'Patent' ETF a Way to Play Large-Cap Growth

A few days ago I wrote about the new Claymore/Sabrient Defender ETF (DEF Quote) as having a secondary effect of being a proxy for large-cap value. That same day, Claymore listed the Ocean Tomo Patent 300 ETF (OTP Quote), which could be a proxy for large-cap growth.

The big-picture idea behind Ocean Tomo Patent 300 ETF is that as the U.S. economy has evolved, there is now more economic value to be derived from intangible assets, like patents, than from tangible assets, like plants and equipment. Without being an expert on this, it does seem intuitive that the idea at least has some merit.

As you might expect, the back test also supports the idea. Over the last 10 years, the patent weighting has averaged 3 percentage-point better returns annually over the S&P 500, with a 92% correlation to the index. The methodology assesses the economic value of a company's patent portfolio, then assigns a score to that portfolio and ranks it with other companies. The universe of companies is the 1,000 most-liquid stocks, which creates a tilt to large-cap.

When I first heard about this fund, it occurred to me that financial companies don't have much in the way of patents, and sure enough, I was told in an interview with Ocean Tomo that there is only one stock from that sector in the fund.

It was at this point that the secondary effect as a large-cap-growth proxy seemed plausible.

While the back test was a decade, the real-world trading is only a few days, so there may not be much immediacy to buy the fund. But I believe there is an interesting strategy that presents itself if the fund lives up to the back test.

To repeat, the thesis is that OTP is a large-cap growth proxy. I believe that most of the large-cap dividend ETFs are likely proxies for large-cap value. A blend of the two could offer better results than just holding the S&P 500 SPDR (SPY Quote).

I was not able to get dividend information for OTP, but using the yield from iShares S&P 500 Growth Index Fund (IVW Quote) as a proxy, OTP might yield close to 1.21%. The WisdomTree High-Yielding Equity Index Fund (DHS Quote) is supposed to yield roughly 3.5%. A 50/50 mix could yield 2.35%, compared with 1.71% for the S&P 500.

As mentioned above, OTP's back test has beaten the S&P 500 by an average of 3 percentage points a year. The DHS fund from WisdomTree has outperformed by an average of 3.5 percentage points over the last 10 years. (I should note that WisdomTree's back test was against the Russell 1000, which has a 95% correlation to the S&P 500.)

The TOMO With Momo Ocean Tomo 300 Index annual total returns vs. S&P 500 Index
Year	Ocean Tomo 300 index	S&P 500 Index
1997	29.75%	33.36%
1998	26.72	28.58
1999	33.59	21.04
2000	6.37	-9.11
2001	-5.82	-11.88
2002	-28.81	-22.1
2003	40.21	28.68
2004	10.03	10.88
2005	7.46	4.91
YTD through 11/30	11.63	14.19
* Annual total returns are for the noted 1-year periods beginning 12/31 and ending 12/31 the following year Source: Zephyr StyleADVISOR