First Trust ETF Follows Quant Funds by Betting Big on Tech

Quantitative hedge funds that bet winners will keep winning just had their best month in more than a year buying technology stocks. Now, it’s exchange-traded funds’ turn.

The First Trust Dorsey Wright Focus 5 ETF, which uses a computer algorithm to choose stocks that are likely to outperform, recently ramped up its holdings of tech shares in a big way. The fund-of-funds dumped its position in the First Trust Utilities AlphaDex fund in favor of the First Trust Technology AlphaDex ETF -- giving it a 60 percent weighting in technology.

That’s the most tech-heavy the fund has ever been, according to Ryan Issakainen, ETF strategist at First Trust.

The fund, ticker FV, acts like a passive version of a quant hedge fund. After evaluating the “relative strength” of various sector funds, the Focus 5 ETF picks the ones where prices are rising fastest, according to a marketing document. In that way, it’s similar to hedge funds that use technology and formulas to automate the investment process.

Funds that buy momentum stocks had their best month in more than a year in October. The strategies advanced 4.9 percent, the most since June 2016, leaving hedge funds that follow other automated strategies in the dust. As this year’s best performing sector, technology contains a large amount of momentum stocks.

Going all-in on technology shares isn’t without its risks however, according to James Pillow, managing director at Moors & Cabot Inc., which has a small position in FV. Notwithstanding this year’s gains, the fund’s outsized concentration in a single sector is “a big red flag,” he said.

FV has returned 18.2 percent this year, compared with 16.1 percent for the S&P 500 Index, which it underperformed last year.

Other hedge funds are diversifying away from tech. Some have boosted bearish bets on the sector, making them the least reliant on American technology firms in nine months, according to data from Credit Suisse Group AG prime services. 

Highfields Capital Management, Passport Capital and Moore Capital Management all sold out of their positions in the tech-heavy PowerShares QQQ Trust Series 1 ETF last quarter, according to regulatory filings. The moves may not reflect bearish sentiment but rather part of a hedging strategy.

    Before it's here, it's on the Bloomberg Terminal.