New Hedge Fund ETFs For Small-Cap And International Stocks

| About: Global X (GURI)
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New ETFs from Global X Funds seek to replicate high conviction ideas from hedge funds.

Annual management fee of 0.75% - No need to pay the '2-20%' fees of a typical hedge fund.

The ETFs use publicly accessible information contained in the 13F Filings.

Last month, Global X Funds launched two new "Guru" ETFs, which seek to track the performance of equities selected by the best hedge funds and institutional investors. These new ETFs have been launched because of the popularity of its Global X Guru Index ETF (NYSEARCA:GURU), which currently manages more than $500 million of assets, and strong investor demand for innovative ETF strategies. The Global X Guru Index ETF primarily tracks large-cap companies, and the new funds would allow Global X to offer similar selection methodology for small-cap stocks and international companies.

Although ETFs are designed to track a specific index, the pace of innovation with indexing has blurred the distinction between active and passive investing. These "Guru" ETFs resembles active management, as they track indices created by Solactive that are designed to copy trades made by hedge funds. The increasing prevalence of such funds allows investors to generate alpha through the convenience and advantages of an ETF wrapper. There is, however, one important concern about choosing ETFs resembling active styles of management over passive strategies, which is the higher annual charges on such ETFs.

The new ETFs are the Global X Guru Small Cap Index ETF (NYSEARCA:GURX) and the Global X Guru International Index ETF (NYSEARCA:GURI). They both use a similar methodology as their predecessor, the Global X Guru Index ETF, to replicate the performances of small- to mid-cap stocks and international companies, respectively. The Global X Guru Small Cap Index ETF tracks the Solactive Guru Small Cap Index, which selects 100 stocks on an equally weighted basis, according to its proprietary methodology. Only stocks with a market capitalization of between $100 million and $3 billion are screened for selection in the index.

The Global X Guru International Index ETF tracks the performance of the Solactive Guru International Index. This index uses a similar methodology to select 50 international companies with a U.S. listing held by a select group of hedge funds. It similarly holds these equities on an equal weighted basis, and adjusts its holdings quarterly. It is important to note that a significant proportion of its holdings are ADRs.

The three funds use publicly available information of the equity holdings of hedge funds contained in the 13F Filings. They claim that the proprietary methodology used for the indices seek to identify the "highest conviction ideas from a select pool of hedge funds and other institutional investors". The selection methodology includes screening funds for a low fund portfolio turnover, and identifying equity positions which represent the largest holdings in the funds' portfolios. The stocks are also screened for liquidity, and their holdings are adjusted on a quarterly basis.

It is important to note that there are some pitfalls with replicating trades by using information from the 13F Filings. Form 13F is only required to be filed within 45 days after the end of the calendar quarter; which means the hedge fund may have already disposed its position in that stock by the time the document is publicly available. Fund managers are not obliged to disclose their short equity positions or their investments listed on a foreign exchange. However, they are obliged to declare their U.S.-listed long equity positions, equity options, warrants, and certain debt securities.

All three of these ETFs from Global X charge an annual management fee of 0.75%. These may not be the cheapest ETFs, but they seem relatively inexpensive when compared to the typical "2-20%" fee schedule that most hedge funds charge. This low cost makes these ETFs an attractive choice for those who wish to adopt the "follow the rainmaker" strategy, but wouldn't want to spend the time to sift through individual 13F Filings and adjust their holdings accordingly.

The Global X Guru Small Cap Index ETF is perhaps the most interesting, because of the greater potential for hedge funds and institutional investors to seek alpha from undercovered small-cap stocks. Small-cap companies also tend to outperform their larger counterparts over the long term. Most passive ETFs tend to be market-cap weighted. But, the equal weighting in the Solactive Guru Small Cap Index further helps to increase the ETF's exposure to smaller companies.

Since its inception less than a month ago, the ETF has declined by 2.1%. But, in the past 12 months, the Solactive Guru Small Cap Index, the ETF's underlying index, had risen by 30.3%; and over the past 5 years, the index had more than tripled, with an increase of 213.8%. But, it is important to remain cautious with those figures, as past performance may not be indicative of future returns.

The fund is quite heavily tilted towards the three following sectors: consumer discretionary (27%), energy (18%), and information technology (14%). By comparison, the Russell 2000, a small-cap index of 2000 stocks, has only 14.4% of its sector weighting geared towards the consumer discretionary sector. The energy sector represents only 5.3% of the Russell 2000 index, with technology representing 14.3%. Global X Guru Small Cap Index ETF's current holdings include some recognizable small- to mid-cap names, such as: Cooper Tire & Rubber (NYSE:CTB), Office Depot (NYSE:ODP), Atlas Energy LP (NYSE:ATLS), Golar LNG Limited (NASDAQ:GLNG), and Rosetta Resources (NASDAQ:ROSE).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.