Tom Dorsey, president and founder of Dorsey Wright &
Associates, has been around
since before they were even called ETFs. In other words, you
won't find a bigger ETF enthusiast. In fact, his business of
point and figure technical analysis is now focused on ETFs, and
their role in all he does will only increase.
Dorsey is always quick to say he considers the ETF the most
important financial innovation in his nearly 40-year career in
the money management industry, and sees ETF development so far
amounting to the first foot of a 26-mile marathon.
To put a finer point on that, he told IndexUniverse.com
Managing Editor Olly Ludwig that while development of individual
ETFs is likely to slow down, what he calls "ETF alchemy"-an
active overlay involving the combination of different ETFs to
enhance returns-is already taking off in the world of money
In the first four months of 2013, asset gathering for
U.S. ETFs was in the neighborhood of $64 billion, and on pace to
beat 2012's record of $188 billion. Are you surprised? Is the sky
the limit? How far is this ETF juggernaut going to go?
Well, I don't think the sky is going to be the limit. I don't know
that there are any more ETFs that anyone can bring out that will be
the new fandango. The key word here is a phrase I coined:"ETF
Think about this for a second:If I take H
and I add O, what do I get?
Yes, water. Each one of those two elements is separate. But when I
combine the two, I come up with a substance-water-that you can't
live without. Each one separately is not as good as the two
combined. And the concept here is, What's out there in terms of
ETFs I can combine together to make a better product?
Take for instance the Standard & Poor's Low Volatility
Index-and if you add that to PDP, which is our Technical Leaders
Index, and combine the two, it's like taking two glasses of water
and pouring them into one bigger glass of water, 50-50. I end up
with a better product than either one of them separately.
You'll find this as we go along:the ability to combine different
ETFs to create a better unit where the whole is better than the sum
of its parts.
You're combining the PowerShares DWA Technical Leaders
Portfolio (NYSEArca:PDP) and the PowerShares S&P 500 Low
Volatility Portfolio (NYSEArca:SPLV) in that example? Can you be
a little more granular about how this combination is established
or how it works in practice?
The way it works is the Standard & Poor's Low Volatility is
exactly what it suggests. So, a low-volatility version of the
S&P 500 would be more of a beta type of thing, and I want to
add alpha to that, which would be PDP. Our PDP outperforms all of
its bogeys:the S&P 500, the Equal Weight S&P 500, whatever
you want to compare it to, but PDP outperforms it.
But in times of market consolidation, you want something in that
combination that has some brakes, and that is the Standard &
Poor's Low Volatility Index. I can do the same thing with our
PowerShares DWA Emerging Markets Technical Leaders (NYSEArca:PIE),
our emerging market ETF. It outperforms, hands down (NYSEArca:VWO)
and (NYSEArca:EEM) which is another story unto itself. But why stop
there? Take the PIE, let's say, and add it to (NYSEArca:EELV),
which is emerging market low volatility. Combining those two I have
a better product.
I only mentioned our products because that's mostly what we have
worked with in putting these into our backtester. And by taking
these together, you're creating something that, working in
combination, is better than any one of them by themselves. And you
can create models in this way, and I think that's ETF alchemy. The
"alchemy of ETFs" is combining things together to make better
products, and that is really where this is going to end up being
the biggest play for portfolios.
You're saying that the ETF world is quite possibly
saturated already. But this ETF alchemy frontier is going to
afford a whole new impetus to allocate to the exchange-traded
approach. So, what does this mean for mutual funds?
Well, for mutual funds, as long as there is a commission trailer,
and as long as it's beneficial to the advisor selling the mutual
fund, I think you'll see flows continuing to go into mutual funds.
If they were able to, say, make mutual funds equal to ETFs, where
you just had one fee and there was no trailer, nothing combined to
it, I think at that point you would find that mutual funds would
begin to lose a lot of money, and that it naturally would be put it
into ETFs. Until that happens, and you still have the trailers, and
it's beneficial for the broker to own mutual funds, you're going to
see still a lot of money in mutual funds.
t the risk of sounding a little snarky, you're saying that
as long as the gravy train of brokerage fees in the form of a
trailers, for example, remains, that will be what preserves the
mutual fund-even though that's probably not in the interest of
investors in terms of taking some of their returns out of their
pockets and into the pockets of brokers?
Yes, this is not telling stories out of school or anything like
that. It's the trailers. If you're an advisor and you're getting
that trailer, and it means more money to you to be recommending
that, then firms are going to want you to do that.
The key for the ETFs for the advisor is being in a program in
which the advisor is the portfolio manager, like where the broker
charges a fee for what he does. Then the ETF is going to make more
sense to him at that point in time.
ETFs are now 20 years old-the SPDR S&P 500 ETF
(NYSEArca:SPY) was launched in January 1993. And this ETF
alchemy, as you're describing it, is the new frontier. In terms
of time, when do you see this ETF alchemy manifesting and
becoming a bigger part of how ETFs are used and integrated
into investment portfolios?
Well, it's already happening. At Dorsey Wright, we're probably the
first ones to have begun modeling ETFs out there. We've had models
actually running for iShares since 2002, and we were modeling long
before that. People have picked up on that, and as more people
create models, they're fundamental, they're technical, they're
built in many, many different ways. Ours are 100 percent relative
strength, where we compare and contrast different things like our
PDP. Our technical leaders are the 100 strongest relative-strength
stocks out of 1,500. And that's updated every quarter.
IU.com:Are you pretty much of an unequivocal fan of ETFs,
or do you see some downsides?
The reason I'm an unequivocal fan is, No.1, I'm probably the first
person to ever be involved with an ETF with the Philadelphia Stock
Exchange when they created the index participation unit which was
the first ETF that ever traded in the 1980s. It was a Standard
& Poor's 500 security.
The problem with that first one is we used derivatives as the
underlying, and ultimately we were sued by the futures exchange as
being a futures product instead of a fund, and the futures exchange
won and took the product.
Right, I've heard about those.
So when that didn't work, the Toronto Exchange came to the
Philadelphia exchange and said, "Hey, could we use your template?"
The Philadelphia exchange gave them a template and they came out
with the TIPs, Toronto index participation units. But the
difference here is the underlying was real stocks. So it was the
first one that took and traded and has been trading every
So that's really the first ETF.
Yes, and I can't tell you how many seminars I have taught to
professionals on ETFs and the eyes that widen and the lives that
change once they understand it and understand how to use it; it
tells me we're on the right path and this is the exact right
Like I've said to you before, it's probably the most important
product ever created in my 39 years in this business. And I believe
back then when I talked to you that we're in the first foot of a
And regarding this educational effort that needs to take
shape over the coming years, when does a typical investor with
sizable investable assets turn to his or her broker and say,
"Listen, we need to segue my holdings into an ETF wrapper"? Will
that happen in five years, or 10 years? What do you
I'd say we'll be a long way down the road in five years. So, any
stockbroker out there, any advisor, had better embrace ETFs, had
better embrace ETF alchemy and understand how to put these
portfolios together, and companies like DWA need to help brokers.
Because as fees and commissions continue to get more compressed,
they have to find new ways to go out and talk to the public and get
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