ALTL: Innovative ETF, but style is prone to huge risk

By Rob Isbitts

Pacer Lunt Large Cap Alternator ETF (NYSEARCA:ALTL) is the type of ETF that could be a game-changer for investors. But it isn’t. That’s not really the fault of the algorithm used to drive this ETF’s decision-making, nor the manager that designed it. The issue here is in the reality that algorithmic-driven switching between two opposite strategies, what many refer to as “market-timing,” is very difficult to succeed with consistently. That’s because it assumes that investment markets will continue to reward what they have rewarded in the past.

In the modern investment era, and as an investment manager who has seen, tested, and even developed such strategies, I just don’t think these types of vehicles can generate future alpha. But they do always have great backward-looking track records, which prompts the firms to create an ETF, gather assets based on the successful back-test, then hope that past is prologue. This type of thinking is better for asset-gathering and marketing than it is for value-added investing. So, while ALTL might ultimately be one of the exceptions, my review of it does not convince me of that. I rate it a Sell. There’s just too much risk of a quirky market changing the rules on ALTL, while the game is in progress, so to speak. Past is usually not prologue in modern markets. Ask bond investors in 2022, when they realized that bonds can drop as fast and as much as stocks.

Strategy

ALTL is based on the Lunt Capital US Large Cap Equity Rotation Index. That index was created by Lunt Capital Advisors, an SEC-Registered Investment Advisor based in Salt Lake City, UT that specializes in tactical investment strategies. It alternates between two types of large capitalization strategies: low volatility and high beta. It uses an algorithmic process to switch between a 100-stock portfolio of one of those strategies to a 100-stock portfolio of the other.

ETF Grades

• Offense/Defense: Offense

• Segment: Broad Equity

• Sub-Segment: US Large Cap

Technical Ratings

• Short-Term (next 3 months): D

• Long-Term (next 12 months): D

Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor

For a detailed description of MII’s proprietary technical rating system, see disclosures at bottom of this report.

Holding Analysis

Most ETFs have fairly low turnover rates. That is not the case with ALTL. Its turnover rate averages a whopping 722% per year. Translated to traditional time metrics, that means it completely replaces its portfolio more than 7 times per year, approximately every 50 calendar days. Currently, it is invested in the 100-stock low-volatility portfolio. The next time it switches, that 100-stock basket will be sold off and replaced with a 100-stock high beta portfolio.

Strengths

As someone who has made a career out of allocating and rotating portfolios among ETFs, I am always looking for a strategy that can do some of the work for me. Any type of switching strategy that can exploit markets consistently, generating alpha in uptrends and preserving capital in downtrends, has to be given a look.

This strategy was exceptional shortly after ALTL debuted back in mid-2020. Just from November of that year until a few months later, it vaulted higher versus the S&P 500, as it was invested in the high beta portfolio, and that market segment was running hot. This was the period in which the market essentially decided the pandemic would disrupt the economy and corporate activity, but would not crush it for an extended period of time.

Weaknesses

Ah, but alas, this is a feature of many such rotation strategies. They can run hot and cold, and are susceptible to changes and evolution in what moves markets. In addition, “high beta” and “low volatility” as defined here may end up like growth and value stocks over time. That is, what defines and distinguishes them from one another may become very murky. Long-tenured investors will recall the days when growth was growth and value was value. Today, many stocks may be considered a blend of both. These types of market “factors” are gradually becoming more like labels, and less like disciplines. This potentially reduces the impact of factor investing, which ETF firms and financial advisors have put a lot of faith into for the past decade.

I tracked down the performance of the Lunt index that shows performance prior to the ETF’s debut. As noted earlier in this report, the back-test look beautiful. It usually does. But so far, there are a few events that have occurred that make me skeptical about whether this timing mechanism is one to be relied on, long term.

Opportunities

The main reason an investor could get excited about ALTL is if market conditions again become more friendly to this strategy. For that to happen, low-volatility stocks will need to do a better job of defending against market downturns than in the past.

Threats

I see a long list of threats to ALTL’s future ability to deliver. 2 pictures will help visualize this. Above, we see that this ETF tracked high beta stocks, represented here by another ETF, Invesco S&P 500 High Beta ETF (SPHB). But as you can also see, ALTL’s version of high beta has ultimately underperformed SPHB. That in itself is a source of lost alpha.

Another issue is one that I noticed just in looking at ALTL’s performance during the first 6 weeks of 2023. High-beta stocks have started the year very strongly. But ALTL is well below that, and the S&P 500. The reason: the switching system has had the ETF in the low-volatility portfolio all year. All it takes is one big “miss” on the timing of the rotation between the two strategies, and ALTL is in major catch-up mode.

Conclusions

ETF Quality Opinion

I continue to believe there are rotation strategies that can add value for investors. But outright timing/switching strategies, based on very strict rules that do not account for how markets operate today versus years ago, do not just get a free pass with me. ALTL is one of many examples of an ETF that will run hot and cold. And there are so many ways for investors to do that without merging two different disciplines into one timing strategy, as this fund does.

ETF Investment Opinion

I rate ALTL a Sell. I will continue to follow it, since as I noted above, this ETF is one that could represent a cog in a larger portfolio. But that will take more rational markets than we have today. And I’m not holding my breath.

Modern Income Investor’s proprietary technical rating system was created by the firm’s founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).