Smart Beta Investing: A Momentum ETF Strategy

The growth and momentum factors are leaders among smart beta strategies this year, a positive sign for exchange traded funds, such as the Powershares DWA Momentum Portfolio (NASDAQ: PDP). PDP is up 14.3% year-to-date, an advantage of more than 300 basis points over the S&P 500.

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.

“All securities in each Index universe are further ranked using a proprietary relative strength (momentum) measure. Each security’s score is based on intermediate and long-term price movements relative to a representative market benchmark,” according to a Seeking Alpha analysis of momentum ETFs.

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.