Mr. Mahn: Certainly. Hennion & Walsh is a full-service investments firm headquartered in Parsippany, N.J. Bill Walsh and Rich Hennion started the firm in 1990 with the goal of being an advocate for the individual investor. The firm's heritage rests in fixed income securities, notably municipal bonds. However, the firm has broadened its product and service offerings in recent years to provide both income and growth solutions to the individual investor following our core principles. We operate out of three distinct companies, one is Hennion & Walsh Incorporated, which is a full-service broker dealer catering to the individual investor, and has slightly over 15,000 clients and approximately 2 billion in client assets.
We also have Hennion & Walsh Asset Management Company, which provides personalized portfolio management solutions to high-net-worth individual investors as well as small to mid-size 401(k) plans. Through the asset management company, we launched three open-ended mutual funds in June 2007 - the SmartGrowth¨ Mutual Funds, for which I am fortunate to be the portfolio manager. We also currently have nine different unit investment trusts (UITs) that we market under the SmartTrust¨ brand. Finally, the third company is Hennion & Walsh Wealth Advisors, which helps to provide individual investors with insurance solutions and estate-planning assistance.
What I'd like to focus today mostly on is the evolving story of our SmartGrowth¨ Mutual Funds, as they represent an investment solution that we put together for individual investors looking for a professionally managed, diversified growth opportunity. The SmartGrowth¨ Mutual Funds are an investment strategy that utilizes exchange-traded Funds (ETFs) and exchange-traded notes (ETNs) in an asset allocation framework to provide investors with opportunities for risk-adjusted return based upon their own appetite or tolerance for risk.
We have a conservative fund, we have a moderate fund, and we have a growth fund. Three ticker symbols are LPCAX, LPMAX and LPGAX, respectively. Within those strategies are different combinations of ETFs and ETNs that are arranged to provide for optimal growth while staying within a certain band of risk that we measure by standard deviation. We at Hennion & Walsh Asset Management do not pick the ETFs or ETNs for the portfolios but rather track the ETFs and ETNs that are in the associated Lipper Optimal Indices. You see, the SmartGrowth¨ Mutual Funds are essentially index-tracking funds in that they attempt to track the Lipper Optimal Indices. Lipper, a Thomson Reuters company, is one of the most recognized mutual fund and ETF research companies in the world. And we have an exclusive arrangement with Lipper such that no other company in North America can launch a mutual fund off of the Lipper Optimal Indexes other than Hennion & Walsh Asset Management. The Indices, and by default the funds that track them, rebalance or rather reposition themselves each calendar quarter. The quarterly repositioning is one of the main premises behind the indices, as the Lipper methodology contends that a portfolio designed for diversified growth should be repositioned at least four times a year. Following this quarterly rebalancing mandate, the Lipper Optimal Indices use the last six months' worth of historical returns, the last six months' worth of correlations and the last six months' worth of standard deviation data to build a portfolio that they think will be optimal for the next three-month period for each associated range of risk. The best way to look at this strategy, I believe, is to think of it as a three-month portfolio that is consistently rebuilt four times a year.
With respect to portfolio composition, Lipper uses a very interesting approach to selecting the ETFs or ETNs collectively known as exchange-traded products (ETPs) for the portfolio each quarter. They start by looking at ETPs that meet certain initial screening criteria, such as those ETPs that have been trading in the U.S. marketplace for at least six months. They then look for those ETPs that have a good amount of liquidity, which we are defining right now as having 1.5 million traded each day based upon an average of the three-month and six-month trailing volume averages. They also take into consideration those ETPs that have a high correlation to their underlying benchmark/index. In so doing, they are basically trying to find the true passive vehicles as opposed to any actively managed ETFs, or those that do not track their underlying benchmark/index closely. Finally, if Lipper comes across multiple ETFs or ETNs for the same asset class or sector in the portfolio creation process, they will look to select the one with the lowest relative expense ratio after all other factors are considered.
After the initial screening process has been completed, the field of ETPs, which amounts to roughly 721 total ETPs right now, according to the Investment Company Institute, is narrowed down to approximately 250 to 260 ETPs. Lipper then runs a statistical routine called "factor analysis," which in layman's terms attempts to identify the smallest number of ETPs that explain the day-to-day behavior of the larger pool of remaining ETPs. In turn, this narrows down the pool of ETPs to somewhere between 50 and 60 ETPs. Finally, following a modern portfolio theory (MPT) approach, Lipper runs a mean variance optimization (MVO) routine to arrive at three different distinct target risk-oriented portfolios - actually five since they have five Optimal Indices to stay within a certain band of risk that they believe will help to provide for optimal return potential over the next three-month period. I think 2008 was an excellent test case for how well this particular methodology can hold up - and did hold up - in an extremely volatile market environment.
As we all likely know by now, 2008 was the second worst annual performance in the history of U.S. stock market. However, it didn't end there as the first quarter of 2009 represented the worst quarterly performance in U.S. stock market history. Despite these extremely volatile markets, for the calendar year of 2008, our conservative fund (LPCAX) lost approximately 7.7%; our moderate fund (LPMAX) lost approximately 8.8%, and the most aggressive fund in our SmartGrowth¨ family of funds, the growth fund (LPGAX), lost approximately 18.3%. To put this in perspective, the S&P 500, which is widely considered as a barometer of the U.S. stock market, lost about 37% in 2008. While we are never proud of losing money, I believe that an extreme test like the one that we were presented with in 2008 shows just how well the methodology can hold up when downside volatility is at its fiercest.
However, I believe the main reason we are able to provide the level of downside protection that we were able to achieve in 2008 is not just due to the methodology but also based on the evolution of the ETP marketplace itself. Now we have ETPs that allow an investor to go long or short a given asset class or sector on a leveraged or unleveraged basis. Through ETPs, we now also have the ability to access different commodity markets and different foreign currency markets. We have the ability to access the fixed income markets both on a taxable and tax-free basis through ETPs. Finally, we now have the ability to look overseas into developed markets and emerging markets, and go further to look at different sectors within those international markets through different ETPs. What an evolution. Consider that back in 1995, there were only two ETFs even in existence, and now there are over 721 that allow investors to access virtually any asset class or sector within the market that they want to on a transparent, tax-efficient and relatively low-cost basis.
The question then becomes, for individual and professional advisers, how best to assemble the various ETPs to meet each of their client objectives. In this regard, I encourage each of these advisers or individual investors to consider the SmartGrowth¨ Mutual Funds, which could provide them with a packaged product to access the different ETFs and ETNs available in the U.S. markets that meet the Lipper criteria within a portfolio that strives to stay within their own selected band of risk tolerance.
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