For Old Blue Eyes, these are his ‘kind of ETFs’


While many commentators still think Passive Investing, is indeed just that, nothing could be further from the truth.  To see why, consider the observation that the current churn rate of the S&P 500 is at around 5 per cent per year, which suggests that 50 per cent or more of the companies in the index will be replaced over the next 10 years. 

It is this evolving feature that is built into most indices which means they are almost always rules based and come with a built-in mechanism ensuring that the portfolio implemented against the index is not static and automatically updates in line with the business landscape.

Many examples abound in the ETF space that are based on the principle that the portfolio will change over time, and what better way to show that the ETF industry has an innate knack for delivering innovation than to look at a couple of products listed on the London Stock Exchange, both having performed particularly well this year.

The Chicago based firm VanEck might be one of the lesser known ETF players, but their fund which tracks Morningstar’s US Wide Moat index single handedly puts them in the top spot.   

Morningstar’s Economic Moat Rating was introduced in 2002 and ranks companies based on their competitive advantage, while also taking into consideration whether the stock is trading above or below fair value.  Since early 2007, Morningstar’s analysts’ rankings, as represented through the Wide Moat Index, have on average outperformed the S&P 500 by over 3 per cent annually which, given the long bull run, is no mean feat.

The ETF’s ticker is not surprisingly called MOAT and comes with an annual management fee of 0.49 per cent and was first listed in October 2015.  As the fair value of moated stocks rises and falls, the number of stocks in this index dynamically decreases or increases ranging between 40 and 80.

Talking of innovative ETFs, in a similar vein the First Trust US Equity Opportunities UCITS ETF, which tracks the US IPO market, provides another fantastic example of how to harness a good idea so that it works in practice.  It stands to reason that new IPOs are the lifeblood of the equity markets.  Just think, it wasn't that long ago that words like Facebook, Amazon, Netflix and Google were simply not in our investing lexicon.

The problem with new IPOs is that they are not created equal, so exactly how should one build a portfolio that filters out the losers but keeps the winners? Research carried out by Dr Josef Schuster and his team, I should add who are also based in Chicago, has resulted in the IPOX 100 US Index which has a track record dating back to mid-2004.  

With a current universe of over 800 newly 'minted' stocks, Schuster’s rules-based methodology whittles this down to just 100.  You will not be surprised to learn that this index over the period from 2004 onwards has comfortably outperformed large and small cap US equity indices. 

What particularly caught my attention was the inclusion rule that once a stock was more than four years old it will get dropped from the index.  This combined with a mechanism that avoids owning the new IPOs for that very short initial period when it is not uncommon to see stock prices gap up or down, goes a long way to explaining how this approach manages to tame a popular, but somewhat risky investment idea.

First Trust, who are also based near Chicago, have a rich tradition of well-designed investment products.  Within Europe this fund was first listed on the LSE and comes with a TER of 65bps.  While not the lowest management fee, the performances has made this a sound investment, returning 33 per cent year to date.

That's right, if you are an investor, Chicago might be 'Your Kind Of Town', and even old Blue Eyes would have loved these ETFs.

specialreports
other gfm publications
GFM corporate logo