One of the prime benefits of the revolution in ETF and ETN investing is that investors have access to a range of investments that were once virtually impossible to invest in. There are ETNs for commodities such as coffee, sugar and cotton. And there are ETFs for sectors such as farming, cloud computing and new public companies. The boom in these exchange traded products has allowed investors to broaden their portfolios and returns. Today, we would like to analyze one of the newest ETFs in the market, the Global X Social Media ETF (SCOL).
This ETF is the first on the market to track a basket of social media stocks, such as Sina (SINA), LinkedIn (LNKD) and Google (GOOG). This is clearly an innovative ETF, but is now the right time to invest in it? There are a few factors that investors must consider before they dive into this new fund, which we delve into below.
- Exposure to China: The majority of this ETF's holdings are Chinese internet stocks such as Sina, Tencent (OTCPK:TCEHY), and NetEase (NTES). China accounts for close to 36% of the fund, while the U.S. accounts for just over 26%. The fund managers have defended this, saying that exposure to China should be favored, given that there are more Internet users in China than the U.S. has people. However, investing in China carries unique risks. Many of these stocks are new, and with the exception of Baidu (BIDU), and perhaps Sina and NetEase, the accounting practices at these companies have been unproven. Many investors have lost enormous sums of money betting on new Chinese companies, and this ETF could be vulnerable.
- Concentration: 30% of this ETF is currently in three Chinese companies. 11% is in NetEase, 10.64% is in Tencent, and 9.49% is in Sina. This leaves the fund heavily exposed to the swings of these three stocks, all of which are volatile.
- IPOs of U.S. social media firms: Part of the reason that the fund is tilted toward China and other non-U.S. countries is the relative lack of social media IPOs in the United States. Among true U.S. social media companies, only Pandora (P), Groupon (GRPN) and LinkedIn represent the U.S. in this ETF. Google is also present, but there is debate over just how much of a social media stock it is. Facebook, Twitter, Zynga, Yelp and LivingSocial have all yet to begin trading on either the Nasdaq of NYSE, and as such, the fund is theoretically underweight the U.S., an imbalance that should correct over time as these firms go public. But when they do is really anyone's guess.
- Expense ratio: The fund has an expense ratio of 65 basis points, and we think this is a reasonable rate given the specialization of this fund and the market it opens up. Furthermore, it is entirely possible that as more social media ETFs debut, the ratio will be lowered.
Given these four factors, is this ETF a buy? Not at the moment.
While we do like the long-term potential of social media, and are confident that years from now this ETF will have a much higher market price than it currently does, now is not the time to buy. The current market environment is simply too volatile. By and large, investors do not care about corporate fundamentals. It doesn't matter that the companies in this portfolio are all growing rapidly. Chinese stocks, at least in the short run, trade more on sentiment than fundamentals, and there is still skittishness over the profitability of the U.S. companies this ETF holds.
Over time, these concerns will dissipate, but the current market environment makes it impossible to do so. The fund's performance since it began trading proves this. Since November 16, the fund has dropped by 9.53%, compared to the S&P 500's 5.54% drop.
Click to enlarge
Social media has revolutionized the way we live, work and communicate, and over time, it will bring great rewards to those who invest for the long run. We fully believe that this ETF will have a much higher price in a few years. It is a definite buy, but investors should hold off on initiating a position until current market volatility presents a more compelling entry point. Social media connects us all, and this ETF will, over time, connect investors with great returns. But the time to befriend this ETF and add it to your portfolio has not yet arrived.
Additional disclosure: We own shares of Google (GOOG) through a mutual fund that gives it a 2.9% weighting. In addition, we are long Google, (GOOG) Baidu (BIDU), Sina (SINA) and NetEase (NTES) through the PowerShares nasdaq Internet Portfolio, which assigns these companies a weighting of 9.39%, 7.47%, 2.68% and 2.38%, respectively.