Is ESG Keeping Pace?

The past two years have been inundated with an influx of ETFs that utilize environmental, social, and governance (ESG) criteria when selecting securities. Over time, the selection criterion has evolved and even differs among various index providers. Academic research has shown that ESG driven strategie to either keep pace with broader market-cap indexes or even in some cases, outperform. 2016 was a quite a busy year for ESG focused ETFs offering both broad exposure and niche thematic exposures. While ESG ETFs have existed in the market place since 2005, they seem be to garnering more media attention rather than assets.  

The graphic below depicts a list of broad based ESG ETFs (excluding products like water, solar, etc) and their relative benchmarks. Form the list below, you will notice that only two products have at a year a 3 year track record (DSI and SUSA). The cells highlighted in green indicate if that ESG strategy is outperforming the broad benchmark for that respective time period (and vice versa with the red shading).

A few key points to highlight it that YTD, the emerging markets focused products are outperforming EEM. Additionally, the two most tenured products have both underperformed SPY on a 1, 3, and 5 year basis. Many of these ESG products are relatively new to the market and for the time being it seems that the market has gotten ahead of demand. The jury is still out on these ETFs but they are likely to attract more attention as their track record builds.  

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The ETF Imbalance

While most investors have hit the beaches at this point, the ETF industry remains hard at work. The U.S. ETF industry reached a paramount milestone in July, surpassing $3 Trillion in assets.  It seems on almost a daily basis one in inundated with news of a new product launch or a new sponsor entering the market to have their chance at success. While on the surface it may seem that everyone is enjoying this state of euphoria, the reality is there is a disproportional spread of assets. For example, the “Big 3”, comprise of iShares, Vanguard, and State Street account for over 80% of the $3 Trillion in assets.

Issuer agnostic, at the product level, the largest 25% of products account for 95% of all assets

The colossal growth in the industry means that investors now have access to nearly any part of the market imaginable. While ease of access has most certainly been a driver of success, the key component has been cost. Of the 2,000 plus products in the marketplace, less than 15% of them are priced at 20 bps or lower. But alas, those 15% have quite the stronghold on assets, accounting for 66% of industry AUM. On the other side, 40% of the products in the market are 60 bps and higher, but only account for 7% of assets.

As one would expect, the “Big 3” have a strong presence at the lower end of the fee spectrum. For example, the “Big 3” represent 78% of the products in the 0-10 basis point bucket.

But where do revenues come from? While the lower fee buckets are home to the vast majority of assets, they are not the most profitable niche in the market. With a similar breakup of the fee segments from above and a back of the napkin revenue calculation, it’s the 61 bps and above arena that generates a hefty portion of the industry’s revenues.

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Best Performing ETFs You've Never Heard Of

With all the hype around the growth of ETFs, iShares and Vanguard tend to garner most of the attention. While we can’t hide the dominant presence of these two firms, investors should be aware that are some interesting options available to them in the back of shelf.

Currently there are just over 400 ETFs that fail to meet the $20 million threshold. Although these 400 account for 20% of the products in the U.S., they only represent $3 Billion in assets, barely enough to nudge the needle on $2.5 Trillion of ETF assets

List of the Top 30 performing ETFs YTD (Below $20M in Assets)

No surprise to see predominantly technology focused names at the top, but also Europe-focused ETFs are among the leaders given a rotation overseas. Honorable mention goes to a slew of Brazil ETFs (BRAQ: Brazil Consumer), which would have made the list, if not for their recent sharp decline. Two IPO ETFs also join the top thirty. 

Extending the horizon a bit future out, below are the top performing funds over a 3-Year period. At the top….Japanese Healthcare and Smartphones

Performance as of 5/21/2017

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Sectors Through A Factor Lens

When it comes to the world of sector investing, the SPDR Select Sector ETFs have a rather dominant stronghold in each of their respective sectors. Additionally, one can also look to Vanguard and Fidelity for cheap market-cap weighted exposure at the sector level. While Vanguard and Fidelity offer cheaper options than State Street, the Select SPDRs have been around since 1998.

Among the hottest topics in the market now is the growing implementation of “multi-factor” ETFs. For the most part, a majority of the discussion is focused around these methodologies applied to a larger universe like large-cap stocks, developed international stocks etc. Multi-factor ETFs are essentially becoming a staple offering among most ETF providers. For these purposes, I wanted to get a bit more granular and look at the multi-factor approach applied at the sectors of the S&P (excluding Real Estate). In addition to the size and cost of these ETFs, I also wanted to see if a“smart-beta” approach has aided in performance.

While John Hancock and iShares launched their suite of sector ETFs within the last 2 years, First Trust has applied their Alphadex methodology at the sector level since 2007. Lastly, although not a multi-factor approach per se, Powershares launched a line of Dorsey Wright momentum-based sector ETFs in 2006.

In the tables below you will find the sectors of the S&P along with ETFs offering respective sector exposure. Performance has also been run along with top and bottom performance to highlight some of the rather large dispersions among ETFs tracking the same sector. Assets in each category are very top heavy, with the SPDR ETFS at the top and accounting for the lion’s share of assets.

Notable takeaways

Energy – It’s been a rough ride for energy names recently but the Powershares Momentum ETF was hit particularly hard. Over a 3-Year period, it’s been plain ol’ market-cap weighting at the top

Discretionary – Lets call this the “Amazon” effect because the ETFs with the largest weight there have pulled ahead recently. Take note of the First Trust Discretionary ETF, which only has a 1.13% weight to Amazon. Market-cap weighting  schematics dominate performance here. 

Energy, Financials, Technology

Materials, Utilities, Industrials

Discretionary, Staples, HealthCare

Where The Volume At?

A common myth is that small ETFs, or those with low trading volume are, by definition, illiquid. While the intricacies of true ETF liquidity entails a deeper dive into the underlying securities, the purpose of this post is to simply provide a look at the where some of the most traded ETFs lie. Its important to keep in mind that this data is looking at the past 3 months so some of the trading seen could be a byproduct of what is happening in the broader capital markets.

The reality is that the majority of ETFs on the market are thinly trade and many investors may be restricting themselves and their available options by relying solely on trading volume. If we look the distribution breakdown by average number of shares traded, less than 50% of U.S. listed ETFs trade more than 50,000 shares a day. Many investors may use the 500,000 share threshold as a screen for potential ETFs, but as you can see, that narrows the universe down to only about 13% of the market. 

Below is a closer look at the most traded ETF by asset class. Overall, SPY is king but investors (or in this case traders ) sure do love those gold miner ETFs, as 4 of them make the top 15. Notice in fixed income that high yield bond ETFs are at the top, clearly sending a message that investors value the daily liquidity benefits of ETFs for assets classes that may be more difficult to access. 

*Volume data is 3-month ADV as of 3/17/2017 

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Mind Your Factors

The proliferation of smart beta ETFs has prompted many investors to rethink their traditional investment allocations and consider new alternatives to achieve desired outcomes. Among one of the hottest trends is “factor-based” investing where an ETF identifies a basket of stocks to harness specific drivers of returns (momentum, quality, etc).

There are of course several ways in which investors can access a suite of factor based ETFs. They can purchase multifactor ETFs, which package multiple factors into one turnkey product. The other alternative is to pick and choose single factor ETFs based on market outlook. The multifactor approach is meant to take the guesswork out of choosing single factors by utilizing a rules-based process to combine an array of factors. The single factor approach allows for a bit more flexibility to mix and match factors, which allows for more explicit targeting of factors based on market views.

For this look, I wanted to look at the later approach where an investor would pick and choose his or her own factor ETFs. For these purposes, I used the suite of iShares Edge Single Factor ETFs

·       Momentum (MTUM) - Exposure to large- and mid-cap U.S. stocks exhibiting relatively higher price momentum

·       Value (VLUE) - Exposure to large- and mid-cap U.S. stocks with lower valuations based on fundamentals

·       Size (SIZE) - Exposure to large- and mid-cap U.S. stocks with a tilt towards the smaller, lower risk stocks within that universe

·       Quality (QUAL) - Exposure to large- and mid-cap U.S. stocks exhibiting positive fundamentals

The purpose here is not to take a definitive view on any specific factor, but rather highlight the performance of the ETFs and take a closer look at the underlying holdings.

While the academic support for factor investing dates back decades, for these purposes I went back to the inception dates of these ETFs in 2013, which is more indicative of what an actual investor would have access to.

The first chart highlights the cumulative performance of each factor ETF since 2013. MTUM has been the clear winner on a cumulative basis. 

The cyclicality of the factors is a bit more apparent on a rolling chart where you can easily see shift in trend between MTUM and VLUE.

One of the issues that requires addressing is that these factor ETFs are created independently of each another; meaning that there could be a instance where a stock is included in both a Momentum ETF and a Value ETF. In a multifactor ETF, duplicate holdings are netted out but for a “do-it-yourself” factor investor, it important to take notice of the overlap among varying ETFs.

For example, if we look at the aforementioned ETFs, we can see that all of the holdings in MTUM, QUAL, and VLUE are also included in SIZE. The numbers indicate what weight they have in SIZE, so for example, the names in MTUM account for 21% of the weight in SIZE, and so on. 

In addition, there is commonality among MTUM, QUAL, and VLUE.

  • MTUM/VLUE: 7% Overlap
  • MTUM/QUAL: 16% Overlap
  • VLUE/QUAL: 20% Overlap

Investors should be mindful of the overlap among their ETFs and the impact that has on correlations. ETFs that have significant overlap inherently means that investors could be doubling down on certain stocks and may not have the desired diversification across factors. 

The adoption and usage of factor ETFs (both single and multi) will continue to remain strong as investors continually seek more innovative approaches to building efficient portfolios. 

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Fee War

Vanguard cast another stone last week cutting fees across a wide array of its ETFs. In this post, lets take a closer look at the fee breakdown among some of the largest players in the space.

The chart below highlights the top 15 ETF providers along with some fee metrics. The average fee column is a simple average of all the sponsors’ products but the asset-weighted column helps to add a bit more context. 

As expected, Vanguard and Schwab have the lowest average fees among the top players in the industry. While you won’t find much in the way of smart beta offerings from Vanguard and Schwab (They do have the RAFI Fundamental ETFs), you can be sure to get one thing…cheap beta exposure. On an asset-weighed basis, it’s a tie among the two at 9 basis points… (that’s right, 9 basis points)

Other firms like First Trust and Proshares, tell a slightly different story. These firms have a wide range of products ranging from smart-beta to leveraged exposure. The average fee for a First Trust ETF is 73 bps (67bps on a weighted basis), which ranks among one of the highest for a sponsor of that size. This is a telling story especially around differentiation and how investors view your products. This also speaks volumes to the power of the distribution team at some of these ETF sponsors. Gone are the days of “build it and they will come” in the ETF ecosystem so a solid distribution network is imperative for success. Proshares has a rather robust offering of shorter-term trading vehicles (leveraged and inverse products), which tend to have higher fees.

Think of this as Walmart (Schwab, Vanguard) versus going to specialty retailer (First Trust, Proshares). When you go to specialized store, you have the understanding that a differentiated product may require a premium.  

And not to forget, what can be said about the king in the category, iShares. With an offering of over 300 ETFs, their lineup has an average fee of 36 bps (Asset-weighted 25bps)

Lastly, the breakdown below highlights the 10 least expensive and the 10 most expensive ETFs. 

While the goliaths look to do battle in the ETF arena, at the end of the day the ultimate victor is the end investor. 

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A Brief ETF Industry Breakdown

In 1993, a U.S. investor had one ETF to choose from; SPY. In early 2017, that number has grown to nearly 2,000 options ranging across asset classes. While product development teams have been quite busy for decades, they really ramped things up over the last 5 or so years. Of the nearly 2,000 ETFs available currently, about half of those have come to market in 2011 or later. The table below breaks down the number of ETFs by launch year. 2015 and 2016 were particularly busy years accounting for 25% of all U.S listed ETFs

The asset breakdown by year tells a different story. Nearly 77% of the assets are sitting in products launched in 2007 or prior. The largest single portion of assets ($400B) are sitting in products that launched in the year 2000. 

While competition heated up in 2016, we can best classify 2016 as the year of the fee cut.  ETF sponsors like iShares, Vanguard, Schwab, and Fidelity all slashed fees, making the ETF arena that much more competitive. While the true cost of ownership for an ETF extends beyond just its expense ratio (tracking, bid/ask spreads, etc), we can see the lower cost ETFs are skewed towards the ETF veterans, who have the luxury of more assets. 

To Launch or not to launch?

ETF sponsors, both incumbent and new entrants, are vigorously analyzing trends to justify the bringing a new product to market. The threshold level to measure success for an ETF can be debated, but I broke down the industry into some key buckets.

Entrance into the “Billion-Dollar Club” is a luxury enjoyed by just over 300 ETFs. For 11 of those elite, they opened up shop in 2014 or later. An encouraging sign is that while although many ETFs are new to the market and have not left much runway behind them, over 1,200 products have reached the $30 million mark. 


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