This ETF Will Work...Until It Doesn't

First Trust Dorsey Wright International Focus 5 ETF IFV has received arguably the least amount of fanfare among the most successful ETFS. Just 10 months after coming to market, the First Trust Dorsey Wright International Focus 5 ETF is now home to $641.1 million in assets under management.

Judging by flows data, IFV got off to a slow start as essentially all of the ETF's current assets under management tally has flowed into the fund this year. Of course, it is worth noting IFV enjoys a big marketing advantage. It is the international equivalent of the wildly popular First Trust Dorsey Wright Focus 5 ETF FV. FV does not turn two until March and it already has over $4.2 billion in assets.

IFV applies the methodology used by FV at the international level. Meaning IFV holds five First Trust single-country or regional funds displaying favorable momentum characteristics. IFV's current lineup includes the First Trust United Kingdom AlphaDEX Fund FKU, First Trust Switzerland AlphaDEX Fund FSZ and the First Trust Germany AlphaDEX Fund FGM.

The drawback with momentum strategies, including those applied within ETFs, is that while they shine during bull markets, they are often swiftly rejected during market declines.

“Momentum can work really well for a period of time, typically during a bull market. But when the market suddenly turns, momentum strategies tend to be overweight in areas that fall the fastest. So, net-net, over a full market cycle, any outperformance during the bull market can get wiped out during a market decline. For example, in 2011, when the MSCI EAFE Index was down about 12%, a similar Dorsey Wright international-equity ETF declined 18%,” according to Morningstar.

To be fair, IFV is up nearly 3 percent over the past year while the MSCI EAFE Index is higher by just 0.4 percent. However, FV can teach investors some lessons about what to expect with IFV when the latter's holdings fall out of favor.

For example, FV languished almost immediately out of the gate because soon after that ETF debuted, 2014's brief bear market for biotechnology and Internet stocks struck. And although FV's year-to-date performance looks good, the ETF is off almost 11 percent over the past 90 days, a period that includes significant retrenchment in biotech stocks.

Relative strength analysis of IFV's holdings is conducted weekly, so it is possible that if country- or region-specific issues come to pass, IFV can quickly ditch a problem ETF and then rebalance to equal weight at quarter end.

“This strategy is based on the observation that areas of the market that are currently outperforming tend to continue to outperform. So far, the fund's strategy is working. Over the last year, it outperformed its market-cap-weighted benchmark by about 500 basis points,” notes Morningstar.

However, the research firm also notes the problem with an ETF like IFV is that ordinary investors are likely to buy high and sell low.