On the Merits of Active ETFs and Stock Sectors

by: Roger Nusbaum

AdvisorShares is back with its second actively managed ETF. Recently it launched a long short fund, which you can read about here, and yesterday came the WCM/BNY Mellon Focused Growth ADR ETF (NYSEARCA:AADR). If it is not clear, it will only invest in ADRs, be they NYSE listed or pinksheet traded.

The fund is concentrated in 25 ADRs along with a little bit of cash. It looks as though the intention is to always have a small number of holdings. The largest holdings currently are Baidu (NASDAQ:BIDU), Walmart de Mexico (OTCQX:WMMVY), Li and Fung, client holding Teva (NYSE:TEVA) and Nestle (OTCPK:NSRGY). Each of those five have weightings in the 5% range, so while it is concentrated the single stock risk is not huge.

Based on the current holdings, which can change at any time, the fund is not well diversified at the sector level. There appears to be no utilities, telecom or energy holdings but large weightings to growth areas like tech, healthcare and consumer stocks. This is not a negative per se as anyone buying this fund is buying the decisions of the managers.

The difficulty in owning a fund like this is that the current holdings might fit in with someone's portfolio today but as there is no way to know what the fund will own in the future there is no way to know how it would fit in to a portfolio in the future, but this is true of all actively managed funds.

The one space where I think an actively managed ETF would be a boon to investors is in the financial sector. That may seem surprising given how down I am on the sector and how down I've been on it since before this site started, but that is exactly the reason why an active ETF could make a lot of sense. If you look under the hood of just about any financial sector ETF and what do you see? If it is a domestic fund you see JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C). If it is a foreign sector fund you see HSBC (HBC), Banco Santander (STD)--the one from Spain-- and a French bank or two. Further down the list you'd probably see some UK banks.

People have made great trades on a lot of these names but in terms of investing I want no part of them. There is no convincing me there are no more shoes to drop (something I have been saying all along). An actively managed financial sector ETF could potentially bypass or at least underweight US and European banks.

Looking over longer periods of time there have been foreign banks that have had relatively little attention paid to them -- that is, they have not been in the news much -- that have done quite well in what has been a down market.

We have owned the same Australian bank since before this site started and for the last five years it is up 22% versus the Financial Sector SPDR (NYSEARCA:XLF) which is down 53% in five years. We have had the same Canadian bank since before this site started and for five years it is up 37% and our Chilean bank we probably first added in late 2004 but were out of it for a short period of time and it is up 127% for five years. Additionally all three pay very large dividends. We also own a publicly traded exchange and an index provider.

The catalyst for looking for these banks way back when was, and this will be a repeat for long time readers, that the financial sector's weight in the S&P 500 exceeded 20% which I take as a warning of trouble. This is not intended to be a brag after the fact as I've been writing essentially the same thing since the start of this site in 2004. I've also been been saying that this sort of analysis and then finding stocks that fit the bill is not terribly difficult.

Anyone willing to do some stock picking, there you go, but I realize many people are not comfortable with stock picking but are comfortable investing at the sector level which given the landscape of financial sector ETFs this would be a great spot for an active product. Unlike the AADR mentioned above, you know that six months from now it would own financial stocks. It may or may not own the right ones but it would always be a proxy for the sector.

For what its worth I think the best areas in the sector continue to be banks from countries that no one talks about and certain publicly traded exchanges. Obviously there are other areas where the fundamentals are sound too.

One other little ETF item is that the Lithium ETF is planned for Friday and should have symbol LIT. Amusingly Quimica Minera (NYSE:SQM) will be the largest holding but only at 20% of the fund, not the 100% I've been joking about. Half the fund will be lithium miners and the other half will be lithium users (think batteries) so the fund will be heavier in the US than I was expecting. I plan to do a write up for theStreet.com that should run next week.