Q:  What is the history of the firm? A : We started forming the firm about a year and a half ago and held our business opening gala with over 250 industry executives at the NYSE on February 5, 2013. That’s when we officially opened for business. Dan Carlson, Larry Medin and I started the firm. I was working as an executive at Horizon Kinetics in New York. During my 12 years at the company, assets under management rose from $300 million to almost $40 billion in 2007. I worked in the private client group and I was a member of the investment committee and a big part of my job was building ETF, closed-end fund, and mutual fund portfolios to round out the allocations for our clients with investments in Horizon’s concentrated equity portfolios. Coincidently, Dan and Larry were executives at a 40 year old New York based RIA, Avatar Associates, that transformed itself to a successful ETF strategist. That firm began using ETFs in their portfolios in the mid-1990s and by 2011, when Dan and Larry left, had transformed its book to be over 90% ETFs from traditional stock and bond portfolios. Their efforts also included the trailblazing efforts of embracing ETFs into the 401(k) plan market. Meanwhile, at Horizon Kinetics, we became very aware that the ETFs were going to change the investment world. We needed to figure out how this change impacted our clients and, second, how we, as a firm, could benefit from such a dramatic change. I was tasked with that job. One of the ways we participated at Horizon was by being an early investor in the launch of a couple of ETF firms, one being Emerging Global Advisors. We also tried to buy an interest in an ETF strategies firm, which happened to be Avatar, which was how I came to know Dan and Larry. Ultimately Horizon Kinetics decided not to make the investment in Avatar due to some internal corporate issues. However, Dan, Larry and I stayed in touch. After Dan and Larry left Avatar, the three of us began thinking about how to build a business together. We looked at acquiring or combining a couple of different ETF companies or ETF strategists together; but, we found that those opportunities generally came with “strings attached,” which ultimately limited our ability to build the firm according to our vision. That’s when we decided to create Toroso. Toroso is a combination word -- the Spanish word for bull is “toro” and the Spanish word for bear is “oso.” Q:  What were you trying to do? A : The goal of Toroso is to create ETF-focused portfolios that do well in all economic environments. That is the foundational theory behind everything that we build. There are two overriding beliefs behind Toroso and how we build portfolios. First is that the ETF market is growing so rapidly that it constantly creates opportunities and pitfalls for investors that don’t look under the hood at what they actually own. A great example of that would be small caps. The Vanguard small cap ETF, which has recently seen explosive growth, is actually 66% invested in mid cap stocks, or stocks with a $2 billion market cap or greater. When we talk to advisors and point this fact out, many have no idea. So, we really pride ourselves on looking at the effects of the growth in the ETF industry and doing a thorough fundamental analysis of the index construction and valuation metrics of the securities packaged up as an ETF, thereby grabbing opportunities or avoiding traps that such a rapidly expanding marketplace creates for the uninformed. Second is that asset allocation has been done essentially the same way for the last 50 years – following the principals of Modern Portfolio Theory (MPT). We find that most investors have a pretty short investment time horizon, which we call a life-adjusted time horizon. So with most investment strategies built around MPT and the higher than expected correlations of such strategies, we believe our forward looking, economic regime based strategies will provide unique alternatives embraced by the investing public. Simply put, life-adjusted time horizons take into account the fact that most individuals have life events like births, deaths, marriages, divorces, college payments, career changes, illnesses, and inheritances. Some events are planned and others are not planned. The unpredictability of life coupled with the unpredictability of the economic regimes, causes us to reconsider the viability of the 30-year time horizon anticipated by MPT investing. To summarize, our goal is to build forward looking ETF-based portfolios that account for the four primary market cycles of prosperity, recession, inflation and deflation. We build these portfolios by taking advantage of opportunities and avoiding pitfalls created by the rapidly growing ETF marketplace. And, we do this with a different allocation approach to better reflect the life-adjusted time horizon of the typical investor. Q:  What were the problems with the other ETF strategy companies? A : The quick answer to this question is brand control. When you decide to merge two companies or buy a company, brand and culture are two of the most important ingredients to consider in determining the likelihood of success. Most of the firms we looked at either did not control their brand or their brand was not differentiated enough from others. We felt we needed a unique value proposition that we could control. Being 15th to market with a pure beta play was not going to insure success in our view. We had two core beliefs (see previous question) from which we wanted to build the firm. And, if the firm did not control the brand, or the market identity was too much aligned with MPT investing, we thought it would be better to build from scratch. Also, we felt a new culture was going to be required. More often than not, other firms were pretty set in their methods and beliefs, and we determined that we needed to set out with a fresh approach. We did not want to have to fight traditions to implement our beliefs. Again, starting from scratch seemed to be the right approach for us and our clients. Ultimately, it came down to creating Toroso so we could offer investor portfolios that are focused on economic regimes and have an asset allocation designed for their true life-adjusted time horizon. Q:  What core beliefs guide your investment philosophy in the mutual fund? A : Following through on the economic regime focus, we started the fund using Harry Browne’s permanent portfolio concept, an asset allocation model that divides the portfolio into four equal classes with contrasting qualities. Unlike traditional Modern Portfolio Theory investing, where assumptions need to be made on future returns and correlations between asset classes (some choose to even use return and correlation data on a backward looking basis), this approach is not dependent on market predictions or expectations. The theory starts with the idea that what really drives returns are the economic conditions of the marketplace; whether we’re in a bull or bear market, inflationary or deflationary environment. The theory proposes stability in the fund and regardless of the economic conditions so that the portfolio is not devastated because exposure to any asset class is limited. The portfolio begins with 25% of the money allocated towards a prosperous environment, which usually goes into equities, and then 25% in a fixed income portfolio designed to hold firm in a recessionary environment, which is really cash alternative. In the other half, 25% towards deflation beneficiaries, which would be securities like long-dated Treasuries or other tax-free bonds, and the final 25% towards inflation, using precious metals, commodities or resource companies – the securities that maintain purchasing power during inflation. Then, we periodically tactically rebalance the portfolio to reflect the allocations that will take advantage of the momentum of the market or protect against any identified negative trends. Q:  Can you expand and explain your investment process? A : So we start with the four asset classes – equities, bonds, cash and commodities. The next step is choosing the securities in each class. We have a rigorous securities selection methodology and we’ve developed proprietary software that helps us in selecting proper securities for each of the four buckets or economic conditions I talked about earlier. In the prosperity bucket we start with VTI (Vanguard Total Stock Market ETF) as the benchmark. We start there because the portfolio is built around the entire US stock market and stocks should rise during a prosperous economy. We set a goal of providing a better return than VTI, so step two is to look at the ETF landscape and the world of indexation and see where there are inefficiencies; see where there are macroeconomic trends being left out of ETF ownership or overused by ETFs. In either case, we can identify ETFs that will take advantage of the inefficiency. Each day we look at how much of our investable universe is owned by passive vehicles. Today you’ll find about 3.86% of every stock that is traded in the United States is owned by ETFs. This gives us a level to identify areas that are under-owned or over-owned. We generally avoid the over-owned securities because their fundamentals are generally off the path of the rest of the market. Additionally, we believe certain securities are getting allocations simply because they’re part of an index, and not because the business enterprise has value. Often we find that under-owned areas of the market provide opportunities; maybe there is an institutional desire to avoid a sector and thereby creating an ownership void waiting to be filled, or we find fundamentals do not accurately measure the true value. Once the selection process is done, we daily test our selected ETFs with our proprietary software. We make sure the fundamentals of our portfolio are stronger than the fundamentals of the Vanguard Total Market Index. Some of the key metrics we look at are price-to-earnings, price-to-book, and price-to -sales, as well as dividend yield, expense ratio, and net margins. Q:  Can you expand on your tactical allocation process? A : The tactical process looks at the volatility and price movement of each security to determine if there is a positive or negative momentum trend in that security. In an increasingly volatile environment the analysis time period on price movement of the security is shortened. Once a trend is established, a relative strength screen between the economic regimes with positive trends is performed, determining which regime to overweight. We run these momentum screens daily, but find that the frequency of rebalancing is moderated by the relative strength screen. Q:  How is the quantitative aspect and fundamental selection combined? A : I would rather characterize our approach as the blending of qualitative research with quantitative overrides. The quantitative work makes the fund tactical. Toroso’s qualitative research and fundamental ETF selection is the basis on which the fund is built. The tactical allocation among the 4 economic regimes is managed through the proprietary momentum models of Newfound Research LLC. Each one of the four regimes ranges between 12.5% and 62.5%, so that the fund will never be fully out of any market regime. Toroso Investments is in charge of the ETF selection within each of the 4 market regimes, and then Newfound’s relative momentum analysis is performed on each security Toroso selects. I guess this is part of the secret sauce that makes our strategy really special. One of the downfalls with some tactical strategies is that once the allocation is scaled, other firms that follow the strategy closely can “front run” the trading and negatively impact the performance of the fund. Not only do we feel our fundamental process can add value beyond the static tactical benchmark it also makes the strategy much more dynamic and less likely to be susceptible to front running. Q:  Can you give some examples to explain how tactical allocation process works under different economic conditions? A : The tactical process works the same no matter the economic condition. Because it is a momentum model it removes the guess work on which economic regime to over-weight. By following the momentum, the portfolio strives to be positioned to take advantage of the movements in the economy. Toroso’s qualitative work enhances the themes to over-weight from the momentum screens. The momentum screens focus only on price and volatility of the security being measured compared to historical price and volatility levels of that position. And then the relative momentum screens of the 4 regimes creates the over and under-weights. Another aspect of the momentum model is that it helps to provide a behavioral science element to the portfolio. In many respects, the economy is driven by the confidence people have in their economic future. We want to make sure we are not on the wrong side of their confidence. Newfound’s work helps to keep our portfolio in sync. Q:  In the ETF product world there are always new products entering in the market offering new ways to get exposure. Which are some of the noteworthy products? A : This is a part of the business that has us very excited. We work with some of the most innovative and creative ETFs and we know more will be coming. Some of the new themes will give us some very interesting methods to build alpha in our portfolios. For example, we have found about ten ETFs that fit in this spot, we call them characteristic based indexes, so instead of focusing on market cap or geography or subsector, they focus on an active characteristic of businesses. Here are a couple of examples: PowerShare Buyback Achievers ETF (PKW) – this is an index of companies that are buying back shares; Guggenheim Insider Sentiment ETF (NFO), the index where insiders are engaged in heavy buying of the shares; and finally the Guggenheim Spin-Off ETF (CSD), which is a spin-off index, a characteristic that many hedge funds seek. Here are a couple of brand new ones: Forensic Accounting ETF (FLAG) does a forensic accounting of the S&P 500 and weights the companies based on their accounting quality score as opposed to their market cap; AlphaClone Alternative Alpha ETF (ALFA) which looks at the research of hedge funds and clones their ideas and Global X Guru Index ETF (GURU) that invests in the best ideas from some of the most successful hedge funds. There is another ETF from Market Vectors (MOAT) which focuses in on companies that have long product life cycles and high barriers to entry, and then there is the latest one from Power Shares (NYCC), which focuses only on the companies that have been listed publicly for at least 100 years which brings in a business characteristic that their product has staying power. This is a new universe of ETFs that I believe is going to be the bridge between active and passive. It’s also a universe that we focus on a lot. We currently own two of those in our portfolio. The ETF fundamentals are the quantitative check for us, but those ETFs mentioned above are definitely ones that we seek out, characteristic based ETFs rather than market cap that are equal weighted. We are looking for specific characteristics that enhance returns for various economic environments. Q:  Could you shed some light on your research team and what your research process is? A : Toroso has a unique consulting arrangement where we work with other advisors and ETF strategists to help them fundamentally optimize their portfolios. Our partners meet advisors that are building portfolios using ETFs or mutual funds and offer an independent review from Toroso. We review about ten portfolios a week from other advisers and we give them our ideas. But they give us ideas as well. We believe the give and take of ideas is the best research tool available. Through this approach we get a first-hand, unvarnished look at an ETF. Then we can reach out to the ETF manufacturer to confirm how the ETF works, and then draw our own conclusions. This puts us in control of finding ETFs that meet our needs and allows us to be efficient with our time. Often through this process, we find anomalies. This is what triggers a very deep dive into the construction of the index or the scenario in the economy where that particular area could do well. So I would consider us as a research group specializing in ETF construction and focused on business characteristics, business scenarios. And we get to test our ideas and theories on the advisors whose portfolios we review. The group is led by David Dziekanski and me. David joined about six weeks ago. He was a portfolio strategist at Ladenburg Thalmann and helped bring their ETF and mutual fund portfolios from $75 million to about $2 billion. Q:  What is your view on risks, what risks do you look at and how do you manage them? A : For us, risk is defined as the loss of permanent capital. Our community of investment professionals likes to define risk as volatility. That’s a decent measure if you’re in that world of owning stocks for the next 30 years because it tells you how to put everything together. Our concern is losing real principal for our clients so the purpose of our strategy is to maintain principal in five-year business cycles or five-year rolling returns. So to us risk is losing money in those five-year cycles. On top of that, we don’t believe risk is just about losing money because the stock market went down. We believe it’s also losing purchasing power or being negatively affected by deflation, inflation, not participating in an upward market or being overly participatory in a down market. That’s why we designed the portfolio around economic regimes and controlling the risks brought to us by the economy. So I believe strongly that we have created a multi asset class portfolio, utilizing cost-effective, transparent, tax effective ETFs; that are designed to deal with four different kinds of risk and participate in the market at a meaningful level.