With the increasing popularity of ETFs, it may serve to stray from the plain vanilla ETFs and explore some of the more exotic ones. One such exotic ETF is the Guggenheim Spin-Off ETF (CSD). This ETF is designed to track a third party index called the Beacon Spin-Off Index, which is comprised of a maximum 40 stocks that have been spun-off within the past 30 months, but no more recently than the last 6 months. This index defines a spun-off company as one that either underwent an equity distribution of a subsidiary company to its parent company shareholders, or underwent an equity "carve-out," in which the parent company sells a portion of its subsidiary's equity to public shareholders. Beacon then selects from this universe of spun-off companies through its proprietary methodology and adjusts the index semi-annually. Currently, the index has 26 holdings, mainly small and mid-cap companies, with the heaviest weightings in the Energy, Industrials, and Consumer Discretionary sectors. The Guggenheim ETF tracks this index through low-cost passive investing and subsequently has a minimal net expense ratio of 0.65%.
Now besides the intrigue into this ETF given the mere concept behind this investment vehicle, the ETF also tells a compelling story of a remarkable history of outperformance. CSD handily beat the market each of the past 4 years and is up a staggering 170.9% vs. 61.3% for the S&P since the start of 2009. Last year, CSD was up 24.5% while the S&P was up 11.7%. So far it is lagging the S&P by 1% this year, but I don't see that holding up for long given CSD's history.
And spun-off companies' history of outperformance is validated through more than just this ETF. Credit Suisse ran a good piece of research back in 2008 that analyzed major U.S. spin-offs in the last 5 years, 39 in total, and how they performed. The results were that the median spin-off performance in year one beat the market by 22%, as 70% of spun-off companies outpaced the market. Lehman Brothers also conducted a study of 88 spin-offs between 2000-2005 and found that they beat the S&P 500 by an average of 45% in their first two years of trading.
So why has this ETF and spin-offs in general steadily beat the S&P each and every year? Spin-offs are known to "unlock value," and turn the subsidiary company into more of a pure play, rather than being part of a larger business with wide-ranging goals. The spun-off company typically is now better able to focus on its core market segment, while management is given greater accountability with the new stand-alone public company than before as part of the larger enterprise.
Lets take a look at CSD's biggest position as a possible example of this. Its current largest holding is Fiesta Restaurant Group (FRGI), which was spun-off from Carrols Restaurant Group Inc. (TAST) back on May 7, 2012. Carrols owns and operates quick-casual and quick-service restaurants, specifically 297 Burger Kings as of April 1, 2012, making it the largest Burger King franchisee in the U.S. Before the spin-off, Carrols also owned Pollo Tropical and Taco Cabana, two fast-casual ethnic restaurants located throughout the southern United States, the Caribbean, and Central and South America. The spin-off separated the Pollo Tropical and Taco Cabana chains into the new Fiesta Restaurant Group company. This spin-off provides an example where it probably made more sense to break the company into two, as different parts of the business had different profiles, with different customer bases, and different areas of operation and growth, etc. The new Fiesta Restaurant Group now has more of a concentrated focus and since has secured agreements to develop franchises in Guatemala, Aruba, Bonaire, Curaçao, and most importantly India. Who knows, maybe an expansion into India would not have been possible if it had not been for the spin-off.
In summation, while I am typically wary of trying to follow trends, this might be a case of something that is not too good to be true. I do not see any fundamental reason why spin-offs in the future would be less likely to outperform the market than spin-offs in the past, and therefore, I think CSD makes a good investment. A final note, Guggenheim has some other interesting ETF's I encourage you to look at, such as the Insider Sentiment ETF (NFO), which reflects favorable corporate insider buying trends, as determined via public filings of such corporate insiders as well as Wall Street estimate increases.