karelnoppe
The Invesco Dorsey Wright Industrials Momentum ETF (NASDAQ:PRN) leverages a momentum strategy focused on racy industrial stocks, defined proprietarily. This approach is capable of delivering meaningful returns when the stars align, as past performance has illustrated. However, there are a few issues with this vehicle.
First, the current market environment does not look entirely supportive of the momentum style and high-beta stocks overall. Both bulls and bears can leverage the August CPI report to construct their hypotheses on the market’s trajectory in the upcoming months. Bulls would likely say inflation is on its way lower as expected, adding that a marginal decline in the 10-year Treasury yield is a harbinger of a broader tech/growth rally resuming shortly. Bears would almost certainly label it wishful thinking and point to the fact that the CPI has come in above consensus. Also, the oil market rally has been reinvigorated by the extended production cuts and the China slowdown risk shrugged off, and higher commodity prices are yet to percolate into the headline CPI, potentially translating into fresh surprises in the next inflation readings and, in the worst-case scenario, making the Fed’s job of bringing it back to the comfort zone harder and thus deferring the nearest rate cut, ruining bulls’ hopes of the hawkish era finally ending in early 2024.
And even though I am not decidedly bearish, I believe there is a risk of high-beta strategies underperforming in the short term, which makes PRN unattractive. Also, as a long-term holding, the ETF is unattractive again as it has underperformed a few simpler industrial ETFs as well as the iShares Core S&P 500 ETF (IVV) since the strategy change in 2014, delivering much steeper drawdowns.
Strategy: Centered on Relative Strength
According to its website, PRN tracks the quarterly rebalanced and reconstituted Dorsey Wright® Industrials Technical Leaders Index, which:
is designed to identify companies that are showing relative strength (momentum), and is composed of at least 30 securities from the NASDAQ US Benchmark Index.
Relative strength, the cornerstone concept of the strategy, is defined as:
the measurement of a security’s performance in a given universe over time as compared to the performance of all other securities in that universe.
As described in the index methodology, the 2,000 constituents of the NASDAQ US Benchmark Index with the largest market capitalizations are the selection universe.
Incepted in 2006, PRN changed its strategy in February 2014, replacing the Dynamic Industrials Sector Intellidex Index with its current underlying index. For this reason, only the March 2014-August 2023 period will be assessed in the performance discussion section.
Delving Deeper: The Factor Story
As of September 8, PRN had 44 holdings (excluding a money market fund), with the group of the main ten having a 38% weight. An important note here is that the index uses “DWA’s proprietary industry classification system,” so investors should be prepared for exposure to GICS sectors other than industrials. More specifically, the PRN holdings dataset shows one stock from the energy sector, Dorian LPG (LPG), one materials company, Graphic Packaging Holding (GPK), 6 holdings from the IT sector, with Jabil (JBL) being the largest with a 2.6% weight, and one financial company, Fiserv (FI); in total, these positions account for over 16.3% of the net assets.
All three main equity echelons, from small to large caps, are present, though with a notable tilt toward the latter. For better context, the weighted-average market cap stood at $21.96 billion as of September 12, a figure impacted by approximately 59% of the net assets allocated to companies valued at more than $10 billion. The table below is supposed to offer more context on PRN’s current factor exposures.
| Metric | PRN |
| Market Cap | $21.958 billion |
| EY | 4.42% |
| P/S | 3.55 |
| EV/EBITDA | 16.45 |
| EV/Cash Flow | 22.79 |
| ROE | 25.15% |
| ROA | 9.24% |
| EPS FWD | 17.52% |
| Revenue FWD | 11.87% |
| Quant Valuation (B- or higher) | 20.44% |
| Quant Valuation (D+ or lower) | 64.4% |
| Quant Profitability (B- or higher) | 78.2% |
| Quant Profitability (D+ or lower) | 4.34% |
| Quant Momentum (B- or higher) | 86.5% |
| Quant Momentum (D+ or lower) | 2.17% |
| 24-month beta | 1.1 |
| 60-month beta | 1.29 |
Calculated using data from Seeking Alpha and the fund; holdings as of September 8, financial data as of September 12
What can be deduced from the above?
- First, the current version of the portfolio is heavy in high-beta stocks, which is completely normal for a momentum strategy. For example, among the top contributors to the weighted-average figure is Fluence Energy (FLNC), with its 24-month beta at 2.13.
- It seems this cohort is valued adequately, with the earnings yield being on par with the one offered by the market. Also, the EY is supported by a solid forward EPS growth rate as well as decent quality as shown by ROE, ROA, and the large share of holdings with a B- Quant Profitability rating or higher.
- On the negative side, EV/EBITDA, a more reliable metric when it comes to industrials, is pointing to valuation issues nonetheless, as the weighted average is significantly above the sector median of 11.86x. EV/Cash Flow, as well as an over 64% share of holdings with a D+ Valuation rating or worse, tell a similar story.
Performance: Bleak Long-Term Returns
Since the beginning of the year, PRN has been on a tear, mirroring the broad market’s value-agnostic rally. In this regard, the ETF’s A- Momentum grade does not come as a surprise.
Besides, as the table above shows, 86.5% of the holdings (36 stocks) have a Momentum rating of no less than B-.
However, investors should not focus too much on the most recent returns, as the longer periods provide an entirely different view. To illustrate that, I created the following table compiling total returns over the March 2014-August 2023 period. Here, PRN is benchmarked against IVV, the Industrial Select Sector SPDR Fund (XLI), and the Invesco S&P SmallCap Industrials ETF (PSCI). And the results do not speak in favor of it, as it delivered the weakest annualized total return. The max drawdown of 30.37% is another disappointment; however, PSCI still had a steeper drawdown as well as a higher standard deviation.
| Portfolio | PRN | IVV | XLI | PSCI |
| Initial Balance | $10,000 | $10,000 | $10,000 | $10,000 |
| Final Balance | $23,318 | $28,905 | $24,896 | $24,582 |
| CAGR | 9.32% | 11.82% | 10.08% | 9.93% |
| Stdev | 18.93% | 15.04% | 18.24% | 22.05% |
| Best Year | 36.39% | 31.25% | 29.09% | 29.60% |
| Worst Year | -25.09% | -18.16% | -13.24% | -13.20% |
| Max. Drawdown | -30.37% | -23.93% | -27.13% | -35.31% |
| Sharpe Ratio | 0.51 | 0.74 | 0.56 | 0.49 |
| Sortino Ratio | 0.81 | 1.15 | 0.87 | 0.76 |
| Market Correlation | 0.9 | 1 | 0.92 | 0.88 |
Created using data from Portfolio Visualizer
Investor Takeaway
PRN has an index-based strategy designed to benefit from industrial stocks that have been demonstrating significant momentum. Owing to the proprietary definition of ‘industrials’ used by the index provider, investors should be prepared for the presence of other GICS sectors like energy, financials, etc.
Even though PRN has had a rather strong 2023 to date, I am skeptical about it. For example, the fund was unable to beat either PSCI or XLI over the long run, let alone IVV, with the expense ratio of 60 bps obviously being one of the main detractors. On the positive side, there is an interesting factor story under the hood, but the issue is that for a fund with a 142% turnover, factor exposure can change quickly; on a side note, the next reconstitution is due this September. So with inflation remaining a concern, it would be wise to proceed carefully when it comes to high-beta stocks. In this regard, I would opt for a Hold rating today.