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

A new Claymore ETF is an interesting take on the economy.

A few days ago I wrote about the new Claymore/Sabrient Defender ETF (DEF) - Get Free Report 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) , 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) - Get Free Report


I was not able to get dividend information for OTP, but using the yield from

iShares S&P 500 Growth Index Fund

(IVW) - Get Free Report

as a proxy, OTP might yield close to 1.21%. The

WisdomTree High-Yielding Equity Index Fund

(DHS) - Get Free Report

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.)

In theory, this combination could deliver an extra 3.5% to 4% per year of return over just holding SPY. You can decide for yourself if the concept is valid or whether the back test makes sense to you, but these are broad-based index funds, so realistically, a worst-case scenario, if my idea is completely upside down, is a lag of a few percentage points.

One caveat: I mentioned the back test outperformed the S&P 500 by 3 percentage points annually for 10 years. However, it lagged the S&P 500 for the last five-, three- and one-year time periods. This may actually strengthen the case for OTP as a large-cap growth proxy, as the iShares S&P 500 Growth Index Fund also lagged the broader S&P 500 for those same time periods.

Another big strike against OTP in this role might be in the details of the back test, with most of the success coming in just three years: 1999, 2000 and 2003. Candidly, I am not sure what to make of this. It could be argued that the strategy is inconsistent, so perhaps another themed ETF could be better.

The more important thing to me is that as new funds come, they may or may not add value, but in the case of OTP, just trying to guess what patents might do for your portfolio might miss the benefit that a new fund could bring.

At the time of publication, Nusbaum held no positions in the stocks mentioned, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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