Dorsey: ETF Revolution Just Starting

IndexUniverse.com

 

Tom Dorsey, president and founder of Dorsey Wright ' Associates, can’t say enough positive things about ETFs. His business of point and figure technical analysis is now focused on ETFs, and their role in all that he does will only increase.

When IndexUniverse.com Managing Editor Olly Ludwig caught up with Dorsey on the sidelines of IndexUniverse’s Inside Trading ETFs conference last week at the New York Stock Exchange, Dorsey predicted that one of the four ETFs it created with Invesco PowerShares, the PowerShares DWA Technical Leaders Portfolio (PDP), is likely to cross the $1 billion threshold sometime early next year.

That’s hardly a surprise to Dorsey, who considers the ETF the most important financial innovation in his 37-year career in the money management industry, and sees the development so far amounting to the first foot of a 26-mile marathon.

 

Ludwig:I want to talk with you about technical analysis, and how it was that you got into this particular piece of the financial markets and securities trading. Give me a little background.

Dorsey: Well, I go back to 1974 with Merrill Lynch Pierce Fenner and Smith, where I first started as a stock broker. After about five years there, I was offered an opportunity at Wheat First Securities to develop and manage its first option strategy department, which I did.

In so doing that is how I came across the method of point and figure technical analysis. And after running the department for nine years, I started Dorsey Wright ' Associates in 1987. That was 25 years ago.

Ludwig: And how do you fit into the whole pantheon of technical analysis? I’m thinking of guys like John Murphy. He’s sort of written the tone, in some ways, no?

Dorsey: Well, he’s written the tone, but he does something different. Like in technical analysis, there’s everything from astrology to bar charts, to candlestick charts, Fibonacci retracements, wave cycles, everything you can think of. And point and figure charting is probably the oldest method of charting in America. And that’s the piece I ran across; I decided that was going to be my slice of Wall Street. So as far as point and figure technical analysis—myself and my company—we are that.

Ludwig: When you look at the arc of your career since you developed point and figure charting, made it your own and branded yourself as the person who did this, can you speak a bit to how the markets have changed? And I’m heading toward the ETF here. But I’m just trying to get a little background—the arc of how the securities markets have changed, and how that has informed what you do.

Dorsey: Well, regarding the way the securities markets have changed, the ETF is the most important product that Wall Street has come across in my 37 years in this business. The advent of listed options in 1974 that preceded me by a few months, was one of the most important things that happened on Wall Street. The next thing was cash management by Merrill Lynch. But the most important product is the exchange-traded fund.

 

 

Ludwig: We’re coming up on the 20-year anniversary of the ETF. In terms of technical analysis and your methodology, is there a distinct piece of the ETF that perhaps the typical person may not grasp? Distinguish, in other words, between doing technical analysis on an exchange-traded fund—say a plain-vanilla equity fund, versus, let’s say, an individual stock like IBM.

Dorsey: Well, the difference is simply this. Let’s say you watch the Discovery Channel, and you see a fish swimming. Then you look at a school of fish. And the school of fish intuitively moves in the same direction. One fish moves, the whole thing moves. With an ETF, you’re looking at a school of fish. Otherwise, you’re buying an individual fish. A mutual fund is a school of fish also, but it’s not defined. You have a manager who may or may not be following his discipline. With the ETF, it’s totally visible.

Ludwig: Because it’s an index vehicle?

Dorsey: Yes. It’s an index vehicle.

Ludwig: So, does that mean that active ETFs won’t be as usable for your purposes?

Dorsey: Yes, the active ETF is bastardizing the product. Because what you have with an active ETF is simply another mutual fund. That’s all you have. The active ETF is suggesting that the managers can manage better than the S'P. Most of them don’t.

I think the ETFs should be rules-based, where you know what the rules are, and it’s totally transparent. Once you get into the active ETFs, I don’t think they’re getting traction.

Ludwig: So what you end up with is a relatively pure look at the school of fish, to use your image. And the point and figure system attempts to capture the behavior of the crowd then?

Dorsey: Right.

Ludwig: Because it’s a crowd, is the whole technical analysis going to be more reliable?

Dorsey: Well, we’ve been following the S'P 500 Index on a technical analysis basis now for 150 years. And it’s an ETF now. What’s the difference?

No matter what method of technical analysis you use, it has to come down to the irrefutable law of supply and demand. That price changes because of the  law of supply and demand, period. That’s what the point and figure chart measures—that’s where it starts, and that’s where it ends.

Ludwig: Now, how do you respond to naysayers of the whole technical approach who say, “Oh, it works until it doesn’t work.”

Dorsey: Well, I can tell you this. In the 2008 meltdown, were there fundamentally sound stocks that collapsed? The answer is, yes. But there were no technically sound stocks that collapsed. They had to begin giving you signals way beforehand—trend line breaks; relative strength changes; sell signals—on anyone’s methodology of technical analysis. So investors rode fundamentals down into the dirt; not so with technical.

Ludwig: Understood. Now speak for a moment if you will about your relationship with PowerShares. The first question that comes to my mind is, Why PowerShares? I tend to think of PowerShares as entrepreneurial. They do business with Rob Arnott; they do business with you. They’ve got some interesting securities, and some real home runs that they’ve hit. So explain a little bit of the background.

Dorsey: The background is Ben Fulton, who’s the president of PowerShares; he’s a very good friend of mine. There’s your background.

 

 

Ludwig: So it all comes to the human touch.

Dorsey: Well, when they wanted to have technical analysis, he came to me. We’re the ones who helped roll out the iShares product—we’re the ones that traveled the country educating brokers on what iShares was. Now, we have models at Dorsey Wright ' Associates that every ETF provider pays us to create.

PowerShares came to us and said, “Hey, we’d like you to do an ETF.” So we did the ETF, and it’s very successful. We’ve got close to $700 million in PDP right now. I think we’ll go over $1 billion in the first quarter of next year, which is a milestone.

Then they came to us about an international Technical Leaders ETFs—that’s (PIZ). And then they came to us and said, “Let’s do a emerging markets Technicals Leaders ETF.” Why not? Put it in the family (PIE). Then they came to us and said, “Let’s do a small-cap Technicals leaders.” We put it in the family (DWAS). So now we have four ETFs in the family.

Ludwig: What’s the future of the ETF? Is it going to grow more prominent?

Dorsey: Let me put it in laymen’s terms. We’re in the first foot of a 26-mile marathon. In other words, if you traveled around the world anywhere you can think of, it’s all untouched by ETFs. It’s so open, ready for the ETF. Even here in the United States, where we know them pretty well, most brokers don’t know them, and most brokers don’t use them yet.

And when you travel to Europe and then further to Australia, to Singapore, to Indonesia, Vietnam, Philippines, it’s all brand new.

Ludwig:So are you saying that, over time, the ETF supplants the mutual fund?

Dorsey: The world is open for business. I don’t know that the ETF will supplant mutual funds; they can live together. Many people use mutual funds because they have the load, because they have the trailer, and that’s going to be their business. That’s how they get paid. Once they put a person into a mutual fund, it’s a continual payment the rest of their lives. So these people will continue to use it. So the mutual fund business is going to be around. But the ETF will eat away at it. Because the more people understand and learn about ETFs, the more they will want to gravitate to them.

Ludwig: So the world is the ETF’s oyster, is what you’re saying.

Dorsey: From what I found, and I travel the world.

 

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