When The Trend Is Not Your Friend: The Pacer Trendpilot ETFs

| About: Pacer Trendpilo (PTEU)

Summary

The Pacer Trendpilot ETFs use a momentum-based, trend-following strategy to time the market.

Three ETFs are available covering U.S. large-cap, mid-cap and tech stocks, while the fourth tracks the Eurozone.

Nearly one year on, have these ETFs delivered?

The Pacer Trendpilot suite of ETFs utilize a trend-following strategy to "time" the market. Three products were launched on June 12, 2015 covering various aspects of the U.S. stock market. On Dec. 15th, 2015, a fourth ETF was launched based on tracking the European stock market.

  • Pacer U.S. 750 Trendpilot ETF (PTLC), tracking the Wilshire US Large Cap Index.
  • Pacer U.S. 450 Trendpilot ETF (PTMC), tracking the Wilshire Mid-Cap index
  • Pacer 100 Trendpilot ETF (PTNQ), tracking the Nasdaq 100 market
  • Pacer Trendpilot European ETF (BATS:PTEU), tracking the FTSE Eurozone Total Return Index.

As explained in Maks Financial Services' recent article, these ETFs are actually a continuation and rebranding of the recently closed Trendpilot series of ETNs issued by RBS and distributed by Pacer Financial. The previous ETNs were shut due to "RBS plc's exit of the structured retail investor products business." An obvious benefit of the use of an ETF wrapper vs. an ETN is that investors are no longer dependent upon financial health of the counterparty (in this case RBS).

Relevant fund data are shown below (data from Morningstar).

Fund PTLC PTMC PTNQ PTEU
Yield [SEC] 1.54% 0.90% 0.65% n/a
Expense ratio 0.60% 0.60% 0.65% 0.65%
Inception Jun. 15 Jun. 15 Jun. 15 Dec. 15
AUM $372M $152M $70M $22M
Avg. Volume 154K 59K 34K 8.8K
Morningstar rating n/a n/a n/a n/a
Click to enlarge

Trendpilot's trend-following strategy (and comparison with ALFA)

Trend following is a tried and true strategy for avoiding the worst of bear markets. However, as we observed for the AlphaClone Alternative Alpha ETF (NYSEARCA:ALFA), which uses the 200 day simple-moving average (SMA) as an indicator to enter and exit the market, market whipsaws can cause trend-following strategies to suffer significant losses. Like ALFA, the Trendpilot suite also uses the 200 SMA to "time" the market, but instead of having only two stances (100% long and market-neutral), the Trendpilot ETFs can adopt one of three modalities (as shown for PTLC):

  • Equity Indicator: When the Wilshire US Large-Cap Total Return Index closes above its 200-day SMA for five consecutive business days, the exposure of the Index will be 100% to the Wilshire US Large-Cap Index. From the equity position, the index will change to the 50/50 position or the T-Bill position depending on the 50/50 Indicator and the T-Bill Indicator.
  • 50/50 Indicator: When the Wilshire US Large-Cap Total Return Index closes below its 200-day SMA for five consecutive business days, the exposure of the Index will be 50% to the Wilshire US Large-Cap Index and 50% to 3-Month US Treasury bills. From the 50/50 position, the Index will return to the equity position or change to the T-Bill position depending on the Equity Indicator or T-Bill Indicator.
  • T-Bill Indicator: When the Wilshire US Large-Cap Total Return Index's 200 day SMA closes lower than its value from five business days earlier, the exposure of the Index will be 100% to three-month US Treasury bills. From the T-Bill position, the index will change to the equity position when the Equity Indicator is triggered. The index will not return to its 50/50 position unless the Equity Indicator is first triggered.

In comparison to ALFA's hedge, which is activated when the index falls below the 200-day SMA at month-end, Trendpilot's trigger is both more and less sensitive, but for different reasons. Trendpilot's trigger is less sensitive because the ETFs do not immediately go into market neutral mode when the first bearish indicator is observed. Instead, there's an intermediate stage, the "50/50" mode (i.e., 50% long), that is first activated. Only the appearance of a second bearish indicator will cause the fund to enter into "T-Bill" mode. Additionally, the indicators must remain bearish for at least five consecutive days (for the 50/50 indicator) or close lower than its value five days ago (for the T-bill indicator) for the trigger to be activated, which could prevent excessive dilly-dallying around the trend line leading to losses. On the other hand, Trendpilot's strategy is more sensitive than ALFA's because it can be activated any time during the month, and not only at month end.

Trendpilot in practice

How does the Trendpilot system work in practice? Shown below are the indicators that have been activated for U.S. large cap stocks (NYSEARCA:SPY) since the inception of the first Trendpilot ETFs.

Click to enlarge

We note from the annotated chart above that both T-bill and equity indicators have each been activated twice since inception of the ETFs. Interestingly, in both hedging periods the strategy did not spend any time in 50/50 mode. This is because after SPY spent five consecutive days below the 200-day SMA (the 50/50 trigger), the 200-day SMA itself had also fallen to below its value five days ago, thus immediately activating the T-bill stance and bypassing the 50/50 mode altogether.

Fund performances

Now let's take a look at each of the Trendpilot ETFs since inception. PTLC tracks the same index as the Schwab US Large-Cap ETF (NYSEARCA:SCHX). As can be seen from the chart below, the performance of PTLC has been uninspiring. Since inception, PTLC has returned -11.9%, compared to -0.91% for the benchmark SCHX. This underperformance can be explained by sharp market whipsaws in the underlying index. Since the indicators need to flash for five consecutive days before the change is activated, this means that the strategy sometimes sells stocks too late in a downtrend, when the damage has already been done, and buys stocks too late in an uptrend, thus missing a significant portion of the recovery.

PTLC Total Return Price Chart

PTLC Total Return Price data by YCharts

For the mid-cap PTMC, its performance has matched the benchmark Schwab U.S. Mid Cap ETF (NYSEARCA:SCHM). Note the long stretch of time from September 2015 to April 2016 where the fund was fully in T-bills.

PTMC Total Return Price Chart

PTMC Total Return Price data by YCharts

Out of the four ETFs, PTNQ has performed the worst since inception. It has lagged the benchmark PowerShares QQQ Trust (NASDAQ:QQQ) by some 13% since inception. Again, whipsaw appears to be to blame.

PTNQ Total Return Price Chart

PTNQ Total Return Price data by YCharts

PTEU has unexcitingly remained in T-bills since inception, losing -0.10%, while the iShares MSCI Eurozone ETF (BATS:EZU) has declined by -3.15%.

PTEU Total Return Price Chart

PTEU Total Return Price data by YCharts

Summary

After (nearly) one year, the Pacer Trendpilot ETFs have been, as Maks Financial Services put it, a "mixed bag." PTEU has outperformed its benchmark slightly, PTMC was even, but PTLC and PTNQ have significantly underperformed. Analysis of the Trendpilot strategy's entry and exit points with U.S. large cap stocks reveals that this momentum-based trend-following strategy is susceptible to market whipsaw, as expected.

However, the expense ratios of the Trendpilot ETFs (0.60 to 0.65%) seem to be a bit on the high side, especially when the underlying benchmark ETFs are charging next to nothing (e.g. SCHX: 0.03%). Is it worth paying an additional 0.50% in expenses just to have Trendpilot execute a few buy and sell orders for you per year? So far, the answer appears to be no.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.