Historically, consumer staples sector has been categorized as being defensive in nature and a safe haven in times of market turbulence. Consumer staples are usually those produce we use every day regardless of economic conditions, and include cigarettes, soaps, beer and liquor, and food. Consumer staples firms are typically low growth with below average dividends, and are considered lower risk.
Investors gravitate to consumer staples as a balance to their higher growth positions and to lower the volatility of their portfolios.
However, with the advent of “smart” ETFs, investors can now goose up their returns. Invesco PowerShares has teamed with Dorsey Wright Associates to offer a line of ETFs that incorporate stocks that are in the top of their sector for relative strength, or those who have performed better than their peers. The portfolio is adjusted quarterly to reflect updated performance. The ETF holds around 30 positions.
As an example of the quarterly rebalancing, at the first of the year, the ETF removed Jarden Corp (JAH), Snap-on Corp (SNA) and Dr Pepper Snapple (SNA) from their top 10 positions and replaced these with Kroger, Tyson Foods, and UHaul Amerco.
The key to this ETF is the quarterly rebalancing. Within the sector, Dorsey Wright identifies those firms and stocks that have outperformed their peers and holds about 30 to 35 of these companies. From their website: Relative Strength, the measurement of how one security performs in comparison to another, is a key concept within Dorsey Wright's methodology. Before investing in UPS, one should understand its recent performance relative to FedEx, or the S&P 500. The same logic can be applied to sector analysis, asset class evaluation, mutual funds, ETFs, commodities, fixed income, and even foreign countries. A relative strength matrix is like a massive tournament, where a huge quantity of investment options can be compared to one another - and we see who is strongest. Relative strength is the basis for virtually all of our managed products, where we select the best investment options from within a large universe of options.
PSL has outperformed both the S&P 500 and the S&P Consumer Staples ETF (XLP). In 2015, PSL returned 12.14% while XLP returned 5.82%. PSL has returned 22.9% annually over the previous 3 years and 21.3% annually over the previous 5 years, compared to 18.9% and 16.9% respectively for XLP.
The divergence in performance favoring PSL accelerated in mid-2014. However, reviewing previous years, PSL outperformed has outperformed the S&P 500 and at a minimum matched its sector peer.
However, as a “smart” ETF, the portfolio is actively managed. Unlike the S&P Indexes, PSL adjusts its portfolio four times a year, incurring both higher costs and higher risks. A few months ago, Financial Industry Regulatory Agency, FINRA, issued an Investor Alert titled, "Smart Beta-What You Need to Know". The bottom line of the alert is the old adage: Know what you are buying and what the strategy is of the specific ETF. There are about 840 products that fall into a smart beta category, representing almost half of all the exchange-traded products listed in the U.S. and investors should understand that any strategy that aims to beat the market carries its own risks.
The FINRA report concludes, "Recently, there has been significant growth in the number of financial products, primarily ETFs, which are linked to and seek to track the performance of alternatively weighted indices. These indices are commonly referred to as "smart beta" indices. They are constructed using methodologies that rely on, for example, equal weighting of underlying component stocks, or measures such as volatility or earnings, rather than market-cap weighting. Investors need to understand there is no free lunch here. Any time you are deviating from the market, you're taking some kind of tilt. Understand what the fund is doing that is different than the market. That is a risk."
A copy of the FINRA Alert is below:
Investors looking to boost their exposure to the defensive nature of consumer staples would be well advised to add PSL. However, also heed FINRA’s advice and make sure you are comfortable with the added risks of this actively managed ETF.
This article first appeared in the Feb issue of Guiding Mast Investments. Thanks for reading, George Fisher