The index ETF frontier is shrinking, but the outer space of “index alchemy” awaits.
Though ETF proliferation shows little sign of slowing, somewhere down the road new products built on single indexes could become passé. And that’s where strategies like Tom Dorsey’s relative strength rotation methodology open up a new universe of possibilities.
“You can only have so many ETFs that use the S&P 500, but if I combine the index with something else, it creates something new,” says Dorsey. “The key is to find a combination that is greater than the sum of its parts. Moving forward, this business is not going to be about finding the next index ETF. There’s already a huge list of ETFs that won’t make it.”
Dorsey, 69, co-founder of Richmond, Va.-based registered investment advisor Dorsey Wright & Associates (DWA), built his firm with relative strength strategies. DWA now delivers tools and analytics to advisors, and manages more than $6 billion in assets.
In 2016, DWA brought to market nine ETFs using its relative strength methodology with the help of its parent company, Nasdaq, which acquired the firm in 2015.
“We saw it as an opportunity to expand the licensing business and bring on thousands of advisors using their strategies,” says Rob Hughes, Nasdaq’s head of index and advisor solutions. “It also helped us to expand our relationships with licensees like First Trust and PowerShares that DWA had established great rapport with.”
Nasdaq wanted to boost its indexing business, and thanks to the DWA deal it has become a smart beta leader: DWA added 17 relative strength-based ETFs to the 69 smart beta ETFs Nasdaq had already licensed. Nasdaq now has $52.8 billion in smart beta AUM.
Before Nasdaq, most of DWA’s ETF strategies focused on equities. With Nasdaq, DWA has launched exchange-traded strategies in fixed income, multi-asset income, commodities and master limited partnerships, along with a factor-rotation strategy.
“That was a big innovation, expanding out into income and alternatives and bringing factors inside of a single ETF,” says Jay Gragnani, DWA vice president.
The Nasdaq deal brought DWA an infusion of technology, greater awareness of its strategies and opportunities for innovation. It also helped DWA engage its subscribers more directly and launch a mobile application, and it’s now redesigning its research tools.
Nasdaq also brought DWA’s strategies to new markets, including Canada, and is expanding DWA’s offerings in Europe and Asia with Dorsey in the lead as a globe-trotting salesman. Though retired from his executive role, he remains as a consultant proselytizing the virtues of relative strength to advisors and investors.
Don’t Go In Reverse
As a young man, Tom Dorsey wasn’t Wall Street material—he was essentially illiterate into his 20s.
“I am learning disabled and I have dyslexia. I wrote my first book report before I could read my first book,” Dorsey says.
Dorsey was passed because his family moved often. He attended 16 different schools before graduating high school, so he was never in one place long enough for his teachers to recognize his problem.
After flunking his first semester of junior college, Dorsey served four years in the Navy before Vietnam escalated. Back in the civilian world, he returned to Richmond to go to school on the G.I. Bill.
“This time I knew I had to learn to read, so I taught myself,” recalls Dorsey, adding that he drove a green Chevy Vega that had no reverse. “That was a metaphor for my life: Never go in reverse, just keep moving forward.”
After earning degrees in economics and business administration, Dorsey looked for work at Merrill Lynch in Richmond in 1974. As it was just after a pronounced bear market, the local branch manager was not initially interested in Dorsey’s services.
After weeks of relentlessly fighting for an interview to the point of occupying the branch’s waiting room, Dorsey was taken on and sent to New York for Merrill Lynch’s training program.
“Passing my Series 7 was one of the greatest things that happened to me in my life,” says Dorsey. “I’ll never forget the moment that I looked over to the wall where they posted the scores, and I saw a ‘P’ by my name for ‘passed.’ I almost passed out. I was registered with the New York Stock Exchange, the greatest institution in the world. In one second, I went from nobody to a somebody. I knew that I had found the right industry.”
One year later, the advent of the discount brokerage model and the introduction of the Vanguard Index Trust portended a changing industry. Dorsey wanted to differentiate himself, so he became an expert in options not long after the first standardized options contracts began trading on the Chicago Board Options Exchange in 1973. Armed with new skills, he launched Merrill Lynch’s first options strategy office.
In 1987, Dorsey and his partner, Watson Wright, borrowed $90,000 and founded the first stand-alone options consulting business: Dorsey Wright & Associates. (Watson Wright sold his share of the business in 2011.) That year, Dorsey discovered relative strength from a book given to him by one of his first hires.
“It dawned on me that the only reason stock prices rise and fall is supply and demand,” says Dorsey. “If there are more buyers than sellers willing to sell, prices rise; if there are more sellers than buyers, prices fall. All of the clouds on Wall Street cleared for me at that moment.”
Point-And-Figure
In October 1987, Dorsey decided to change gears amid a market crash. Instead of options, he focused his expertise on technical strategies using relative strength analysis, which is a measure of supply and demand that compares price momentum between two investments.
At the heart of DWA’s business were its point-and-figure charts. Point and figure charting was discovered in the late 19th century by Charles Dow as a method to compare the performance of two charts. Rather than a linear graph, point and figure charts are designed as columns of X’s and O’s plotting two investments’ relative performance.
“Each one of us could do 500 charts in a day,” says Dorsey. “At the end of the day, you’d pass your book to the next analyst, so by the end of the week you had seen 2,500 stocks. No one ever had an office. We all sat in a circle. It was a hands-on thing.”