IDMO: As I Suspected, Timing Is Everything For This ETF (NYSEARCA:IDMO)

Introduction

This article reviews the Invesco S&P International Developed Momentum ETF (NYSEARCA:IDMO). While I have come across numerous US equity momentum ETFs, this is my first that applies that strategy to International stocks. Momentum investing has been studied for years and its success runs counter to the Efficient Market Hypothesis that states earning Alpha via a targeted investing strategy should not be possible. A study in 2018 by UCLA found evidence that momentum investing does work but couldn’t explain why.

Why does momentum work? In his research into 25 years of academic literature on momentum, Subrahmanyam found that many of the rationales presented for the strategy’s success fall into one of two behavioral categories: Investors either overreact to important information, or they underreact to it. Because, after all, we’re only human.

Source: anderson-review.ucla.edu/momentum

A more recent study points to a change at Morningstar that could explain why momentum strategies have underperformed the market over the past 20 years. The Ohio State University stated their case this way:

Before its mid-2002 rating-system change, Morningstar compared all U.S. stock funds with each other based on their past performance, regardless of their investment focus. The best performers got a 5-star rating and the worst ones got a 1-star rating. After 2002, Morningstar began comparing each fund only with others of the same investment style, like large-cap growth or small-cap value. This meant some funds got higher star ratings than they did under the previous system, because they were no longer being compared with funds of other styles that had higher returns.

The change in the rating methodology shifted how capital was allocated across mutual funds.

Source: .WSJ.com OSU study

One conclusion was that this strategy was very sensitive to outside changes. I’ve read elsewhere that most targeted strategies cease to be Alpha-generating once they become more mainstream.

Invesco S&P International Developed Momentum ETF review

Seeking Alpha describes this ETF as:

Invesco Exchange-Traded Fund Trust II – Invesco S&P International Developed Momentum ETF is an exchange traded fund launched and managed by Invesco Capital Management LLC. It invests in public equity markets of global developed region. The fund invests in stocks of companies operating across diversified sectors. The fund invests in momentum stocks of companies across diversified market capitalization. The fund seeks to track the performance of the S&P Momentum Developed ex-U.S. & South Korea LargeMidCap Index, by using full replication technique. Invesco Exchange-Traded Fund Trust II – Invesco S&P International Developed Momentum ETF was formed on February 6, 2012 and is domiciled in the United States.

Source: seekingalpha.com IDMO

IDMO has $169m in AUM and has a reasonable 25bps fee. The TTM yield is 2.33%.

Index review

Key to understanding an index-based ETF obviously is seeing how the index is constructed. S&P describes their index as:

The S&P Momentum Developed Ex. U.S. & South Korea LargeMidCap is designed to measure the performance of securities in developed markets, excluding the U.S. and South Korea, that exhibit persistence in their relative performance.

Source: spglobal.com index

The S&P index Factsheet provides the construction details investors need.

The key point is the stocks with the highest momentum score (top 20%) are included in the index. S&P uses the Z-score to generate the momentum score that is used in the ranking process. This is how it’s explained.

Index weights are based on each stocks floating-adjusted weight. The index is rebalanced every March and September. Currently, the index holds about 200 stocks.

Holdings review

Being an International ETF, the first allocation to look at is country weights.

Investors in IDMO currently better love Japanese stocks as that weight is over half the portfolio. With the Nikkei 225 Index hitting record levels, that helps explains IDMO’s spectacular one year results.

European countries make up a majority of the remaining country allocations. Next allocation examined is sectors, where we see that Information Technology is not the top allocation, Industrials is at almost 25%.

Most of the top sectors are dependent on strong economies in both their home market and/or offshore ones.

Top holdings

Even with over 200 positions, the Top 20 account for almost 47% of the portfolio, which would be expected by me in a momentum driven investment strategy. There was little in the way of currency hedging and the ETF’s Prospectus stated that currency risk could cause a decline in the ETF’s NAV if the currency of a non-U.S. market in which IDMO invests declines versus the U.S. dollar.

Distributions review

As I would expect, payouts are not consistent. This would be caused by sector shifts executed by the momentum strategy as some sectors offer higher yields than other sectors. This results in the Seeking Alpha grading system giving IDMO a D+ rating for dividends.

Comparing results

Looking at IDMO’s results in isolation tells investors little. Did their strategy outpace what an ETF invested in the same stocks but not screened for momentum is what needs to be known. I failed to find an ETF based on the S&P Developed Ex-U.S. & Korea LargeMidCap Index, but I was able to compare both indices.

If you removed the spectacular 1-year results, the 10-year Total Returns are about even.

Of course what that means is a momentum investor can achieve very good results over a short period of time; knowing when that will occur is the secret and not one of my skills. Comparing IDMO against the iShares MSCI EAFE ETF (EFA) was done next. I used this ETF as its MSCI also excludes South Korea besides excluding the US.

The IDMO strategy results less weight in stocks classified as Blend, and a slight tilt upwards in market-cap. IDMO’s growth weighting is almost 50% larger than what the non-momentum index generates for EFA. The difference in strategies also drastically shifts allocations between sectors, with five having an allocation difference of over 4%.

Comparing CAGRs, we see a similar pattern as shown with the index comparison; the past year explains the overall CAGR difference between these ETFs, but not for the past three years. Of the 13 full/partial calendar years of data, IDMO was best each of the last six years, but only once over the prior seven.

Portfolio strategy

As both above charts show, momentum investing does work except when it doesn’t. That is my way of saying, as the title indicates, timing is everything as success or failure can run on for years. Overall, IDMO has provided little in extra return or less StdDev when using these two comparisons. I build my equity allocation using what I label “Core” ETFs (article link), then allocating funds to narrow strategy ETFs like IDMO. I have tried domestic momentum ETFs and have gained little in terms of Alpha over the long haul.

Investors with a good model to predict when this strategy works, then this ETF might get a Buy rating, but since momentum investing goes in cycles and this ETF has had a banner year, I decided to give the IDMO ETF a Sell rating instead at this time.