable cash and use a variety of hedging techniques to help reduce volatility. The only difference between the strategy of the Tactical Upgrader Fund and the Tactical Total Return Fund is that TOTLX also uses fixed income.

The primary goal of the Tactical strategy is to smooth the ups and downs of stock market investing. We anticipate that in dampening volatility, the Tactical strategy may have less downside risk and at times, this may also mean less upside potential. The fund has the flexibility to potentially earn money regardless of stock market direction.

Why might an investor be interested in the Tactical approach?
Many investors believe that their only choice to manage risk in their portfolio is to hold fixed income. At a time when investors are concerned about rising interest rates and the prospects for fixed income, some may either over-allocate to stocks or find themselves stuck in cash. If they over-allocate to stocks, they increase the volatility of their portfolio and have a hard time staying the course when the market gets choppy or when they are faced with bad news. If they stay in cash, they may be unable to earn the return they need to meet their long-term investment objectives. Our Tactical strategy provides an alternative to fixed income, cash or the stock market exposure of fully invested equity funds.

What should I expect if I use TACTX in my portfolio?
We manage the portfolio to be much less volatile than a fully invested portfolio of stocks. Therefore, we don’t expect the portfolio to fully participate in sharp advances or declines.

Our goal is to participate more in the gains of the market than we do in the declines, to limit the volatility of returns, and to earn a positive return when the primary trend is sideways.

How does the FundX Tactical Upgrader Fund (TACTX) invest?
The foundation of the portfolio is a diversified selection of funds (mainly ETFs) that we identify as market leaders based on our performance-based rankings. Most of the funds we hold are broad based, but we may include limited exposure to sector funds, commodities funds, and other specialized funds.

We often hold cash, sell covered options to generate income that can also provide a modest cushion, and actively adjust stock market exposure by adding and removing hedges in response to changing market risk. All of this flexibility allows us to proactively manage the risk and reward potential of the fund and adjust to different market conditions.

Why is the fund’s performance so weak when measured since inception?
When we launched the fund in 2008, we used a very different strategy than we do now.  In 2008-2009, the fund was either fully invested or fully out of the market based on a weight-of-the-evidence timing model. The trouble with this model is that there is no way to manage risk when the model keeps the portfolio fully invested as ours did through 2008. We believe that the model we adopted had one of the best long-term records of any that we have seen. That said, 2008 proved that it was an insufficient tool to manage risk in all environments.

There are too many possible unforeseen variables, and the penalty for error is simply too severe when one’s portfolio is either fully invested in stocks or fully in cash.
In late 2009, we amended our strategy to accommodate a broad range of outcomes and make many more incremental adjustments as we navigate the market’s ebbs and flows. We now use options and have the flexibility to make incremental changes in terms of market exposure to allow for a variety of potential outcomes – with a goal of participating in the long-term gains from equity investments coupled with proactive risk management.

We continue to use a model to monitor market conditions to evaluate investor sentiment, valuations, monetary conditions and other variables that influence market risk. We use this model to adjust the range of exposure the fund may have at any given point, but there is always some hedging in place against unforeseen outcomes.

How have we done lately?
Since we adopted the current tactical strategy, the fund has performed in line with our expectations through volatile periods including the “flash crash”, sovereign debt fears, Japanese earthquake, and a series of steep corrections and significant stock market rallies. Past performance is not predictive of the future. The performance of TACTX since 2009, however, does reflect our goals as we manage the fund on a daily basis.

The chart below shows TACTX vs. the average of the 156 funds in the long/short equity fund category as reported by Morningstar from 12/31/2009 through 6/30/2011. Source: morningstar.com

Performance data quoted represents past performance; past performance does not guarantee future results.  The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.  Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month-end is available on the performance page. Performance data shown does not reflect the 2.00% redemption fee imposed on shares redeemed within 30 days. If it did, total returns would be reduced.

Each Morningstar category average represents a universe of funds with a similar investment objective. You cannot invest direct in an index.

• Small- and medium-capitalization companies tend to have limited liquidity and greater price volatility than large-capitalization companies.
• Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods.
• Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities.
• Non-Diversification Risk –The Underlying Funds may invest in a limited number of issuers and therefore may be considered non-diversified.
• Short Sales Risk –The Underlying Funds may engage in short sales, which could result in such a fund’s investment performance suffering if it is required to close out a short position earlier than it had intended.
• ETF Trading Risk – Because the funds invest in ETFs, they are subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of an ETF’s shares may trade at a discount to its net asset value (“NAV”), an active secondary trading market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact a Fund’s ability to sell its shares.

Diversification does not assure a profit or protect against a loss in a declining market.