How to beat the market: Pick the worst stocks that may do a U-turn

If the Dogs-of-the-Dow and buy-the-dip investing strategies had a baby, it would probably look a lot like a relatively new ETF that places bets on the past week’s biggest losers.

The Vesper U.S. Large Cap Short-Term Reversal Strategy ETF, which has the ticker symbol of UTRN (get it? U-Turn?) turns over its top holdings every few days by investing in some of the worst performers of the S&P 500. It buys 25 of the S&P 500’s biggest losers from the prior week and equally weights them.

The bet is that most of these stocks will mount a short-term comeback, or U-Turn, in the week after they lagged the market.

The strategy is working.

The UTRN ETF is beating the S&P 500 this year, with a gain of nearly 30% compared to about a 25% gain for the S&P 500. The ETF launched in September 2018 and is based on an index that has been backtested to 2006. The index has done more than twice as well as the S&P 500 since then and has outperformed the blue chip index in 11 of the past 13 calendar years.

Buy market losers with the hopes for a quick rebound

Turning over the holdings every week allows the fund to avoid getting stuck with stocks that are on a long-term downhill spiral, said John Thompson, president and founder of Vesper Capital Management, which developed the ETF in conjunction with Victor Chow, a West Virginia University finance professor who has studied the behavior behind short-term stock moves.

This differs from the famous Dogs of the Dow philosophy, which has investors buy a handful of the 30 Dow stocks that ended a calendar year with the highest dividend yield and hold them for a year. Because the dividend yield is calculated by taking the dividend and dividing it by the stock price, underperforming companies with a falling price tend to have higher yields.

But Chow said his research looked more at how investors tend to dump a stock en masse because of bad news. That can create a short-term buying opportunity. He developed “the Chow ratio” to measure a company’s financial stability and potential for short-term gains.

“There is a human bias towards loss aversion. People overreact to negative information and sell stocks too fast following negative news,” Chow told CNN Business. “The overreaction causes prices to go down too much and set up the potential for a near-term rebound.”

Strategy would have been prohibitively expensive in the past

Chow said that this type of investing strategy would have been impossible to do a few years ago because trading costs would have been prohibitively high.

But now that many brokers have slashed trading fees (in many cases to zero), Thompson said that the fund can make wholesale changes every week and not charge investors too much in the process.

The expense ratio for the ETF, which is how much a fund charges to cover management and administrative fees as well as operating costs, is 0.75%. That’s higher than a standard passive ETF, which merely mimics the stock holdings of a top index like the S&P 500 or Nasdaq 100. But it’s in line with the expense ratio charged by more active funds.

“Investors that love a buy-the-dip strategy can do that with the fund at a low cost,” Thompson said, adding that the fund takes advantage of the fact that many short-term investors are less concerned about stock valuations and company fundamentals.

It’s not a fund for the faint of heart. One of the virtues of owning a boring S&P 500 index fund is you know what you’re getting — exposure to Microsoft, Apple, Amazon, Google owner Alphabet and Facebook. In other words, the tech giants that dominate the broader market. The U-Turn ETF has different holdings at the top every couple of days.

But Chow said that because the ETF weights the new holdings equally, there is less of a chance that one or two underperforming picks will tarnish the returns for the entire fund. You’re not going to be stuck indefinitely with stocks like Macy’s or Kraft Heinz.

The five biggest holdings in the U-Turn ETF as of November 22 were online travel company Expedia, industrial supplies manufacturer WW Grainger, tool giant Stanley Black & Decker, regional bank Zions and insurer Unum.

None of them were among the top holdings in the ETF at the end of October.