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Income, Growth and Safety with O'Shares ETFs

Paul Dykewicz is leading financial journalist and editor for StockInvestor.com. He recently met with Kevin O’Leary — well known as Mr. Wonderful — to discuss the the O’Shares ETFs, which were designed around the billionaire's value-oriented investing strategy.

Kevin O’Leary created O’Shares Investments to launch exchange-traded funds that would model his personal investment priorities of producing income, preserving wealth and delivering capital appreciation.

O’Leary, a billionaire who serves as a wealthy panelist on ABC’s “Shark Tank”, shared his personal investing strategies with me recently when I interviewed him in the Shark Bar at the Palms Casino Resort in Las Vegas.

Since the first of the four O’Shares exchange-traded funds (ETFs) only launched in July 2015, none of them have a long track record that can be used to measure their performance against other ETFs.

However, O’Leary said that among the roughly 1,700 ETFs that exist, none adhered to his three core investment principles of income, wealth preservation and capital appreciation, so he decided to launch his own.

Years of experience in hiring managers to manage his personal wealth on the equity side taught O’Leary about the wisdom of analyzing balance sheets in choosing investments.

More from Paul Dykewicz: Asia-Pacific ETF Offers High Yields for Contrarians

Many years ago, O’Leary said he became impressed by a female balance sheet analyst who was agnostic about market capitalization and sectors but developed four rules for investing in stocks. "Each quarter, she would analyze four metrics on a S&P 500 company’s balance sheet,” O’Leary recalled

The first rule is to consider return on assets, which is “an old school” metric which generally takes two quarters to manifest itself either up or down, O’Leary said. It sometimes takes just one quarter if “inventory is piling up,” he told me.

The second rule it to look at free cash flow, while staying agnostic to the cash on hand, O’Leary said. The third rule is to assess leverage to determine whether it is going up or down every 90 days. The fourth rule is to check for volatility against the overall index.

She didn’t care about market cap and instead focused on volatility, O’Leary recalled. With the S&P 500 stocks that she used as her universe of stocks for investing with her four rules, the larger the market capitalization, the lower the volatility.

Basically, O’Leary said what he learned from her was that he received the S&P's returns with 26 percent more yield, 20 percent less volatility and only incurred 62 percent of the downside on the index’s drawdowns.

O’Leary worked with global index partner FTSE Russell, which created innovative rules-based indices for the United States, Europe and Asia to focus on his core objectives.

His inaugural ETF, O'Shares FTSE U.S. Quality Dividend ETF (OUSA), is now listed on the New York Stock Exchange and was envisioned by O’Leary to address his long-term investment objectives of owning a diversified portfolio of quality U.S. stocks that pay dividends and have low volatility.

The fund seeks to track the performance, before fees and expenses, of its target index, the FTSE USA Qual/Vol/Yield Factor 5% Capped Index.

The low volatility focus is aimed at the preservation of capital to guard against the kinds of market pullbacks that have occurred occasionally since late 2018. In recent months, OUSA has withstood the worst of the fallout from rising trade tensions between the United States and China.

In the latest example between July 26 and Aug. 5, OUSA avoided 21 percent of the fallout absorbed by the S&P 500. Another example occurred between April 30 and June 3, when OUSA sidestepped 35 percent of the drop endured by the S&P 500. The key is to limit balance sheet risk, O’Leary said.

OUSA has $516.5 billion in total net assets, a 30-day SEC yield of 2.56 percent and an expense ratio of 0.48 percent. The fund’s biggest holdings, as of Aug. 12, were Procter & Gamble (PG), 4.99 percent; Exxon Mobil (XOM), 4.75 percent; and Johnson & Johnson (JNJ), 4.70 percent.

The ETF’s three biggest sector holdings are consumer goods, 15.77 percent; health care, 13.65 percent; and consumer services, 13.59 percent. The ETF’s total return, based on its net asset value (NAV) on Aug. 12, reached 13.79 percent year to date, 9.28 percent in the past year and 9.06 percent in the past three years, according to Morningstar, which rated the fund three stars.

O'Shares FTSE Russell Small Cap Quality Dividend ETF (OUSM) is an ETF that seeks to track the performance, before fees and expenses, of the FTSE USA Small Cap, ex Real Estate 2Qual/Vol/Yield 3% Capped Factor Index. OUSM consists of more than 200 small-cap stocks selected for quality, strong balance sheets and profitability, as well as limited volatility.

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Founded on December 30, 2016, OUSM has $95.7 billion in total net assets, a 30-day SEC yield of 2.25 percent and an expense ratio of 0.48 percent. Its top holdings, as of Aug. 12, were information technology companies Leidos Holdings (LDOS), 3.91 percent; Teradyne (TER), 2.73 percent; and Cypress Semiconductor (CY), 2.39 percent.

The largest sectors held by the fund, as of July 31, were information technology, 22.54 percent; industrials, 20.14 percent; and financials, 18.78 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 13.74 percent year to date, but dipped 2.99 percent in the past year, according to Morningstar.

O’Shares FTSE Europe Quality Dividend ETF (OEUR) is intended to track the performance, before fees and expenses, of the FTSE Developed Europe Qual/VOL/Yield 5% Capped Factor Index that measures the returns of public large-capitalization and mid-capitalization dividend-paying issuers in Europe that meet key market-capitalization, liquidity, quality, low volatility and dividend-yield thresholds.

The strategy is designed to limit exposure to high-dividend equities that have incurred large price drops. Launched on August 19, 2015, OEUR has $24.4 billion in total net assets, a 30-day SEC yield of 3.11 percent and an expense ratio of 0.48 percent.

Its top holdings, as of Aug. 12, were consumer goods company Nestle S.A (NSRGY), 5.53 percent; pharmaceutical company Novartis (NVS), 5.07 percent; and pharmaceutical maker Roche Holding AG (RHHBY), 5.00 percent.

The fund’s three largest sectors, as of July 31, were health care, 20.60 percent; consumer goods, 13.96 percent; and energy, 13.33 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 9.57 percent year to date, 0.24 percent in the past year and 2.71 percent of the past three years, according to Morningstar.

O’Shares Global Internet Giants ETF (OGIG) is designed to mirror the performance, before fees and expenses, of the rules-based O’Shares Global Internet Giants Index featuring some of the largest global companies that gain most of their revenue from the internet and e-commerce sectors.

The holdings are chosen to provide quality stocks with growth potential. The ETF’s biggest holdings, as of Aug. 12, were Alphabet Inc., the parent company of Google (GOOG); 6.63 percent; Tencent Holdings Ltd. (TCEHY), 6.15 percent; and Alibaba Group Holding Ltd. (BABA), 6.03 percent.

The three biggest sector holdings of OGIG, as of July 31, were information technology, 36.93 percent; communications services, 35.33 percent; and consumer discretionary, 27.71 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 25.69 percent year to date but dipped 0.20 percent in the past year, according to Morningstar.

O’Leary expressed optimism that investors would look for ETFs such as those at O’Shares to limit volatility in hopes of preserving capital when the markets drop.

For investors who like O’Leary’s strategy and don’t mind paying higher-than-average expenses to follow his four rules for investing, his funds offer something that the other approximately 1,700 ETFs in existence currently cannot match.

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