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PowerShares' Dynamic ETF Results
A year ago, I described a
new twist on exchange-traded-funds (ETFs) marketed by
PowerShares
Capital Management, which appeared to have an advantage over the
competition. Last week, I checked on how the
PowerShares funds have done over the past year. Unfortunately, so far,
the results have been mixed. I’ll get into the details in a minute, but
first some background.
In you’re not familiar with the term, ETFs are
similar to index mutual funds. They track a particular market segment.
For instance, say that you believe that large company, value-priced
stocks, will outperform the market over the next few months. Instead of
researching and analyzing individual stocks in that category, you could
simply buy an index mutual fund or an ETF tracking a large-cap, value
index.
ETFs, which are a relatively new development, trade
just like stocks. Unlike mutual funds, which frown on frequent trading,
you can buy an ETF at 10 am and sell it at 10:15 if you like. Many
mutual funds require a hefty opening investment, often $5,000 or higher.
But you can buy or sell most ETFs one share at a time. However, you pay
the same commission for ETFs as you would for stocks when you buy and
sell. Depending on your broker’s fees, that feature may render ETFs
unsuitable for investors who invest small amounts, say $100 or $200, on
a monthly basis.
In last year’s column, I described PowerShares new
twist on the indexing concept. Here’s a quick rundown.
PowerShares New Twist
Usually, the list of stocks comprising the index tracked by an
ETF doesn't change much--only when a company is acquired, or looks like
it’s headed for bankruptcy. PowerShares uses fixed indexes much the same
as other ETFs, but employs computerized formulas to pick the stocks from
the index, that, in its view, have the best price appreciation prospects
over the next few months. Since PowerShares rebalances its portfolios
every three months, in theory, it always has only the best stocks from
the relevant index.
When I wrote last-year’s column, although
PowerShares had 20 available ETFs, only two had been around long enough
to compile significant track records.
The PowerShares Dynamic Market Portfolio fund is
benchmarked (compared) to the S&P 500 Index, although the fund doesn’t
necessarily hold S&P 500 stocks. PowerShares benchmarks its Dynamic OTC
Portfolio to the NASDAQ 100 Index, which contains the 100 largest Nasdaq
stocks, excluding financial firms. When I wrote last year’s column, both
of the PowerShares funds had substantially outperformed their relevant
indexes since their inception in 2003.
In the column, I also described a brand new fund
that had caught my interest, the PowerShares Zacks Micro-Cap Fund. That
fund uses a formula developed by Zacks Investment Research (www.zacks.com)
to pick the best bets from an index tracking the 2,500 smallest U.S.
stocks. I knew that Zacks had developed market-beating stock picking
strategies for larger stocks, so I thought it had a good shot at
repeating with micro-caps.
How have the PowerShares funds done over the past
year? Last week, I used Yahoo’s ETF Browser to find out.
Checking the Returns
You can find the ETF Browser from Yahoo’s main finance page (finance.yahoo.com)
by selecting
Investing, and then clicking on
ETFs, which
takes you to Yahoo’s Exchange-Traded Funds Center. From there, select
Top
Performers and use the Category menu to select a market segment.
Yahoo lists all ETFs in the category along with
returns ranging from one-day to three-years, if the fund has been in
existence that long. You can click on any period to sort the list with
the best performers over that timeframe listed first. I sorted the lists
based on one-year returns.
I started with the
Large Blend category, which includes the PowerShares Dynamic
Market Portfolio, the fund benchmarked to the S&P 500. According to
Yahoo, over the past 12-months, the PowerShares fund underperformed,
returning 5.0% compared to 10.6%
for the S&P index.
The PowerShares Dynamic OTC Portfolio
outperformed its NASDAQ 100 benchmark, 4.7%
vs. 3.3%, over the past year (the PowerShares
fund is classified as mid-cap growth, but the NASDAQ 100 was listed in
the large-cap category).
Finally, I checked the Zacks Micro Cap fund,
which is listed in the Small Blend category. The category includes both
micro-cap and small-cap ETFs. Of the 10 funds listed, only three were
micro-caps. Of those, the PowerShares Zacks Micro Cap returned 8.7%
over the past 12-months, slightly ahead of the First Trust Dow Jones
Select MicroCap fund’s 8.4% return. The third
micro-cap fund, the iShares Russell Microcap Index fund, only managed a
5.5% return for the year.
A year ago, I had high hopes that the PowerShares
quarterly rebalancing strategy would offer a reliable approach to
beating the indexes. So far, that hasn’t happened, at least going by
recent results.
New Kid on the Block
Meanwhile, there’s a new kid on the block.
WisdomTree
Investments builds its ETF portfolios based on fundamental factors,
mainly dividends. WisdomTree’s ETFs haven’t been around long enough to
come to any conclusions, but so far, the results look encouraging. Stay
tuned.
10/15/06
Below is the original column
from October 2005.
ETFs
Move Beyond Simple Indexing
Exchange-traded-funds
(ETFs) appear to be catching on with investors. I counted a couple of
dozen new funds in the works or already operating this year. However,
not all ETFs are created equal.
The ETFs
created by PowerShares Capital Management (www.powershares.com)
appears to me to have a structural advantage, and one of this year’s
crop; the PowerShares Zacks Micro Cap Portfolio, looks especially
interesting.
If you’re
not familiar with ins and outs of ETFs, I’ll give you a quick fill-in
before I get into the details about the PowerShares and its Zacks fund.
ETFs are
similar to index mutual funds. They give you the opportunity to invest
in a particular market sector without researching and buying individual
stocks. For example, if you think energy prices are headed still higher,
you could invest in an ETF specializing in energy stocks.
ETFs offer
advantages and disadvantages compared to mutual funds. You can buy and
sell ETFs just like stocks. Most ETFs require no minimum investment and,
unlike mutual funds, there is no minimum holding period.
You can sell
ETFs short, meaning that you make money if the share price drops while
you hold it. For example, if you think energy prices have peaked, you
could sell an energy ETF short (selling shares you’ve borrowed from
your broker) and profit if you’re right.
You pay the
same commissions for buying or selling ETFs as you would for stocks.
Since you can trade many mutual funds without paying a commission,
mutual funds could be a better deal if you make regular monthly
investments.
In my view,
the best places to research ETFs are Yahoo (finance.yahoo.com)
and Morningstar (www.morningstar.com).
Both have comprehensive ETF sections, but each has plusses and minuses.
So you’ll probably want to use both.
Now, back to
PowerShares, and in particular, its Zacks Micro Cap fund.
PowerShares
Although existing ETF portfolios represent dozens of market sectors
and investing styles, until PowerShares came along, all were designed to
track a predefined group of stocks, either an already existing index, or
an index defined specifically for that ETF.
For instance,
the iShares Dow Jones US Energy fund tracks the already existing Dow
Jones U.S. Energy Sector Index, while the Goldman Sachs Natural Resource
fund tracks an index developed by Goldman Sachs as a benchmark for
U.S.-traded natural resource-related stocks.
In either
case, the portfolio of stocks held by most ETFs only change
occasionally, say when a firm is acquired, or encounters major
difficulties, for instance, bankruptcy. Most ETFs rarely makes changes
simply because it thinks a particular stock is going to outperform, or
underperform the market over the next few months.
By contrast,
PowerShares uses quantitative formulas to periodically rebalance its
portfolios by picking the stocks from a sector with, in its view, the
best capital appreciation outlook over the next few months.
PowerShares
has 20 ETFs out now, and several more on the way. But only two, its
Dynamic Market Portfolio, which tracks the overall market, and its
Dynamic OTC Portfolio, which tracks the Nasdaq, have been around long
enough to rack up much of a track record. So far, both have outperformed
their relevant (benchmark) indexes.
Zacks
Micro Cap Fund
The PowerShares Zacks
Micro Cap Portfolio, which started trading in August, is one of
PowerShares’ newest ETFs. It tracks an index of micro-cap stocks
developed by Zacks Investment Research (www.zacks.com),
which will be rebalanced four times a year.
I’ve
mentioned Zacks in this space before. Zacks has been compiling and
distributing analysts’ buy/sell ratings and earnings forecasts since
1978. Along the way, Zacks has developed computerized (quantitative)
selection models to identify which stocks will outperform or
underperform the market over the next few months.
The
PowerShares Zacks Micro Cap fund fills an interesting niche.
Value
Micro-Cap Rocks
Market capitalization, is the number of shares out multiplied by recent
share price, and according to Zacks, micro-cap stocks (market-caps under
$550 million) have outperformed all other market capitalizations over
the long-term. Further, Zacks points to research showing that within
micro-caps, value-priced stocks have significantly outperformed growth
stocks.
Price
momentum is another factor that many researchers have found valuable for
pinpointing with the best potential. In essence, that means that stocks
that have already outperformed the market are likely to continue their
winning ways.
Zacks
combines value and momentum strategies to build its portfolio.
Micro Cap
Portfolio
The Dow Jones Wilshire 5000 index tracks almost the entire U.S.
stock market. To build its Micro Cap portfolio, Zacks defines micro-cap
stocks as the 2,500 smallest companies making up the Wilshire index.
From that
universe, Zacks picks value-priced stocks with strong price momentum.
The details of what constitutes value and price momentum are, of course,
proprietary. In a twist that’s unusual even for PowerShares, Zacks
reviews its portfolio weekly, and can remove stocks that significantly
miss the portfolio requirements.
According to
Zacks, its Micro Cap Index grew $100,000 into $287,000 in the five-years
ending with June 2005. By comparison, $100,000 invested in the Russell
Microcap index would have grown into $145,000 in the same timeframe
(both return figures exclude dividends).
Since the
PowerShares Zacks fund is only a month or so old, the returns I just
quoted are hypothetical. Oftentimes, apparently successful investing
strategies don’t translate well into mutual funds. So I suggest
watching its performance for a few months before investing.
That said,
Zacks and PowerShares both deserve credit for moving ETF portfolio
building beyond simple indexing.
published 10/2/05 |
