ETF FOCUS
New ETF follows trends based on technical factors
Fund charts relative performance of stocks compared to peers, broad markets
By Murray Coleman, MarketWatch
Last Update: 1:47 PM ET Mar 2, 2007
SAN FRANCISCO (MarketWatch) -- By some estimates, a quarter of all exchange-traded funds on the market are trying to generate market-beating returns even though they follow indexes.
The latest is the PowerShares DWA Technical Leaders Portfolio (PDP
It tracks an index of some 100 stocks created by Dorsey Wright & Associates. That benchmark is built around the Richmond, Va.-based firm's expertise in technical research for institutional investors.
It's being billed as the first ETF implementing a process based on purely technical, rather than fundamental, factors. That means instead of talking to executives, analyzing financial statements and projecting items such as cash flow, the new fund centers on judging chart patterns based on price movements.
The creators of the fund's underlying benchmark say they're trying to take emotions out of the investing process.
'When people hear technical analysis, they think of black magic or something. But our method is really about measuring supply and demand in the marketplace and quantifying those trends.'
— Dorsey Wright & Associates' Tom Dorsey
"When people hear technical analysis, they think of black magic or something," Tom Dorsey, the firm's president, said. "But our method is really about measuring supply and demand in the marketplace and quantifying those trends. Our process is very long-term in nature."
The firm's back-tested data indicates its index would've beaten the S&P 500 index ($SPXS&P 500 Index
by an average annualized 8.76 percentage points from 2001-2006. Last year, the index trailed the general market by more than four percentage points.
Of course, those returns are theoretical. Past gains aren't considered a good measuring stick of how a fund will perform in the future.
The fund's expenses have been capped at 0.60%, according to PowerShares Capital Management LLC, which is a unit of Amvescap Plc and distributes the ETF.
"It's another in the line of ETFs to take a known active strategy and put it into the form of a quantitative index to capture most of that process," Jim Wiandt, editor of the Journal of Indexes, said. "It's a trend that's driving the industry."
The new ETF follows an index that's reconstituted and rebalanced quarterly. "It's a rules-based index that's designed to spotlight stocks outperforming the market," Mike Moody, a senior portfolio manager at Dorsey Wright, said. "So this is a portfolio that isn't very highly correlated to the S&P 500."
The index had 72.83% of its assets in large-cap stocks entering 2007, with a slight leaning to value names. Another 14.37% was weighted in midcaps. "Over time, this fund should tend to have a good representation of growth stocks," Moody said. "But it's designed as a multi-cap core fund. It has the ability to shift around as conditions change."
The underlying benchmark starts by looking at 3,000 stocks of all size caps. "That list looks like the Russell 1000 index but with more names," Dorsey said.
From there, his staff whittles down that list by a process of comparing how each is trading relative to its peers. For example, the ETF currently has Apple Inc. ) in its equal-weighted portfolio. Dorsey takes the price of Apple and divides it by the S&P 500's current price.
The calculation is done everyday, providing a series of numbers. A so-called point-and-figure chart is created. "When that relative strength chart hit a buy signal, that's considered a stock that's outperforming the broad averages," Dorsey said.
His team compares those winners against other outperformers. "We take the 100 best arm-wrestlers and buy them for the index," Dorsey said.
The index should do best when markets are either clearly moving up or trending down. "When the market's going sideways, I wouldn't think the ETF would do much," Dorsey said.
For that reason, it shouldn't be considered an all-weather type of fund, he added.
"It's a tool to use in a well-diversified portfolio to manage trends. This isn't designed as a one-stop type of fund," Dorsey said.
The weights on stocks will change each quarter when the index is rebalanced. "Turnover is going to be very high," Dorsey said. "By the same token, this ETF should be very tax-efficient since all capital gains aren't passed on like they are in a mutual-fund."
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