Today, March 1st, the Invesco Dorsey Wright Momentum ETF ([PDP]) celebrates its 17th birthday. The strategy made its debut on March 1st, 2007, becoming the first momentum ETF to list in the US, and the first ETF to track a Dorsey Wright Index for that matter. [PDP] follows our Technical Leaders Index methodology, and over the years, NDW has partnered with Invesco to bring additional ETFs that track Dorsey Wright indices using the Technical Leaders approach. Today, we want to briefly review the methodology underlying PDP, highlight the fund’s historic outperformance last month, and explain what that could mean for the momentum factor at large going forward.
There are a few steps to our indexing methodology which we call “Technical Leaders,” but none are overly complicated. In short, every quarter we apply the Relative Strength process to compare approximately 1,000 large and mid-cap US stocks, and then select 100 names with the most favorable technical characteristics. The quarterly reconstitution process’s goal is to weed out the weak names and realign the portfolio toward strength. That process can involve a great deal of turnover, or very little change, depending upon how stable the existing market leadership has been.
While there are now many Technical Leaders-based products in the Invesco lineup, they all follow the basic methodology steps shown in the graphic.
Two of the past three years (2021 and 2023) have been very difficult for trend following/momentum strategies because of the reasons outlined in the year links. Note that sandwiched between 2021 and 2023 was a fantastic environment for trend following as discussed here. Unfortunately, one year of good performance amid a bigger drought has not done enough to put PDP at the top of long-term performance tables; however, recent market data suggests the tides could be changing.
Momentum is off to a great start in 2024. In February, PDP had a notable performance; the fund gained 9.62% which outpaced the S&P 500 ([SPY]) with a gain of 5.22%. Since the inception of index data in the mid-1990s there have only been 25 other months when PDP has beat SPY by more than 4% in a single month, but just six times in the past two decades has this been the case! Said differently, 19 of those 25 total occurrences happened more than 20 years ago.
The image below plots the monthly relative performance for PDP over SPY in the last 20 years. Positive readings (green bars) indicate PDP outperformed while negative readings (red bars) indicate SPY outperformed.
A huge monthly outperformance is nice, especially for those invested, but is there evidence suggesting the possibility that the momentum/trend could continue? The data says yes. In fact, the data would argue that it is probable.
We contrived said data by looking at each instance where PDP outperformed SPY by at least 4% in a single month. There is nothing special about 4%, it is just among the largest number we have seen in the past 20+ years. Once we isolated all the 4%+ monthly alpha occurrences, we then eliminated duplicate prints within six months to help isolate market environments and reduce the effect of clusters. Of course, this is not a perfect science nor an airtight academic environment; nonetheless, the study yields interesting results. We bulleted several key observations underneath the table.
- After each of the last eight occurrences, PDP and SPY were positive one year later every time. Furthermore, PDP outperformed SPY in six of the eight years which is a 75% beat rate
- Of all the filtered events (15), PDP outperformed SPY about 70% of the time across time horizons beginning three-months out.
- The relative return distribution is asymmetric, favoring PDP.
- Notice that the “Average If Positive” relative returns are of far greater magnitude across every time horizon (except three-months) than the “Average if Negative” relative returns.
- There is more to gleam from the data, but the main takeaway is that quick bursts of outperformance from momentum do not typically signal exhaustion from the factor. Naturally, there are negative outliers: February and August 2000, January 2006, and May 2020…but these occurrences are not the norm.
Also, on the qualitative front, even if all the investment strategists calling for a market stagnation/correction are correct momentum can still outperform; in fact, it could be even better for the factor. If breadth falters (again), that too could act as a relative tailwind because momentum only owns the cream of the crop anyways. As a trend following shop, we are of course biased, but objective evidence appears to be building that suggests better times ahead for momentum.
Disclaimer:
This article is intended for Financial Professional Use Only.
Click here for more information from Invesco on the Invesco DWA Momentum ETF (PDP): https://www.invesco.com/us/financial-products/etfs/ product-detail?audienceType=Investor&ticker=PDP
Dorsey, Wright & Associates, LLC is owned by Nasdaq, Inc. and we have affiliates who also provide financial services, research, information, and act as Brokers/Dealers to a wide variety of clients. Our affiliates use the information we create to create indexes, which are then used to create Exchange Traded Funds. These things create a potential conflict of interest in that we may have an incentive to promote or use the products and services of our affiliates and business partners. A number of Dorsey Wright representatives are registered with and hold securities licenses with the affiliate broker-dealers. In this capacity, they assist with the marketing and distribution of Exchange Traded Products.
Nasdaq Dorsey Wright is a registered Investment advisory firm. Registration does not reflect any certain level of skill or training.
Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey Wright. The relative strength strategy is NOT a guarantee. There can be times where all investments, asset classes, and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.
The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources believed to be reliable (“information providers”). However, such information has not been verified by DWA or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein. DWA and the information provider accept no liability to the recipient whatsoever whether in contract, in tort, for negligence, or otherwise for any direct, indirect, consequential, or special loss of any kind arising out of the use of this document or its contents or of the recipient relying on any such recommendation or information (except insofar as any statutory liability cannot be excluded). Any statements nonfactual in nature constitute only current opinions, which are subject to change without notice. Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This document does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. Advice from a financial professional is strongly advised.
There are risks inherent in international investments, which can make such investments unsuitable for certain clients. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. Dorsey Wright, and its affiliates make no representation that the companies which issue securities.
Indexes are unmanaged. It is not possible to invest directly in an index.
© Copyright 2024. All rights reserved. Nasdaq® and the Nasdaq Stock Market® are registered trademarks, or service marks, of Nasdaq, Inc. in the United States and other countries.