ALPS Advisors has launched the ALPS Dorsey Wright Sector Momentum ETF (Nasdaq: SWIN), a new exchange-traded fund designed to capture the returns attributable to momentum investing at both the sector and stock level.
Momentum-based strategies seek to exploit several behavioral biases of investors such as price anchoring and regret avoidance.
In collaboration with Dorsey, Wright & Associates (DWA), an investment advisory firm whose innovative solutions draw upon the firm’s expertise in relative strength analysis, the ETF invests in a high conviction portfolio of 50 stocks using a direct replication strategy based on the Dorsey Wright US Sector Momentum Index.
In the context of the DWA strategy, ‘relative strength’ compares the price performance, or momentum, between each sector or security. According to Dorsey Wright, the absolute momentum of the individual sectors/securities is not as important as the relative momentum between them. The model determines whether momentum is increasing relative to another sector or security and assigns a buy signal if it is. The sectors/securities are then ranked in descending order according to their cumulative number of buy signals.
The strategy is applied to the Nasdaq Large/Mid Cap Index by screening first at the macro level, utilizing the Global Industry Classification Standard (GICS) sector index returns (excluding real estate) to isolate sectors with the highest relative momentum.
The top three highest momentum sectors are each assigned a 20% weighting in the final index. The ten securities with the highest relative momentum within each sector are selected and are equally-weighted for a single-security weight of 2%. The next four highest momentum sectors are assigned a 10% weight in the index with the top five momentum securities within each being selected and assigned a 2% weighting. The strategy excludes the three lowest momentum sectors.
As of 6 January 2017 the three highest momentum sectors are information technology, industrials and consumer cyclicals, and the next four highest momentum sectors are healthcare, financials, energy and basic materials.
Mike Akins, SVP & Head of ETFs for ALPS, notes: “SWIN is the first Momentum ETF to combine both macro (sector) and micro (stock) level screens. We believe its unique two-screen construct creates opportunity for outperformance in strong sector momentum cycles, while simultaneously maintaining a diversification cushion to help weather periods where no clear sector leadership is present.”
“We are excited to collaborate with such a prestigious company,” added Tom Carter, President of ALPS Advisors, “The combination of Dorsey Wright’s research and our focus on product innovation has created a new strategy for enhancing portfolio construction.”
The ETF has a total expense ratio (TER) of 0.40%.
Momentum based strategies rely on investors continuing to support stocks which are increasing in value. Investors are indeed trend chasers regarding stock movements, continuing to buy as the stock price increases and sell as it decreases. Some investor traits that have been identified through the study of behavioural finance may provide an explanation.
Investors tend to anchor themselves to perceptions of stock value, responding slowly to new information contradicting their valuations. Also, investors wish to avoid the regret of mistiming the market. In this case they may hold the stock longer than is prudent, not wishing to sell early and miss out on potential returns. Due to these factors, these strategies have historically provided superior returns when compared to broad market cap-weighted equity indices.
The fund is not the first to harness the DWA relative strength methodology. Other notable ETFs include offerings from Invesco PowerShares and First Trust.
The PowerShares DWA Tactical Sector Rotation Portfolio (Nasdaq: DWTR) employs a ‘fund of funds’ structure, selecting its investments from the nine PowerShares DWA sector Momentum ETFs. Its methodology provides for a maximum of four chosen sectors at any one time which are then equally weighted. When relative strength indicators are weak across the sector range, the fund invests in a short-term risk-free debt via the Nasdaq US T-Bill Part 2 Index, in increments of 25%, with a potential total of 100% when no sectors are exhibiting sufficient buy signals. It has a TER of 0.75%.
Launched in March 2016, the First Trust Dorsey Wright Dynamic Focus 5 ETF (Nasdaq: FVC) provides targeted exposure to five First Trust sector and industry based ETFs as identified by DWA’s proprietary methodology. The ETF also has the potential to allocate to 1- to 3-month US Treasury bills as represented by the Nasdaq US T-Bill Index in 20% increments, up to a maximum of 100%, depending on the relative strength of the T-Bill Index compared to First Trust’s sector ETFs. Its TER is 0.89%.