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Turnaround foreseen for struggling ETF

Special to The Globe and Mail

Here's an exchange-traded fund that is likely to break ahead of the pack in the long run: the PowerShares DWA Technical Leaders Portfolio Fund.

Based on back-testing results, the technical analysis-based fund, which is offered by Invesco PowerShares Capital Management LLC, has one of the widest margins of outperformance compared with other ETFs created within the past two years in Canada and the United States.

This ETF would have returned an average 13.2 per cent annually over the 10 years to June 30 if it had been tracking its underlying index, the Dorsey Wright Technical Leaders Index. That compares with 2.9 per cent for the S&P 500-stock index.

In dollar terms, the PowerShares fund would have converted $10,000 (U.S.) into $43,476 over the past 10 years - compared with $17,293 for the S&P 500 index.

The PowerShares fund was launched in March, 2007, and trades on the New York Stock Exchange under the symbol PDP. It tracks a basket of about 100 U.S. stocks exhibiting relative strength - i.e., their prices are rising relative to the market and their industry.

To identify relative strength, the creators of the Dorsey Wright Technical Leaders Index use the point-and-figure technique. (An explanation of it is contained at the bottom of the story.)

In brief, the point-and-figure method filters out small fluctuations in stock prices, with the object of riding underlying trends with upward momentum.

"There are times when momentum works and times when it does not," says Pierre Brodeur, a retired investment banker who maintains the Canadian Point and Figure blog at canadianpointandfigure.blogspot.com.

"But over the long run, by definition, their method [PowerShares] should provide above-benchmark results."

"During periods of high volatility, as we are experiencing these days, it is prone to whipsaws," Mr. Brodeur says, referring to buy and sell signals bunched close together.

With the U.S. stock market now in a bearish phase, the PowerShares fund is struggling.

To the end of August, it was down 13 per cent over the previous three months, compared with a drop of 8 per cent by the S&P 500 index.

Invesco PowerShares, which is based in Wheaton, Ill., introduced two similar ETFs earlier this year. The PowerShares DWA Developed Markets Technical Leaders Portfolio Fund (PIZ) tracks technical leaders in developed countries other than the United States, while the PowerShares DWA Emerging Markets Technical Leaders Portfolio Fund (PIE) tracks technical leaders in emerging countries.

According to back-tests, these two ETFs are more volatile than their U.S. cousin but are likely to deliver higher returns if the trend is bullish. Over the five years to June 30, the average annual growth in the underlying index for PIZ was 22.7 per cent, 39.4 per cent for PIE, and 15.1 per cent for PDP.

The comparable figure for the S&P 500 index was 7.6 per cent.

However, back-testing results overstate performance because annual expense ratios are not deducted. They are 0.72 per cent for PDP, 0.8 per cent for PIZ and 0.9 per cent for PIE. That compares with fees ranging from between 0.17 per cent and more than 1 per cent for other U.S. ETFs.

Brokerage commissions, typically ranging between $9.99 and $29, must also be factored in.

What is point-and-figure technical analysis?

The point-and-figure technique plots Xs and Os on a chart, with the price of the security on the vertical axis. The chart is started off by marking the current price of the stock, say $15, with an X to the left of the vertical axis. If the daily change in price subsequently exceeds a predefined threshold, say $1, another X is put at the $16 level, above the first X. If more daily changes surpass $1, a stack of Xs will appear, like the column on the far left of the chart shown.

If the price ends $1 lower on a given day, an O is placed to the right of the Xs, at the new price. If Os are added for every daily drop of $1, a stack of Os will appear like the one next to the first column of Xs. If the price reverses and goes up again, a new stack of Xs is started. And on it goes until after a while, the chart looks like the one shown here.

Whenever a stack of Xs breaks above the upper level of previous X stacks, called the resistance level, there is a breakout on the upside, such as the tallest stack shows. This is a buy signal in the basic version of the technique.

The position is held until a stack of Os breaks below the bottom boundary of the prior O stacks, called the support line.

This article was written for Globe Investor Magazine Online.

© 2007 The Globe and Mail. All rights reserved.

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