Among the investment factors delivering solid returns this year is momentum, a fact confirmed by several momentum-based smart beta exchange traded funds hitting all-time highs on Wednesday.
The Powershares DWA Momentum Portfolio (NASDAQ: PDP), which utilizes technical analysis from Dorsey Wright and picks out stocks based on relative strength, was one of the momentum ETFs to reach record highs.
The momentum strategy basically bets that hot movers will continue to rise, so investors would buy high and sell even higher. Investors who want to follow this momentum strategy will be betting on outperforming sectors flying even higher.
PDP tracks the Dorsey Wright Technical Leaders Index, which usually includes 100 Nasdaq-listed companies.
“The Index is constructed pursuant to Dorsey, Wright & Associates, LLC’s proprietary methodology, which takes into account, among other factors, the performance of each of the approximately 1,000 largest companies in the eligible universe as compared to a benchmark index, and the relative performance of industry sectors and sub-sectors,” according to PowerShares.
PDP allocates a combined 37% of its weight to technology and consumer discretionary stocks, two sectors that are often hallmarks of momentum-based strategies. However, the ETF’s largest sector allocation is 24.6% to industrials. With energy being the worst-performing sector this year, indicating it is lacking momentum, the group receives only token representation in PDP. A similar scenario was seen in 2014 when oil tumbled and PDP featured scant energy exposure.
Likewise, slower moving, defensive sectors, such as consumer staples, telecom and utilities, are lightly represented in PDP. Although it is not a true actively managed ETF, PDP’s flexible indexing methodology makes Dorsey Wright’s sector shifts notable actions.
An important source of PDP’s momentum can be derived from the ETF’s underlying index not being confined to one market cap segment. For example, just 37% of PDP’s holdings are large-caps, but more than 47% are mid-cap growth or mid-cap blend stocks.
Since momentum strategies can overweight riskier stocks, the ETF could could underperform during another correction. Since defensive stocks typically do better during volatile conditions, the momentum strategy could load up on conservative picks and miss out on the initial recovery in riskier assets.
PDP holds 100 stocks with an average market capitalization of $61.7 billion, according to issuer data. The ETF returned 25% over the past three years.
For more on Smart Beta ETFs, visit the Smart Beta Channel home page.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.