Over the past decade, the growth of the Exchange Traded Fund
(ETF) industry has given investors a host of choices for completing
their objectives. This is largely due to the many innovative
strategies to suit investor preferences which are now available in
ETF form (see
A Primer on ETF Investing
Exchange traded funds now enable investors to express a holistic
view on a particular asset class/economy/sector under the wrapper
of a single ETF product. Some of the recent innovative strategies
embedded in ETFs include merger arbitrage, leverage, inverse
leverage as well as a relatively new category but one that is
already well known among many investors, momentum investing.
Momentum investing explained
Over the past couple of decades, momentum trading has become
extremely popular among day traders and fund managers alike. The
basic idea of momentum trading is to capitalize on the "
rate of change"
of individual stock price movements relative to the broader
A momentum trading strategy involves the belief that,
historically, stocks with faster price movement (i.e. momentum)
relative to the broader market will continue doing moving higher,
sort of a Newton's first law for stocks. In other words, a stock
that is moving higher tends to soar, while stocks that are slumping
often have trouble breaking out of a negative channel.
Having said this, it is important to note that this tendency is
'mean reverting'. This means that once the trend reverses, the
stocks would start to move in the opposite direction at a faster
pace than the broader markets.
In the light of this explanation, it becomes very clear that the
key to success in momentum trading clearly lies in two things:
New Small Cap Technical Leaders ETF (DWAS)
). While there are a ton of fundamental as well as technical
indicators that could assist in ascertaining the two key points
mentioned above, the best strategy to ascertain the two would
depend on the understanding and implimentation of momentum
strategies by individual traders/fund managers.
Momentum ETFs in the Current Market Scenario
The present market environment is characterized by high levels
of uncertainty and volatility. The slowdown in many of the emerging
as well as developed nations has also injected heavy turbulence in
Nor is it easy going on the domestic front. The poor 2Q12 GDP
growth rate of 1.5% coupled with a rising unemployment rate and
below-par earnings season (so far) for corporate America have been
the major reasons for the negative sentiment on Wall Street (see
Three Defensive ETFs for a Bear Market
Also, a series of banking sector alarms like the Barclays LIBOR
scandal, J.P. Morgan's huge hedging loss and HSBC money laundering
scandal have cause investors and businesses to take a conservative
view, as they remain apprehensive of another financial crisis.
At a time like this when global risk aversion has taken its
toll, it is prudent to think of an investment strategy which would
increase the odds of a decent upside and also avoid some of the
market's biggest losers as of late.
One such way to do this in basket form is with momentum strategy
ETFs. These funds take a host of stocks that have high momentum
levels and invest in them, hopefully outperforming broad markets
which include low momentum stocks in the process.
Not only do these ETFs also have significantly lower
correlations with the broader markets, and could therefore also
make for significant tools for diversification, but they could help
avoid some stocks which could be poised to lead the way on the
Three ETFs with Incredible Diversification
However, investors should note that one of the major drawbacks
of momentum ETFs is its liquidity. The dangerously low average
daily volume for the funds targeting this space might prove to be a
bottleneck for many investors adding to total costs.
Still, for those investors willing to capitalize on the promise
of the technique in these uncertain markets, an ETF approach could
be the way to go. For these investors, we have highlighted a few of
the top funds in this segment, each of which possess their own pros
and cons as well as unique ways in targeting the market:
Russell 1000 High Momentum ETF (
Russell 2000 High Momentum ETF (
were both launched during May of 2011 by the Russell fund family in
an attempt to gain a competitive advantage in the High Momentum ETF
space. HMTH targets high momentum on large cap stocks and while
SHMO targets the same thing in the small cap space.
The investment strategy and index methodology of both the ETFs
is very similar. HMTM tracks the
Russell Axioma U.S. Large Cap High Momentum Index
which is a subset of the
Russell 1000 Index
whereas SHMO tracks the
Russell-Axioma U.S. Small Cap High Momentum Index
which is a subset of the
Russell 2000 Index
To construct the underlying index, both funds start with the
parent index and choose stocks which exhibit momentum
characteristics. This is measured as the cumulative returns of a
particular stock for the previous 250 trading days, barring the
last 20 trading periods.
In order to minimize higher portfolio turnover and transaction
costs, HMTM and SHMO limit their exposure to 200 and 400
stocks respectively from the appropriate category of their entire
universe of stocks (see more in the
Zacks ETF Center
Also, their portfolios are reviewed and rebalanced on a monthly
basis to focus on the current trends pertaining to high momentum
stocks. HMTH charges a paltry expense ratio of 20 basis points and
the expense ratio for SHMO stands at 0.30%.
However, both of these funds have failed to draw the attention
of investors, as indicated by the poor inflow into their asset base
and average daily volumes.
HMTM has an AUM of $5.21 million and an average daily volume of
just 2,876 shares. On the other hand, SHMO has managed to amass
nearly $5.04 million in assets under management and around 1,094 of
its shares exchange hands each day.
However these two ETF types have very little correlation with
the S&P 500, as indicated by R-Squared values of 25.40% for
HMTM and 15.84% for SHMO on a one year basis as of 30
June 2012 (read
The Trend Is Your Friend with These Three ETFs
From a performance perspective, both ETFs have managed to report
positive double digit returns this year, as calculated on 30
June 2012. HMTM is up by 11.63%, whereas SHMO has managed to gain
Russell Developed ex-U.S. High Momentum ETF (
is another offering by the Russell fund family which targets the
high momentum stocks from the international equity space. The ETF
captures the essence of developed market equities showing high
momentum characteristics. The index methodology for this product is
the same as HMTM and SHMO.
The fund tracks the
Russell-Axioma Developed ex-U.S. Large Cap High Momentum
which is a subset of the
Russell Developed ex-U.S. Large Cap Index
. Launched in November of 2011, it is the youngest of the three
high momentum ETFs by the Russell fund family.
XHMO also provides opportunities for international
diversification. Having said this, it is prudent to note that the
ETF will be subject to currency risk as it gives investors an
international flavor (read
Three Currency ETFs Outperforming the Dollar
). Moreover, it seeks exposure only to the developed market
equities which are significantly less volatile than their emerging
From a country exposure perspective, the assets of the ETF are
extremely concentrated in the top three nations, which account for
over 50% of its total assets. These include the United Kingdom
(24.80%), Japan (16.23%) and Canada (10.90%). Apart from these, the
ETF places its bets on other developed countries such as France,
Switzerland, Australia, and Hong Kong (see
Comprehensive Guide to Total Market ETFs
Due to its high exposure to the troubled European continent, the
ETF lags behind in terms of year-to-date total returns. As of 30
June 2012, XHMO is up only by 3.33%.
Also, an average daily volume of just 2,274 shares and total
assets of $4.99 million might be cause for concern for investors.
However, the ETF is relatively inexpensive, sporting 25 basis
points in fees and expenses.
Launched in August of 2007, the
ELEMENTS SPECTRUM Large Cap U.S. Sector ETN (
is perhaps the oldest in the high momentum exchange traded product
space. Despite this, the ETN lags behind its three exchange traded
peers in its group, and discussed above, in terms of total assets
and average daily volume. It has total assets of $1.41 million and
an average daily volume of just 1,091 shares.
The ETN tracks the SPECTRUM Large Cap U.S. Sector Momentum Index
which consists of the ten sub indexes of the S&P 500 Total
Return Index. EEH weighs its components on the basis of their
performance, relative to the S&P 500 Total Return Index.
The sub indexes which outperform the S&P 500 Total Return
Index are assigned higher weightings and the ones which
underperform are assigned lower weightings (read
Alternative ETF Weighting Methodologies 101
However intriguing the strategy may sound, it appears to have
failed to achieve its objective as of late. The ETN has returned
2.80% this year compared to the S&P 500 Total return index
which has returned 11.01% at the year's half way point
Also, of all the exchange traded products in the high momentum
space, the expense ratio for EEH is the highest, at a whopping 75
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ELEMENTS SPECTR (EEH): ETF Research Reports
RUSL-1K HI MOM (HMTM): ETF Research Reports
RUSL-2K HI MOM (SHMO): ETF Research Reports
RUSL-DV X-US HM (XHMO): ETF Research Reports
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