PRTO's Approach to Navigating Market Volatility

**SPEAKER_1** (0:00)
Joining me now is Nicholas Lumpp, President, RCN Wealth Advisors. I'm so glad you are with us. We talked about some of the records we've seen here on Wall Street, such as the S&P Russell yesterday intraday, the down close did a record. But today, we went from green to red, and we'll see what the end of the day brings. What do you make of the volatility, but the fact that we are at or near highs at this moment?

**Nicholas Lumpp** (0:29)
Well, first, thank you for having me on. It's a pleasure to be here.
When we look at the markets over the last 10 years, there's been a shift in how money is managed and how money is being invested. What we're seeing is it's actually embedding certain, I'll say endogenous risks in the market that are almost exacerbating the volatility of things and working in both directions.
So probably the biggest culprit, we would say, is the ongoing shift from actively managed funds over to passive index funds. This is having two effects. First of all, it disproportionately benefits some of the largest components of the index. When you look at the S&P as an example right now, it's very technology heavy. These are great companies, but tech stocks tend to be more higher beta, higher volatility. So you're seeing bigger moves as the index leans a little bit more to a growth tilt to that. But as money is moving to these index funds, it's having an effect where it, as they kind of absorb more and more shares off the market, it reduces the supply. It's almost creating like a short squeeze effect. Then though, as money is shifted, you've seen the rise over the last few years, the rise in popularity of momentum driven strategies, the increased use of stock options, leveraged ETFs. Now, all of these, when you layer them on, is having an effect of kind of exacerbating the volatility. So we're kind of seeing where the market is, has pretty big runs to the upside, as these processes build almost like a snowball effect. But if that reverses to the downside, it kind of works both ways. So then we get these periods where we have some pretty severe, pretty sharp downturns as well from it. So it's more endogenous almost as kind of the way money is managed is shifting.

**SPEAKER_1** (2:16)
We did see, for example, I'm thinking about the triple Qs, for example, right? And it pulled in nearly $5 billion in a day on the 5th of August here. Investors were piling into big tech.
Actively managed funds obviously have someone at the helm. And that brings me to RCN, Pareto Strategic Allocation ETF, something you've launched here in the spring. It is the first foray for you and the company here in this realm.
Why now so investors can protect against what exactly?

**Nicholas Lumpp** (2:49)
Yeah. So again, as kind of these shifts are exacerbating the volatility in markets, it all comes down to how you approach managing risk, which is I would say different for everyone based in their portfolio. We believe that utilizing systematic trend following approaches is an ideal way to approach risk management in these markets. The reason being is that the more volatile an asset class is, the better it works to apply systematic trend following to it, where when these processes are building and you get really large uptrends, you want to try to jump on that and ride it as long as you can. Hopefully then exit as things turn and try to avoid as much of the downturn as you can. So as these processes are making the market more volatile, it seems to be working increasingly better from that perspective of utilizing a trend following approach.
So we launched the ETF PRTO back in the spring.
It is Morningstar were classified as a tactical allocation fund. I like to think of it more as a risk-managed growth fund. But what it is is we're applying systematic trend following to a core subset of asset classes with the primary focus of trying to reduce as much of that downside risk as we can, the left-tail risk of the return distribution to compound with a smoother path over time. And so again, we've been leaning more in this direction. We've been running these strategies directly in client accounts and SMAs for almost a decade now. But we're increasingly leaning in this direction as these dynamics are kind of making the markets more volatile.

**SPEAKER_1** (4:30)
So you explained what this tactical allocation actually does to design and reduce downside risk exposure. You're still maintaining the upside return potential. Where do you see the upside? Because you're looking at trends and making adjustments as such. That's what you told me. So that being said, as markets are changing, what upside return potential do you see?