Chuck Jaffe: Trendy new fund is ‘Stupid Investment of the Week=?UTF-8?B?4oCZ?=

By Chuck Jaffe, MarketWatch

BOSTON (MarketWatch) — The investment world is filled with good
ideas that, when turned into a mutual fund, deliver bad performance.

For proof, look to RBS US Large-Cap Trendpilot
 , an exchange-traded note that began trading early in
December and, fresh out of the box, is the Stupid Investment of the

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Stupid Investment of the Week highlights the flawed thinking and
worrisome characteristics that make a security less than ideal for the
average investor, and is written in the hope that showcasing trouble
in one case will make it easier for consumers to avoid trouble
elsewhere. While obviously not a purchase recommendation, this column
is not intended to be an automatic sell signal.

The RBS Trendpilot situation is an interesting one because, on the
surface, the investment looks like a good way for individual investors
to follow a strategy that they might believe is fundamentally sound,
but difficult to implement on their own.


Paying A Service Fee


Simply put, Trendpilot
 invests in the stock market when
the Standard & Poor's 500 Total Return Index (measuring the S&P
500-stock index's
 actual return plus dividends) is above its 200-day
moving average, and it invests in cash — trying to get the return of
the 3-month Treasury bill — when its S&P 500 benchmark is trading
below the 200-day moving average.

The idea behind Trendpilot is simple: The trend is your friend. Invest
when it's going good and sit on the sidelines when it isn't.

It's so simple, in fact, you could do it yourself — and a whole
lot better. But for many investors, their reason to hire a money
manager would be for the personal discipline it takes to live with the
strategy; the fact that most investors would not have that wherewithal
actually also shows some of what's wrong with Trendpilot.

To see how that's possible, let's dig a little deeper.

First, exchange-traded notes (ETNs) are similar but different than the
standard exchange-traded fund, or ETF. Both types of securities track
an index, trade like a stock and are liquid, but ETFs are structured
so that the investor owns the underlying basket of securities. If the
ETF were to go bust, the shareholder usually would get cash for the
market value of the securities. (If an investor has a huge chunk of
the fund — say 50,000 shares — they might be allowed to take their
payout in stock.)

ETNs, by comparison, are debt instruments issued by big banks, Royal
Bank of Scotland in the case of RBS Trendpilot. As a debt instrument,
the ETN doesn't actually own anything; instead, it is making a
promise to track an index and pay out the way an investment in the
index would. If an ETN fails, an investor will not get the investment
back. The average investor probably should think of an ETF like buying
a stock, with the ETN like buying a bond.

The difference is important because an investor who wants to replicate
the Trendpilot strategy would not have a hard time doing it by making
the actual investments. They could use a Standard & Poor's 500 ETF
when they want to be in the markets, and Treasury bills or
money-market accounts when they want to be out.

At the very least, they would save money. Trendpilot charges 1% in
management fees when it is "invested" in the market, and a 0.5%
fee when it's in cash. An investor could make the same investments
for about one-tenth the cost, although they would have to pay
transaction costs for the trades they make.


Behind The Curve


Further, Trendpilot waits five days to confirm the buy or sell signal.
The market has to be above its average for five days before Trendpilot
turns positive, and below it for five days before "going to cash."
Money managers who use moving averages typically act when the line is
crossed; in fact, a do-it-yourself investor could use most financial
Web sites to track the moving average and send them alerts when a
trade should be triggered.

"If it really is trying to follow the trend, then it should move
when the trend changes," said Tom Lydon, editor of the ETF Trends
newsletter. "Give the trend a five-day cushion, the way this fund
does, and you will leave some money on the table on both ends, when
you are buying and selling."

Some people might be willing to pay that price, just for the ease of
having someone else make the trades, but there's a reasonable
question of whether Trendpilot can deliver on its promise.

While RBS is showing back-tested results for the index — which was
created only in mid-November — those numbers may have been helped
along by times that happen to make this strategy look good. In fact,
the back-tested results undoubtedly were boosted by the fact that over
the last half-decade, a flat market was followed by a huge downturn,
and then a rebound; plug in different results — and all we know
about future returns is that they will not exactly mimic the past —
and the back-tested "success" quickly turns to mud.

Moving-average strategies work best when the market has long,
substantial trends, either up or down; when the market has no real
trend, they tend to get whipsawed. That's why average investors have
trouble following them, because in a direction-less market they are
doing a lot of trading — potentially losing money in both directions
— hoping for something to materialize.

In the end, Trendpilot isn't likely to hurt investors — it's
built to reduce risk and it's not going to send anyone to the poor
house — but it's probably not going to deliver the kind of returns
they expect from the strategy either.

"I prefer strategies that work fairly well through most kinds of
market environments," said Mark Salzinger, editor of The
Investor's ETF Report, "so that investors can hold on to what they
have and not sell near bottoms or buy near tops."

Chuck Jaffe is a senior MarketWatch columnist. His work appears in
many U.S. newspapers.

Source: Marketwatch.Com