Crafty combos of different ETFs—‘ETF alchemy’—is the wave of the future in the world of money management, Tom Dorsey says.
Tom Dorsey, president and founder of Dorsey Wright & Associates, has been around ETFs 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 management.
IU.com: 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?
Dorsey: 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 alchemy.”
IU.com: ETF alchemy?
Dorsey: Think about this for a second: If I take H2 and I add O, what do I get?
Dorsey: 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.
IU.com: 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?
Dorsey: 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.