EquityCompass Risk Management Strategy

The EquityCompass Equity Risk Management strategy seeks to provide long term capital appreciation with capital preservation as a secondary objective. The strategy’s portfolio managers employ an investment strategy which seeks to avoid large, prolonged market losses and to reduce volatility.

Benefits of Avoiding Outsized Losses
Avoiding the worst down days is meaningfully more beneficial than the penalty that comes from missing the best up days because severe losses reduce future earnings power due to a smaller capital base. Gains required to fully recover from a loss need to be greater than the original loss. For example, a 20% loss requires a 25% gain for a full recovery, and a 10% loss requires an 11.1% gain to recover. Outsized losses can add years to the time it takes to recover capital.

The Mathematics of Marketlosses

Is It Necessary To Manage Equity Risk?
The implications of proper risk management, or lack thereof, are often underappreciated, poorly understood, or ignored entirely. All investments carry some risk. But steps can be taken within an investment strategy that have the potential to both protect against market stress and downside volatility and to participate in market gains.

EquityCompass believes drawdown, or peak-to-trough decline in monthly value, is the biggest deterrent to an investor’s willingness to stay invested. The table below shows the annual returns and volatility of the S&P 500 from 1958 through November 2016 under three scenarios. The Buy-and-Hold scenario is the most volatile (as measured by standard deviation) and has the greatest drawdown. The second scenario assumes investors miss 5% of the best and worst months during the study period — a more realistic assumption when implementing a proper risk management strategy. While the overall return is higher than Buy-and-Hold, more importantly an investor would experience one-third less volatility, and a drawdown of about one-half. Volatility is even lower in the third scenario. The point to this analysis is to view an equity risk management strategy not as a means to enhance returns necessarily, but to help reduce risk so investors are more likely to stay invested to participate in the long-term returns the market provides.

EquityCompass Equity Risk Management Strategy
The EquityCompass Equity Risk Manager Strategy analyzes technical and fundamental indicators to assess current market conditions and recommends the appropriate tactical allocation. EquityCompass asserts that in the lead-up to the major bear markets of recent history, technical and fundamental indicators of significant downturn were present and detectible. The strategy screens the market seeking to stay ahead of these trends.

  • EquityCompass uses a systematic approach to managing stock exposure and seeks to reduce risk while maintaining upside potential.
  • The strategy seeks to reduce portfolio volatility and provide protection from extended market declines and ill-timed investment decisions, seeking to stay invested during market turbulence.
  • The strategy provides potential risk control during periods of significant systemic stress when the traditional risk management approach of asset allocation and diversification alone is not sufficient.
  • The strategy incorporates the insights of EquityCompass developed by analyzing a decade’s worth of fundamental data as well as technical data covering all bear markets since The Great Depression.

Portfolio Allocation Example
The EquityCompass Risk Management Strategy (ERMS) carves out a portion of an equity portfolio for tactical allocation (could range from one-third to a maximum of 50% of the portfolio):

  • When conditions are favorable, the strategy will be fully invested in equity securities.
  • When conditions are deemed unfavorable, the strategy will shift to cash or inverse (short).

This example assumes a 60% stock / 40% bond allocation with 33% of the Equity allocation invested in the Equity Risk Management Strategy.

Investment Process

Portfolio of U.S. Equity Securities
Under normal conditions, the funds will primarily invest in U.S. companies. EquityCompass uses an approach that is focused on bottom-up stock selection, diversified by sector, assets, and risk levels and equal-weighted positions that are periodically rebalanced.

Fundamental Screen
EquityCompass considers two or more consecutive months of declining earnings expectations for the S&P 500 Index to be unfavorable and increases the risk of large market losses, while two or more consecutive months of increasing expectations is considered favorable.

Technical Screen
Determines the market favorability based on the current level of the Dow Jones Industrial Average (DJIA).

Assess Market Conditions
EquityCompass will allocate assets based on market favorability. If market conditions are unfavorable, ERM may invest all or a portion of its assets in cash, cash equivalents and short term fixed-income. Likewise, in unfavorable market conditions, TERM may invest a significant portion of its assets in securities designed to provide short exposure to broad U.S. market indexes, including ETFs, options and swaps.

Strategy Literature

You should consider each fund’s investment objectives, risks, and charges and expenses carefully before investing. Contact First Trust Portfolios L.P. at 1-800-621-1675 to obtain a prospectus or summary prospectus which contains this and other information about the funds. The prospectus or summary prospectus should be read carefully before investing.


The funds list and principally trade their shares on the NYSE Arca, Inc.

Investors buying or selling fund shares on the secondary market may incur customary brokerage commissions. Market prices may differ to some degree from the net asset value of the shares. Investors who sell fund shares may receive less than the share’s net asset value. Shares may be sold throughout the day on the exchange through any brokerage account. However, unlike mutual funds, shares may only be redeemed directly from a fund by authorized participants, in very large creation/redemption units. If a fund’s authorized participants are unable to proceed with creation/redemption orders and no other authorized participant is able to step forward to create or redeem, fund shares may trade at a discount to a fund’s net asset value and possibly face delisting.


A fund's shares will change in value and you could lose money by investing in a fund. The funds are subject to management risk because they are actively managed portfolios. In managing a fund's investment portfolio, the advisor will apply investment techniques and risk analyses that may not have the desired result. There can be no assurance that a fund's investment objectives will be achieved.

The funds are subject to market risk. Market risk is the risk that a particular security owned by a fund or shares of the fund in general may fall in value.

The funds may invest in small or mid capitalization companies. Such companies may experience greater price volatility than larger, more established companies.

Certain securities held by the funds are subject to credit risk, income risk and interest rate risk. Credit risk is the risk that an issuer of a security will be unable or unwilling to make dividend, interest and/or principal payments when due and that the value of a security may decline as a result. Credit risk is heightened for floating-rate loans and high-yield securities. Income risk is the risk that income from a fund’s fixed-income investments could decline during periods of falling interest rates. Interest rate risk is the risk that the value of the fixed-income securities in a fund will decline because of rising market interest rates.

To the extent that a fund or an underlying ETF engages in derivatives transactions, the funds bear the risk that the counterparty to the derivative or other contract with a third-party may default on its obligations or otherwise fail to honor its obligations. If a counterparty defaults on its payment obligations a fund will lose money and the value of a fund’s shares may decrease.

The use of options and other derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives. These risks are heightened when a fund’s portfolio managers use derivatives to enhance a fund’s returns or as a substitute for a position or security, rather than solely to hedge (or offset) the risk of a position or security held by a fund.

The funds invest in equity securities and the value of the shares will fluctuate with changes in the value of these equity securities. Equity securities prices fluctuate for several reasons, including changes in investors' perceptions of the financial condition of an issuer or the general condition of the relevant stock market.

The risks of owning an ETF generally reflect the risks of owning the underlying securities, although lack of liquidity in an ETF could result in it being more volatile and ETFs have management fees that increase their costs.

As the use of Internet technology has become more prevalent in the course of business, the funds have become more susceptible to potential operational risks through breaches in cyber security. Such events could cause the funds to incur regulatory penalties, reputational damage, additional compliance costs associated with corrective measures and/or financial loss.

The funds’ potential investment in ETFs is restricted by the Investment Company Act of 1940, as amended (the “1940 Act”), and the funds’ associated exemptive relief which limits the amount of any single ETF that can be owned by a fund, individually and in the aggregate with all other registered investment companies and private investment pools advised by First Trust and its affiliates. This limitation may prevent the funds from purchasing shares of an ETF that it may have otherwise purchased pursuant to its investment objectives and principal investment strategy.

TERM may invest in inverse ETFs which would subject the fund to the risks of a short sales. The underlying ETF will incur a loss as a result of a short sale if the price of the security sold short increases in value between the date of the short sale and the date on which a fund purchases the security to replace the borrowed security. In a rising stock market, the underlying ETF’s short positions may significantly impact the ETF’s overall performance or cause it to sustain losses, particularly in a sharply rising market. The use of short sales may also cause the underlying ETF to have higher expenses than other funds.

The funds currently have fewer assets than larger funds, and like other relatively new funds, large inflows and outflows may impact a fund's market exposure for limited periods of time.

The funds are classified as "non-diversified" and may invest a relatively high percentage of their assets in a limited number of issuers. As a result, the funds may be more susceptible to a single adverse economic or regulatory occurrence affecting one or more of these issuers, experience increased volatility and be highly concentrated in certain issuers.

First Trust Advisors L.P. is the adviser to the funds. First Trust Advisors L.P. is an affiliate of First Trust Portfolios L.P., the funds’ distributor.


The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq Stock Market.

Long/short are investment terms used to describe ownership of securities. To buy securities is to “go long.” The opposite of going long is “selling short.” Short selling is an advanced trading strategy that involves selling a borrowed security. Short sellers make a profit if the price of the security goes down and they are able to buy the security at a lower amount than the price at which they sold the security short.

Standard Deviation is a measure of price variability (risk). Sharpe Ratio is a measure of excess reward per unit of volatility.

Swaps are a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument.

Inverse ETFs are ETFs, traded on a public stock market, which are designed to perform as the inverse of whatever index or benchmark they are designed to track.

Past performance does not guarantee future results.

All investments involve risks, including the risk of a possible loss of principal. Foreign investments are subject to risks not ordinarily associated with domestic investments, such as currency, economic and political risks, and different accounting standards. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Small company stocks are typically more volatile and carry additional risks, since smaller companies generally are not as well established as larger companies. The market risk associated with small‐cap and mid‐cap stocks is generally greater than that associated with large‐cap stocks because small‐cap and mid‐cap stocks tend to experience sharper price fluctuations than large‐cap stocks, particularly during bear markets. Due to their narrow focus, sector‐based investments typically exhibit greater volatility and are generally associated with a high degree of risk. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. In addition, duration risk measures a debt security’s price sensitivity to interest rate changes. Bonds with higher duration carry more risks and have higher price volatility than bonds with lower duration. Therefore, if interest rates are very low at the time of purchase of the bonds, when interest rates eventually do rise, the price of such lower interest rate bonds will decrease and anyone needing to sell such bonds at that time, rather than holding them to maturity, could realize a loss. When investing in real estate, it is important to note that property values can fall due to environmental, economic, or other reasons, and changes in interest rates can negatively impact the performance of real estate companies.

Exchange Traded Funds (ETFs) represent a share of all stocks in a respective index. ETFs trade like stocks and are subject to market risk, including the potential for loss of principal, and may trade for less than their net asset value. The value of ETFs will fluctuate with the value of the underlying securities. Inverse ETFs are considered risky and are not suitable for all investors. Typically, these products have one‐day investment objectives, and investors should monitor such funds on a daily basis. Inverse ETFs are constructed by using various derivatives for the purpose of profiting from a decline in the value of an underlying benchmark. Investing in inverse ETFs is similar to holding various short positions, or using a combination of advanced investment strategies to profit from falling prices. Investors should review the prospectus and consider the ETF’s investment objectives, risks, charges, and expenses carefully before investing. Prospectuses are available through your Financial Advisor and include this and other important information. Rebalancing may have tax consequences, which should be discussed with your tax advisor. Diversification and/or asset allocation does not ensure a profit or protect against loss.

Diversification does not ensure a profit or protect against loss. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.

Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends. Companies may also choose to discontinue dividend payments. High-dividend paying stocks may carry elevated risks and companies may lower or discontinue dividends at any time.

EquityCompass Strategies is a research and investment advisory unit of Choice Financial Partners, Inc. (“Choice”). Choice is a wholly owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp.

Portfolios based on EquityCompass Strategies are available primarily through Stifel, Nicolaus & Company, Incorporated.

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