Systematic Relative Strength

ETFdb has a good article on Ten New Years’ Resolutions for ETF Investors. One of their suggestions is to consider other weighting methodogies. Although it may seem like a very technical topic, weighting can make a difference:

If you achieve equity exposure through an ETF, chances are at least one of the funds you own is linked to a market capitalization-weighted index. Most equity ETFs are, simply because many of the best-known equity benchmarks are cap-weighted–meaning that weightings to individual securities are determined based on the value of components’ equity (market capitalization is equal to shares outstanding multiplied by price per share). But some investors have expressed concerns over the methodology used to construct and maintain cap-weighted indexes. Because there is a direct link between stock price and the allocation an individual security receives, there is a tendency to overweight overvalued stocks and underweight undervalued stocks.

There are a number of equity ETFs linked to indexes constructed using various other weighting methodologies, including equal-weighted and dividend weighted funds. Generally, there will be considerably overlap between these funds, with the weighting strategy being the primary difference. And while this may sound like a relatively minor twist, the impact on bottom line returns can be material.

It is true that the difference in returns can be material. They demonstrated some of the options in the following table from the article, with returns through 12/21:

A range from 12.7% to 21.0% is certainly significant. Unfortunately, ETFdb neglected to consider another weighting methodology: relative strength weighting. The PowerShares DWA Technical Leaders Index takes the same basic universe as the ETFs in the table, but it plucks out the strongest ones and weights them by relative strength. Through 12/21, the return for the index portfolio ETF, PDP, was up 27.2%, outstripping everything listed in the table. Something to keep in mind.