Momentum ETFs Dinged By Market Pullback

Momentum, an investment factor rooted in the idea that a security that has already appreciated in price can continue doing so, makes a predictable candidate to overshoot declines when the broad market declines.

When it comes to momentum-based exchange traded funds, however, various funds apply momentum in different ways, creating significant performance-level differences.

What Happened

The iShares Edge MSCI USA Momentum Factor ETF MTUM recently boosted its allocation to technology stocks to almost 40 percent of its weight, more than triple its weight to health care, its second-largest sector weight. Even with that increased tech exposure, MTUM is down about 1.60 percent in May, far better than the 5 percent shed by the S&P 500.

“Using momentum ETFs, investors can gain some diversification using this approach, but it is important to understand the exposure is not static and that momentum funds can be quite different,” said CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth in a note out Thursday.

Rosenbluth has an Overweight rating on the $8.55 billion MTUM, which tracks the MSCI USA Momentum Index.

Why It's Important

The First Trust Dorsey Wright Focus 5 ETF FV is another momentum-based ETF. FV adheres to Dorsey, Wright & Associates (DWA) relative strength methodology and has a selection universe consisting of First Trust industry and sector funds.

Recently, FV removed the First Trust Health Care AlphaDEX Fund FXH, a health care ETF heavy on the sector's growth industries, in favor of the more conservative First Trust AlphaDEX Utilities Fund FXU.

“But while MTUM invests in stocks with strong price momentum, the $2.4 billion FV holds equal stakes in five sector or industry ETFs offered by First Trust with the best relative strength,” said Rosenbluth. “The analysis used for FV is conducted twice monthly, but ETFs are replaced when they fall sufficiently out of favor, which helps to limit turnover.”

What's Next

Although FXU is FV's largest holdings, the four other ETFs residing in FV are biotechnology, Internet and technology funds, indicating the fund is hardly defensive and explaining why FV is lower by nearly 7 percent this month.

CFRA has an Overweight rating on MTUM and does not rate FV.

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