On paper, the AdvisorShares Trim Tabs Float Shrink ETF (TTFS) looks like the perfect means of tapping into the supply-and-demand fundamentals of the stock market.
And based on last year's 42.4% gain, it would appear the 27-month-old, $105 million ETF is actually on to something.
The basic concept is to invest in companies that are seeing their available freely-tradable float shrink. The float is typically calculated by subtracting restricted stock from the total outstanding stock.
It is possible for the float to be shrinking while the outstanding shares are increasing.
As portfolio manager Minyi Chen of Trim Tabs Asset Management explains, there are actually three major quantitative screens involved in building the portfolio of 100 equal-weighted stocks.
The research looks at the float and pace of change in that float, free cash flow, and leverage levels. But, ultimately, it is really about the float, and that principal of supply and demand.
“This is information that is not widely used,” said Mr. Chen. “Fundamentally, it just makes sense.”
It certainly has made sense for the past few years, including a 14% gain in 2012. But it is worth noting that the strategy is riding a well-timed wave of shrinking equity float.
By Mr. Chen's own calculations, the broad equity market tends to rally during periods of shrinking equity float, which has been the case since March 2010.
During periods of increasing equity float, the broad market tends to see increased volatility and periods of decline.
To that, Mr. Chen responds that since he is always investing in the 100 companies in the Russell 3000 Index with the fastest-shrinking floats, there will always be companies that fit inside the portfolio.
Some of the key driving forces behind shrinking float include company stock repurchase programs and insider buying.
A reverse stock split, while technically defined as reduced float, will not qualify a company for the portfolio, according to Mr. Chen, because reverse splits are almost always a negative indicator.