Profit From Panic: New Canada ETF Leverages Emotional Selloffs

(Bloomberg) -- A new exchange-traded fund offers investors the chance to profit from everyone else’s panic.

The actively managed Redwood Behavioural Opportunities Fund, which started trading Wednesday on Toronto’s Aequitas NEO Exchange under the symbol BHAV, buys or shorts stocks that are mispriced due to everything from earnings misses to a spike in news.

“The role of any active manager is to find a mispriced asset and profit from it, so we just started to think, well, how are assets actually mispriced?" said Craig Basinger, chief investment officer at Richardson GMP Ltd., the advisor for the fund. "The conclusion we came to is that very often assets are mispriced because of people’s individual biases and emotional reaction to things."

The fund uses seven strategies to identify mispriced assets:

• Unloved to less unloved, which identifies beaten-down stocks that begin to attract buy ratings from analysts
• Earnings overreaction
• Emotional cascade, when investors have a one-sided reaction to a spike in news
• Indexing bias, a counter-intuitive strategy based on the fact that stocks added to an index tend to underperform while those removed tend to partially recover
• Crowded trades, a contrarian bet on the opposite of what most investors expect
• Neglect, when spinoff companies come under exaggerated selling pressure
• Hard hedge, a contrarian position against irrational exuberance

It uses "pretty strict stop rules" to exit a position if the stock starts to move in the wrong direction, said Basinger.

"This is a bit of a numbers game," he said. "We need to put a lot of instances through the strategy, and what we found is that if you have enough of them going through, the actual alpha you can create is pretty strong."

One of the companies added on the fund’s first day was Fastenal Co., the U.S. construction company that fell 5.8 percent Wednesday after reporting a weaker-than-expected gross margin. Following the “earnings overreaction” strategy, Basinger bet that the selloff was overdone. Fastenal rebounded 2.3 percent as of noon on Thursday.

The fund also bought PG&E Corp., which operates a utility in California. The company suspended its dividend due to potential exposure to billions of dollars in damages from wildfires in the state last year. The shares have dropped 36 percent since mid-October, though have risen three straight days.

"This is what we would call an emotional cascade: all the news for a number of months has been nothing but negative and it’s just hammered the stock, probably more than it deserves," Basinger said. "For us that’s an opportunity."

The fund is run by Redwood Asset Management, a unit of Toronto-based Purpose Investments Inc.

To contact the reporter on this story: Kristine Owram in Toronto at kowram@bloomberg.net.

To contact the editors responsible for this story: Arie Shapira at ashapira3@bloomberg.net, David Scanlan, Chris Fournier

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