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ETF Of The Week: Avoiding Future Losers

Lara Crigger

Earlier this week, GraniteShares, a boutique ETF shop that mostly offers commodity ETFs, launched a fascinating new smart beta equity fund: the GraniteShares XOUT U.S. Large Cap ETF (XOUT).

What makes XOUT unusual for a smart beta ETF—or any ETF, really—is that it doesn't aim to pick winners. Its sole goal is to avoid losers. We thought it would be interesting to look under the hood of this new fund for “ETF of the Week.”

Using fundamental financial data such as revenue growth, profitability and hiring growth, XOUT evaluates and ranks the 500 largest U.S. companies for their ability to weather and keep up with technological disruptions. The stocks determined to be the least well equipped to deal with change are then excised from the index. (The index is reconstituted and rebalanced on a quarterly basis.)

Exclusionary screens are a strategy long used in the thematic and socially responsible investing space, where values are on the line and investors often want to use their money to take a stand. Plenty of fundamental or smart beta funds also set thresholds for, say, volatility or revenue generation, then boot any stock that fails to meet that threshold.

But not often do you see exclusionary screens applied solely to identify performance winners and losers, agnostic of any other metric. The question is, how well will it work?

Surprising & Unsurprising Sector Bets

XOUT currently holds 249 names, or roughly half those you'd find in the SPDR S&P 500 ETF Trust (SPY) or the iShares Core S&P 500 ETF (IVV), the latter of which we'll use as a comparison.

 

Sector Breakdowns In XOUT, IVV
Sector XOUT IVV
Information Technology 31.93% 21.96%
Healthcare 19.18% 13.57%
Consumer Discretionary 13.99% 10.05%
Communication Services 11.75% 10.41%
Industrials 8.45% 9.35%
Financials 6.01% 12.91%
Consumer Staples 5.11% 7.55%
Energy 1.35% 4.54%
Materials 1.31% 2.71%
Real Estate 0.94% 3.24%
Utilities 0% 3.60%

Source: Issuer websites. Data as of Oct. 10, 2019. XOUT's figures are taken from its fact sheet, which is dated Sept. 30; the fund website itself, however, shows figures dating from July.

 

Unsurprisingly, XOUT leans in hard to technology companies: 32% of the fund is currently in information tech stocks, while 12% is in communication services. IVV, meanwhile, allocates 22% and 10% to each, respectively.

Also not particularly shocking is XOUT's minimal exposure to materials and energy firms—only 1% each. Both sectors have lagged this year, as trade war woes take their toll.

Missing Real Estate

But XOUT also has only minimal exposure to real estate, the top-performing sector of the past year, and a strong performer over the past decade (read: "Best Performing Real Estate ETFs").

The fund also has no allocation to utilities whatsoever, despite utilities seeing a 19% rise over the past 12 months (data from Fidelity's Sector Overview tool).

That's not to say the real estate and utilities sectors aren't uniquely exposed to risk from technological disruption; the retailpocalypse,” driven in part by a consumer shift to e-commerce, has hit the commercial real estate space hard.

Meanwhile, utilities have struggled to keep pace with consumer demand, as the latest PG&E debacle has shown. However, with technological disruption happening on an ongoing basis, wouldn't the threat have shown in up in these sectors' recent performance, however slight?

Stocks That Didn't Make The Cut

Looking more closely under the hood, we find some of the biggest and most commonly held large cap stocks do not appear in XOUT, including familiar names like Exxon Mobil, Walmart and Berkshire Hathaway.

 

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

 

Although the time period over which XOUT evaluates a company's financial data isn't immediately clear from the fund's prospectus, it is interesting that nine of the 10 excised stocks specifically listed in the fact sheet have positive returns, year to date. Some, like Walmart and Procter & Gamble, are even far outperforming the broader market.

 

Big Companies That Don't Appear In XOUT
Company YTD Performance
Berkshire Hathaway  1.95%
Procter & Gamble Co. 33.63%
Exxon Mobil Corp. -3.22%
AT&T 25.42%
Bank of America Corp. 11.74%
Verizon Communications Inc. 5.71%
Chevron Corp. 2.21%
Walt Disney Co. 18.68%
Wells Fargo & Co. 2.58%
Walmart 27.42%

Source: GraniteShares; data as of Sept. 30, 2019

 

Of course, a stock's current or recent performance matters less to XOUT's methodology than its potential for future returns to be disrupted by technological change. Again, exposure to disruption is the key criteria in deciding which stocks make it into the benchmark and which don't.

Yet even taking that into account, we find a few surprises among this list of excised names. Disney has made a high profile bet on its new streaming service, Disney+, while Walmart has rolled out an online grocery delivery platform like its rivals. Verizon and AT&T, meanwhile, are locked in a race to roll out the next-gen 5G network.

Rather than negative exposure to technological change, it seems these companies are at least trying to embrace it—or at least keep pace.

No Crystal Ball

Skepticism is healthy, but the truth is, we don't have a crystal ball any more than XOUT's advisor does. Perhaps these sectors and these companies truly are the ones most at risk to be turned on their head as technology continues to evolve at breakneck pace.

What matters more to the success of a fund like XOUT is whether investors buy into the secret sauce. And for that, only time will tell.

Contact Lara Crigger at lcrigger@etf.com

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