Intellectual Property Makes ETF Look Smart
Roger Nusbaum
08/19/08 - 11:00 AM EDT
In late 2006, I
wrote favorably about the then-new
Claymore Ocean Tomo Patent ETF(OTP Quote).
The fund invests in 300 companies with the highest patent ratings, on the basis of a proprietary scoring model of the portfolios of the 1,000 largest U.S.-traded companies, including American depositary receipts. The big theme is that intellectual property is more valuable than hard assets such as plant and equipment.
On that basis, OTP is going to be a large-cap vehicle that will usually tilt toward growth. As you can see from the chart, OTP has blown away the
S&P 500 since its inception and has also meaningfully outperformed since the October peak (OTP is down 13%, and the index is down 17%):
I believe the primary reason for the diversion is that OTP has 2% in financial stocks compared with 14% for the S&P 500 (down from 20% when OTP first listed). Most of the stock market's deterioration since then has occurred in the financial sector, so it is only logical that a broad-based fund that is underweight in the sector would have done much better.
Technology is the largest sector in OTP at 22.81%, followed by health care at 20.11%, energy at 17.21% and industrials at 13.78%. Sector weighting gets much smaller from there.
Most of the individual holdings will be recognizable names. The top three are
General Electric(GE Quote),
Microsoft(MSFT Quote) and
Procter & Gamble(PG Quote). As mentioned above, the fund also owns ADRs. The current foreign allocation is 17%. The weak dollar over the past couple of years has given a little bit of a tailwind to OTP.
But having essentially no financial exposure is a two-way street. Over the last month, the
Financial Sector SPDR(XLF Quote) has snapped back 25%, helping the S&P 500 outperform OTP by 3% over that time. While one month may not mean too much, it does offer a glimpse into the future.
After the carnage that the financial sector has endured thus far, it makes sense to expect a monster rally (not to say it won't go down a lot more first). When the big one does come, I would expect OTP to lag then as well.
The bigger takeaway here is that it is unlikely that any one method can always be the best way to invest. I was favorably disposed to OTP in that first article in part because the inverted yield curve suggested trouble for financials. (This is something I wrote about countless times in
TheStreet.com articles and on my blog.)
From here going forward, the financial trade is less obvious, because the sector has already been cut in half (and may be working its way back). More bad news is very likely to come from the sector, and expecting at least one more failure bigger than
Bear Stearns is a good bet. But still, the sector is now down 40% from its peak.
Another potential obstacle for OTP over the next couple years goes back to the yield curve. Historically, a steeper yield curve has favored value stocks over growth, and usually the curve steepens with the start of a new economic expansion. OTP's growth-over-value bias creates visibility for OTP to lag.
This would be consistent with the back-test done before the fund first listed. Over the life of the back-test (1997 through Nov. 30, 2006), the underlying index outperformed by an average of 3% per year, and it had a better year than the S&P 500 only half the time.
OTP does have one big problem: It has very little volume and assets (1,350 shares per day and $10 million in assets, according to Yahoo! Finance). Claymore shut down 11 funds a few months ago for lack of assets and trading volume. I doubt it wants to shut down more funds so soon, but this risk does exist. The potential consequence to investors is a taxable event: When a fund closes, it pays out the net assets as of the last day. So, in other words, investors don't lose all their money.
Looking beneath the hood in this manner is probably only useful for people who are willing to take a more tactical approach to investing. I believe OTP shows that tactical success can be achieved with broad-based products, as opposed to just with individual stocks, country funds or sector funds.
