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Summary This ETF has a high expense ratio but they are running an aggressive momentum strategy that requires higher costs. The sector allocation combined with a momentum strategy would be enough to put me on edge when I wanted to sleep. If an investor wants to follow momentum investing, this seems like a fine choice. For that investor, I would suggest grabbing some utilities to get a better balance. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds that I’m researching is the PowerShares DWA Momentum Portfolio ETF (NYSEARCA: PDP ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio is .63%. I tend to be very frugal with my expense ratios, so I’m less than thrilled with the expense ratio. Of course, portfolios that require more active involvement from managers are going to generally have higher ratios. The question becomes whether the managers will be able to regularly deliver enough performance to justify that higher ratio. Largest Holdings The following chart shows the largest holdings for the fund: The allocations here are fairly interesting, but you expect that momentum portfolios are going to end up having a very strange allocation. It’ll be interesting to see how the various momentum ETFs perform over a sample size of several years during which investors are well aware of the strategy. The presence of ETFs buying stocks based on the stock price having already appreciated seems like it could end up distorting the performance. If the strategy was highly successful, then I would expect whichever ETFs designed their systems to move first to be the winners in the game since their purchases would further drive up prices and encourage other ETFs to buy into the same funds. All around momentum investing is strange beast to me. I’m just a fundamental analysts at heart with a focus on finding the intrinsic value of a company and figure out which factors will be headwinds or tailwinds. Sectors The following chart breaks down the allocation by sector: The consumer discretionary sector has a fairly massive 31.8% weighting. My first thought here is that I would be scared to hold this ETF if this prolonged bull market turned into a bear market. I’m not convinced that we will see that kind of huge drop off in the economy in the next few years because low interest rates can do a great deal to keep market prices high, but I don’t think I have the risk tolerance for this sector allocation. Utilities That utility allocation is credibly low. For an investor opting to use momentum investing and an ETF like PDP for a major position in their portfolio, I would suggest looking to a low fee utility index to add some diversification to the portfolio as a whole. That is, of course, unless you prefer having more volatility in your portfolio. I know some investors are going to be thinking: “Utilities are sensitive to interest rate movements so I don’t want to hold them when interest rates are clearly moving higher.” There is certainly a correlation there. The utilities may suffer if rates increase, but I think they’ll stay low much longer than some investors believe. The macroeconomic environment just doesn’t provide the situation necessary for a sustained increase in rates. I’ve been positioning my portfolio to hold plenty of instruments that are sensitive to interest rates because I really don’t see any high probability paths for interest rates to move higher. An Interesting Option It would be interesting to see a momentum investing strategy that placed caps on sector weightings so that the portfolio wouldn’t end up this heavy on one sector. I have nothing against the consumer discretionary sector; I just prefer the consumer staples for my portfolio. I feel the sector is substantially stronger at resisting a sell off when the market is crashing. All sectors would be likely to fall, but I would expect fewer losses in consumer staples. Conclusion For investors that are interested in momentum investing, this is one option to get that technique into your portfolio. In my opinion the risk of using this strategy is compounded by the aggressive consumer discretionary allocation. In a prolonged bull market this fund should be a solid choice. I’m not predicting a bear market in the near future, but I’m also not willing to make a play that is this aggressive. I just don’t think I’d sleep as well with such an aggressive allocation. If investors opt to use this ETF, I’d suggest checking at least monthly on the sector allocations so the investor can modify their portfolio weights as desired. If investors don’t adjust their portfolio in response they may find themselves going massively overweight on individual sectors. Scalper1 News
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