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Investors looking for an ETF that is both defensive and has the potential for out performance should review PowerShares DWA Consumer Staples Momentum ETF. FINRA recently chimed in on Smart Beta ETFs with a Caveat Emptor opinion. As long as the US Dollar remains strong, this ETF should continue to excel. As with many previous market downturns, money has been flowing into the “safer” sectors of utilities, consumer staples, and telecom. If one looks at the recent high of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) at $213.50 on May 21, the markets have fallen -9.3% as of Sept 23. Popular ETFs for these sectors are the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the SPDR S&P Telecom ETF (NYSEARCA: XTL ). Since May 21, utility and consumer staples investors have been rewarded with better relative declines of -5.9% and -4.9%, respectively, while telecom lost about market average of -9.8%. However, if one looked at the declines of these sector ETFs from their most recent highs, the carnage is a bit worse. Utilities peaked on Jan 29 and has declined -15.1%, telecom peaked on June 18 and has fallen -11.9%. Consumer staples peaked on Aug 5 and has declined -7.2%. On a year to date base, SPY is down -2.9%, XLU -8.5%, XTL -3.3%, and XLP -1.2%. Within these popular defensive sectors, consumer staples would seem to be the best performer for relative performance against a backdrop of an overall market decline. There are 13 consumer staples ETFs listed on ETFdb.com . YTD performance ranges from 9.39% for the PowerShares DWA Consumer Staples Momentum Portfolio ETF (NYSEARCA: PSL ) to -46.1% for the Global X Brazil Consumer ETF (NYSEARCA: BRAQ ). The top three YTD US performers were: PSL, the PowerShares Dynamic Food & Beverage Portfolio ETF (NYSEARCA: PBJ ) at 5.3% and the Guggenheim S&P Equal Weight Consumer Staples ETF (NYSEARCA: RHS ) at 2.5%. On a 1-yr, 3-yr and 5-yr basis, PSL has outperformed both the SPY and XLP, with the majority of its relative strength clocking in since Oct 2014. Prior, PSL mirrored SPY and bested XLP and the recent outperformance has lifted overall returns. According to etfdb.com, during the past year, PSL has returned 18.5% vs 7.5% for XLP, on a 3-yr basis, PSL has returned 70.5% vs 41.9% for XLP, and on a 5-yr basis, PSL has returned 123.7% vs 93.9% for XLP. A 3-yr graph of PSL vs SPY and XLP is below. What is the investment strategy of PSL that creates the outperformance? As a “smart beta” ETF, the underlying portfolio shifts quarterly centered on individual stock’s technical performance relative to the sector. PSL is a PowerShares ETF offered by Invesco. From their website : “The PowerShares DWA Consumer Staples Momentum Portfolio ((Fund)) is based on the Dorsey Wright® Consumer Staples Technical Leaders Index (DWA Consumer Staples Technical Leaders Index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index. The Fund and the Index are rebalanced and reconstituted quarterly.” Zack’s comments on PSL: “Consumer staples sector is on the rise as it is directly linked with improving economic fundamentals, in particular the spending power, which has increased owing to cheap fuel and rising income. As such, PSL has been able to withstand global worries, gaining 2.6% so far in the second half. The ETF provides exposure to 32 stocks having positive relative strength (momentum) characteristics by tracking the DWA Consumer Staples Technical Leaders Index. It has amassed $203.4 million in AUM and trades in lower volume of 56,000 shares a day on average. Expense ratio came in at 0.60%. The product is pretty spread out across securities, with each holding less than 4.9% of assets. It has a definite tilt toward mid cap stocks while the other two market cap levels take the remainder. Food products, beverages and household durables are the key industries in the ETF having double-digit exposure each.” Momentum investing, aka “momo”, is a strategy of buying stocks that have generated high returns over the past three to twelve months, and selling those that have experienced poor returns over the same period. The ETF seeks investment results that correspond to the price and yield of the DWA Consumer Staples Technical Leaders Index, which evaluates companies based on a variety of investment criteria, including fundamental growth, stock valuation, investment timeliness and risk, comparative to others in the sector. From DWA website concerning their relative strength and top-down approach: “Relative Strength: Relative Strength, the measurement of how one security performs in comparison to another, is a key concept within Dorsey Wright’s methodology. Before investing in UPS, one should understand its recent performance relative to FedEx, or the S&P 500. The same logic can be applied to sector analysis, asset class evaluation, mutual funds, ETFs, commodities, fixed income, and even foreign countries. A relative strength matrix is like a massive tournament, where a huge quantity of investment options can be compared to one another – and we see who is strongest. Relative strength is the basis for virtually all of our managed products, where we select the best investment options from within a large universe of options. Top-Down Approach: We use primary market indicators to get a measure of overall risk, and then analyze broad industry sectors to determine which are in favor. We want to invest in sectors that are controlled by demand. We then select investments that have positive relative strength and have a good probability of outperforming the market. We do not feel compelled to be fully invested in stocks when an alternative investment (cash reserves) offers a more attractive opportunity. In fact, it is our belief that avoiding severe losses is extremely important in achieving strong market performance over the course of an entire market cycle.” PSL is one of 14 momentum driven ETFs utilizing various Dorsey Wright Technical Leaders Indexes and a list of other Indexes is found here . DWA offers an in-depth White Paper on the Dorsey Wright Strategy titled ” Relative Strength and Portfolio Management ” pdf. PSL was rebalanced on June 30 and the most recent list of stocks is below: (click to enlarge) Due to its focus on owning the top momentum stocks with quarterly rebalancing, investors should not be surprised at a high 83% Annual Turnover Rate. According to Morningstar, of the companies listed above, one was purchased in 2012, three in 2013, nineteen in 2014 and nine in 2015. The ETF’s industry allocation is broad based within the consumer staples sector and is reported by Invesco as follow: As the strategy includes NASDAQ stocks, PSL’s portfolio will have higher exposure to mid-caps and small-caps than its large cap S&P ETF brethren. Not only are smaller companies known for higher earnings potential, but usually are focused on domestic US markets rather than an extensive international network. Recently, the strength of the US Dollar has weighted on revenue growth and exchange rates for large cap companies, and this concern is usually less with smaller companies. The strength in domestic markets and reduced currency risk exposure may be a factor in these specific company’s current individual outperformance. The outperformance of PSL compared to XLP coincides with the meteorically rise in the US Dollar starting in Aug 2014. The average market cap in the portfolio is $14.5 billion and 72% of the portfolio are mid-caps or smaller. Below is a table offered by Morningstar of PSL valuation and growth matrix compared to the Benchmark of S&P 1500 Consumer Staples and the Category of Morningstar Defensive. While the comparison indicates PSL is trading at a higher valuation than the Benchmark and Category, its growth profile is also quite a bit higher. With Cash-Flow Growth 25% above the benchmark and Book-Value Growth more than double the Benchmark, a higher valuation would seem appropriate. This week, FINRA issued an Investor Alert titled, “Smart Beta-What You Need to Know”. The bottom line of the alert is the old adage: Know what you are buying and what the strategy is of the specific ETF. There are about 840 products that fall into a smart beta category, representing almost half of all the exchange-traded products listed in the U.S. and investors should understand that any strategy that aims to beat the market carries its own risks. “Recently, there has been significant growth in the number of financial products, primarily ETFs, which are linked to and seek to track the performance of alternatively weighted indices. These indices are commonly referred to as “smart beta” indices. They are constructed using methodologies that rely on, for example, equal weighting of underlying component stocks, or measures such as volatility or earnings, rather than market-cap weighting. Investors need to understand there is no free lunch here. Any time you are deviating from the market, you’re taking some kind of tilt. Understand what is the fund doing that is different than the market. That is a risk.” Investors looking for an ETF that is both defensive and has the potential for outperformance should review PSL to evaluate how it may fit into their current portfolio construction. As long as the US dollar stays strong and the international economies remain in question, this ETF should continue to reward long term investors. However, FINRA is correct: Caveat Emptor. Author’s Note 1: NASDAQ OXM (NASDAQ: NDAQ ) agreed to acquire privately-held Dorsey Wright Associates in Jan for $225 million. This will push NASDAQ into the smart beta ETF market in an aggressive manner. Author’s Note 2: Please review disclosure in Author’s profile. Scalper1 News
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