By Kenneth Rapoza  
Of DOW JONES NEWSWIRES  
14 November 2008 
8:00 PM GMT 
Dow Jones News Service  
English (c) 2008 Dow Jones & Company, Inc.  

SAO PAULO (Dow Jones)--A U.S. recession isn't pretty for most companies, but portfolio managers at Hennion & Walsh Asset Management are betting on a universe of roughly 240 exchange traded funds to beat the worst bear market since the Great Depression. 

The strategy seems to be working. Although Hennion & Walsh's three new mutual funds are losing money, they're losing much less than investors tied to the Standard & Poor's 500 Index by a country mile. 

Hennion & Walsh, a Parsippany, N.J.-based firm with around $170 million under management, created three target-risk mutual funds known as the SmartGrowth funds in 2006 together with Lipper Inc., a mutual fund industry ranking and analytical company. 

Lipper was hired to develop three proprietary indexes as a benchmark for Hennion's asset-allocation services. The deal with Lipper gave them exclusive rights to the indexes. Lipper tested a slew of world indexes as far back as 2000 and this time included ETFs in the mix to come up with the new SmartGrowth indexes. 

ETFs are like mutual funds, only they are actively traded like stocks instead of once daily like mutual funds. 

The SmartGrowth funds that track those indexes are the SmartGrowth Lipper Optimal Conservative Index Fund (LPCAX), the SmartGrowth Lipper Optimal Moderate Index Fund (LPMAX) and its more aggressive sibling, the SmartGrowth Lipper Optimal Growth Index Fund (LPGAX). 

Just before a long selloff in U.S. and global stocks began around July, all three funds outperformed their peers in their Lipper classifications. Each fund was up by as much as 7.4% to as little as 5.5%, compared to S&P 500 returns of negative 13.12% over the same period. 

But, as every investor knows, past performance doesn't guarantee future results. 

Nevertheless, the conservative fund was down 6% to a net asset value of just $9.68 per share, as of the close on Nov. 13. It's still beating the S&P 500, which was down nearly 40% to 911 points Thursday and falling again Friday. 

SmarthGrowth's LPMAX fund, for the moderately risky investor, was down around 7% to $9.63 per share, and the aggressive LPGAX was down nearly 12% to $9.20 per share, as of Thursday's close. 

All three funds are still outperforming the S&P 500, and that's important in a market where the equity funds that lose less are best. 

Kevin Mahn, who manages the SmartGrowth funds, attributes the success of the funds year to date to a healthy blend of around 240 ETFs. 

"We can go short currency, or long on the bond curve. We don't sell during the quarter, only at the end. We are of the mind that ETFs are the saving grace for any portfolio manager," Mahn said. 

"If you don't have ETFs in your portfolio, you're getting left behind," he said. 

The fund has been gaining ground from its positions in the UltraShort S&P500 ProShares (SDS) ETF. The fund was up 6% on Nov. 12 alone, while the rest of the market was plunging. In fact, the UltraShort ETF is up nearly 70% from January to 
Nov. 13. 

"We are riding the short side of the S&P, so when it's down a hundred points, we're up 200," Mahn said. That's because the $2.6 billion ProShares ETF invests 80% of its assets in financial instruments with economic characteristics that should be the inverse to those in the S&P 500. So when the S&P was down 9% in October, SmartGrowth funds were up by 18% because of the UltraShort's downside protection strategy. 

These days, the three SmartGrowth funds are investing heavily in biotech and small-capitalization ETFs, and shorting consumer goods. 

"Our allocation is heavy on biotech and small cap because these are the markets that are going to lead into a bull rally," he said. Small caps and biotech stocks tend to rally first in a bull market because they are a sign that investors have regained confidence and are now willing to assume buying riskier assets like that of smaller firms and heavily indebted biotechs.

"Whenever the market starts its correction, these are the sectors that will rally highest," Mahn said. 

The SmartGrowth Optimal Growth Fund's four biggest ETFs are ProShares UltraShort Consumer Goods (SZK), which corresponds to twice the inverse of the daily performance of the Dow Jones U.S. Consumer Goods index; iShares S&P SmallCap 600 Index (IJR); Vanguard Consumer Staples (VDC) and the Biotech HOLDRs ETF (BBH). 

All four ETFs are outperforming the S&P 500 year to date, including IRJ shares, which are holding their own slightly. Biotech HOLDRs and UltraShort ProShares Consumer Goods are actually up on the month. Biotech is up around 6% and UltraShort ProShares is up around 3%, compared to the S&P, which is down around 8% over the last four weeks. 

BBH is up nearly 10% year to date, as of Nov. 13, with SZK up nearly 50%. The moderate and conservative SmartGrowth funds are more heavily invested in the SPDR Lehman 1-3 Month T-Bill (BIL) ETF. The fund is up 1.5%, as of Nov. 13.

For now, SmartGrowth funds are U.S. focused. The funds sold out of their emerging market holdings in the second and third quarters of this year, namely positions in Russia and Taiwan. 

"We have no allocations at all in emerging markets," Mahn said about the worst performing asset class so far this year.

Investors have been dumping emerging market stocks since July - and aggressively so in early September - after Lehman Brothers Holdings Inc. investment bank folded and it became apparent that more banks would follow suit. 

For example, Brazil's Ibovespa stock index bubble has burst. It has gone from a May high of more than 73,000 points to under 40,000 points in November. 

Mahn is also taking his time dabbling in the U.S. housing market. The funds have a slight allocation to iShares Dow Jones U.S. Home Construction (ITB) ETF. But with the U.S. housing market crashing, and unemployment increasing nationwide, the ITB fund is down over 40% year to date. It's one of the only ETFs SmartGrowth has that makes the S&P look pretty good. 

"We are not fully on board the housing and construction market yet and don't know when you will see a recovery," he said. "Housing prices will probably end up falling again." 

(Kenneth Rapoza covers markets for Dow Jones Newswires from Sao Paulo, Brazil. He can be reached at 5511-2847-4541, 
or at kenneth.rapoza@dowjones.com)