As we approach another Christmas rendezvous with the virus – welcome, omicron – I thought I’d cheer up readers with invigorating tale of innovation in the ETF space.
Heather Bell is a reporter over at the excellent ETF.com, and one of her many jobs is to keep a watchful eye on the new ETFs listed every year in the US market. You can see the latest iteration of her list here. Needless to say she is kept quite busy, because barely a week goes by without a dozen or so new trackers listing, and some of them are wonderfully strange. My favorite tale is of the pair of teenagers who have helped launch the ZGEN, an ETF that tracks the values of Generation Z investors. It sounds a bit crazy at first, but the fund actually has some sensible investments aimed at the ‘youth’ such as Snap, Roblox and Coursera.
The general point, though, is that innovation is speeding up – and in amongst the no-hopers and ‘going nowhere in AUMs’ are some genuinely interesting advancements. Perhaps the most interesting observation that ETF.com makes is that over two thirds of new products are active ETFs, whereas only 4% of the total AUM in ETFs is in active products. Clearly the fund management industry is placing all its bets on one direction of travel.
One example of innovation is the rise of structured products, also known as defined outcome ETFs, or buffer and cap ETFs. The general idea is that your ETF tracks a major index and offers up some downside protection, but in return limits some of the upside. That’s certainly the idea behind the FT CBOE Vest US Equity Buffer series as well as the Wisdom Tree Target Range Fund (GTR). Another variation comes in the shape of the Innovator Double Stacker 9 Buffer (DBOC), which doubles up your upside exposure to key US benchmarks up to a cap whilst also offering a buffer protection for the first 9% of losses on the SPY ETF. As someone who has written extensively about structured products in a UK context I can offer one observation – it’s all too damned complicated. In the UK market, nearly every major provider has settled on a simple structure known as an autocall or kick out product, which pays a defined return (between 5 and 10% per year) as long as an underlying index stays where it is or advances. With a few bells and whistles, that’s it. These products appeal to the defensive investor who wants something approaching the equity risk premium but with some downside protection. It seems to me that too many of these buffer and cap products want to have their cake and eat it too.
Nevertheless, these products are innovative and could find a home in some portfolios. I happen to think a bigger market awaits tail risk ETFs, which act as a kind of hedge insurance policy for investors. Notable new entrants in this market include the Simplify Tail Risk Strategy ETF (CYA), although there are also some worthy incumbents including Cambria Tail Risk ETF (TAIL) and the Fat Tail Risk ETF (FATT). The concept here is admirable – I’d currently be a buyer – but still I wonder whether investors really have the patience to sit tight and wait for the infrequent fat tail ‘event’ to happen.
By contrast, my hunch is that ETF investors have become, in recent years, addicted to growth investing. Call it the ARK effect. ETFs are seen not as boring, simple, passive vehicles but exciting ways of building a growth equity portfolio on the cheap. And thematic ETFs sit at the core of this revolution. I think some of the new products make sense today, largely because there are enough interesting companies to fill out a concentrated portfolio of 30 to 60 stocks. In this category, I see the appeal in thematic ideas such as big data (Franklin Exponential Data ETF, ProShares Big Data Refiners), smart factories (ProShares S&P Kensho Smart Factories), and food (Global X’s AgTech & Food Innovation ETF and the VanEck Future of Food ETF). Sticking with the tech theme, I also think that the Roundhill IO Digital Infrastructure ETF (BYTE) is onto a winner, since digital infrastructure is shaping up to be the cautious way to play the digital revolution. Outside of tech, I think the iBet Sports Betting ETF (IBET) is in a great space – sports betting is going to the moon and back.
That said, the thematic space is also increasingly full of ‘nice ideas’ which I’m not sure will actually work, if only because there’s either not enough sensible stocks for a portfolio or because the definition of the theme is too elastic to have any coherence. In this category I’d place anything with ‘metaverse’ in the title, along with the subscription economy.
But let’s remind ourselves of that first observation – that two thirds of funds are active ETFs. Sure, thematics verge into this space with their active approach to index curation, but what we really want from active managers is high-conviction investing. And in this respect, we are seeing a first wave of funds that I think could be huge. In essence they are all taking on the ARK Invest idea and riffing with their own active alpha strategy. If I could reduce this sub class of active ETFs, I’d use this simple declaration: buy our active ETF and we will curate a collection of high-quality companies that will change business as we know it. Into this category fall a number of new approaches that I think could finally make quality investing a worthwhile pursuit in ETF-land: I’d highlight the Alpha Dog ETF (RUFF), The Future Fund Active ETF (FFND), the Spear Alpha ETF (SPRX) and the Formidable ETF (FORH).
But active managers don’t just work in equities, and I’d suggest that the biggest opportunity is actually elsewhere; namely, in fixed income and commodities. In particular, if a manager can offer the right navigation skills around the mosaic of bonds – in a rising rates environment – or the right bond geographies for bond investing, then I think there’s no reason these funds couldn’t go big. Into this category I’d put the Day Hagan/Ned Davis Research Smart Sector Fixed Income ETF (SSUS) as well as the Gavekal Asian Government Bond ETF (AGOV). And what applies to bonds is doubly true for the confusing world of commodities – cue the Hartford Schroders Commodity Strategy ETF (HCOM).
Last but by no means least, I can’t finish without two honorable mentions for the Tuttle range of ETFs and the Discipline Fund. The Tuttle TCM Strategies are wonderfully eclectic and include a fat tail ETF but also the wonderfully cynical Short Innovation and the Short De-Spac ETF.
But pride of place goes to the elegant The Discipline Fund ETF (DSCF) which is about as counter cultural in ETF land as you can get. Forget active ETFs, structured outcomes and thematics. Based on many of Jack Bogle’s original ideas, it is ‘a long-term focused, highly diversified, low fee, tax efficient fund that builds a systematically rebalancing global stock/bond allocation around a 50/50 benchmark with the goal of helping you behave better and stay the course.’ Sensible stuff, especially that countercyclical rebalancing.