ETF Update: High Concentrations Seem To Be Paying Off

by: ETF Global

A terrific week for tech stocks and the funds that hold them sent them skyrocketing up our Behavioral charts, but have they come too far?

Most of the funds seeing big moves are heavily concentrated in a handful of names, making them vulnerable to a reversal.

Meanwhile, investors seem to be setting up (and hoping) for one retail fund to fail.

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Another week of earnings season has come and gone, with the most noticeable development being the return of the “FAANGs,” or at least a some of them, as some of biggest names managed to get even bigger last week, thanks to exceeding expectations, including Amazon (AMZN), Facebook (FB) and Netflix (NFLX). Even Microsoft (MSFT), one-time cash cow and now once again a growth stock, has hit its stride, up over 5.5% on the week and crossing the vaunted $1 trillion market cap level. Have the good times of 2017 come back to stay?

To answer that, we turn to something our regular readers are familiar with - our list of Behavioral Top Scorers List, where we rank every equity fund in our universe daily on a wide variety of metrics, ultimately breaking down into two broad categories. The first is “technical,” where we look at certain inputs, including momentum, while the second is “sentiment,” where we focus on contrarian factors, including implied volatility, short interest and the put/call ratio. That gives you a little about the “how,” but now what about the “why”?

Ranking ETFs on these metrics won’t tell us whether technology funds are heading for the stars, but it does give both us and our users unique and fresh insights into the ETF universe. You can start with what funds are trending well and which aren’t. Are there patterns, like a certain sector or theme at the top and another at the bottom? Countries that have fallen out of favor? With so many funds, it’s possible to pull a “Beautiful Mind” and get lost in the process, but after an exciting week of earnings releases, we’ve identified a handful of trends that stand out as being important going forward.

1.) Tech Funds Domination

The least surprising thing to any regular visitor to our site was the number of tech funds in our Behavioral Top 100 List with 16 pure play technology funds along with a wide range of “growth-oriented” index funds. Heck, even a wide assortment of consumer discretionary and retail funds made the top 100, thanks generally to a “healthy” allocation to Amazon. The Vanguard Consumer Discretionary ETF (VCR) at #13 and with a 24% position in AMZN is an excellent example of this trend.

Instead of focusing on the sheer number of funds, we think a better lesson is found in what they have in common so investors can learn exactly what sort of funds are leading the pack. In fact, if we looked just at the top three funds - the First Trust DJ Internet Index ETF (FDN), the Invesco DWA Technology Momentum Portfolio ETF (PTF) and the iShares Expanded Tech-Software Sector ETF (IGV), a holdings-based analysis would refocus the conversation on just how widespread the “tech effect” is at this point. Those three funds have largely different names in their top ten holdings, not to mention they also follow different parts of the industry and even use different construction techniques.

In fact, tech stocks are doing well, but not much better than the broader market. Using, about 60% of all tech stocks are trading above their 200-day moving averages, roughly in line with the broader equity market but with a clear bias towards larger-cap companies versus smaller ones. What these three funds do have in common is they build out the portfolio’s using a market cap-weighted system that puts a lot of firepower in their top names, along with a preference for bigger companies. For FDN, which some have referred to as a stealth FAANGs fund, that means putting a quarter of the assets in just Facebook, Amazon and Netflix. Then throw in PayPal (PYPL) and Alphabet (GOOG, GOOGL) for another 15%. For IGV, it’s Microsoft, Adobe (ADBE) and Salesforce (CRM) that have 25% of the portfolio. Both funds have over 50% in their top ten holdings, making PTF the more “diversified fund” with just 42% in the top ten, but also with only 39, and typically much smaller, holdings.

So, what’s running up our Behavioral charts? Highly concentrated technology funds full of hot names, while equally weighted portfolios like the Invesco S&P 500 Equal Weight Technology ETF (RYT) didn’t even make the top 100. And while a combination of both strong price momentum and high sentiment scores pushed them to the top, you have to wonder if there is enough juice at these levels to convert that short interest into a move higher.

2.) A Lone Wolf

A number of consumer discretionary funds have been making the rounds on our top performers list, mostly thanks to a heavy dose of Amazon, but the top-ranked retail fund, the SPDR S&P Retail ETF (XRT), clearly breaks that pattern. Instead of only a handful of names, the fund has over 94, and with just a mere 14% in the top ten, thanks to an equally weighted allocation. That gives the fund a smaller feel and lets it put a respectable amount of money into some of the strong small- and mid-cap names like Carvana (CVNA), but it also means the fund has almost as much invested in Amazon as it does in Ollie's Bargain Outlet Holdings (OLLI).

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A quick look at its daily chart shows it has broken out of a downtrend pattern but remains a long way from its 2018 highs, while our own technical scores are trending towards average. What’s pushed this fund so high up our list is the put-call ratio, which our quant system shows is currently in the top 5th percentile compared to its long history, along with very high implied volatility and short interest. Add in the fact that there has been a steady outflow of assets and we’d guess that an increasingly large portion of the remaining asset base is decidedly short and waiting/hoping for a further breakdown in the sector. After all, XRT has more of its assets invested in GameStop (GME) and Barnes & Noble (BKS) than Amazon.

Given that the other consumer discretionary funds on our list are typically heavily invested in Amazon, while XRT is anything but, it could signify that the retail sector's woes are far from over.

3.) The Case of the Missing Smart Beta

Finally, we ought to shed some light on an investment theme that we think should be considered a dedicated smart beta category or "strategic beta" as our research team asserts. “Buyback” funds, which hold companies that make a commitment to buying back as much of their stock as they can, remain an intriguing category within ETFG's Quant.

For all the ink that has been spilled on the dangers of corporate share repurchase programs, only a handful of funds are dedicated to tracking them, with one - the Invesco Buyback Achievers Portfolio ETF (PKW) - holding a disproportionate share of the assets. PKW is also the only fund in the space to have recently visited the top 100, although it has dropped below that threshold, principally due to lowered implied volatility and moderate short interest. Given that earnings season is typically when announcements of new or increased share repurchase program are announced or, as in the case of Berkshire Hathaway (BRK.A, BRK.B), strongly hinted at, we’re surprised that more buyback funds aren’t rocketing up the charts as investors seek more yield.

The answer lies in the fact that investors are clearly favoring technology and growth names - something often conspicuously absent from most buyback funds - over yield. All three of the dedicated funds in our list have a distinct bias towards value names, which is hardly surprising given that admitting the best use for your corporate cash is to buy up hopefully discounted shares of our own stock isn’t the sign of strong growth prospects ahead! Plus, there’s the question of how you define a company with a strong commitment to share buybacks. For PKW, that’s anyone (with a certain minimum average daily trade volume) that reduced their share count by 5% over the preceding year. A high target, to be sure, and for a mega-cap technology company like Microsoft or Apple, an almost impossible one to meet, which is why neither stock is in PKW or any buyback fund.

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Meanwhile, Berkshire Hathaway maybe contemplating a new buyback policy, but its current spending program is far too low to make it worthy of inclusion in a buyback fund, and even then, would likely not be eligible for inclusion until 2020, if at all. And for all their promise of enhancing returns by returning capital, most of the buyback funds are returning in line with the broader market or slightly less than that. For now, growth is king.


As we wrap up this update, what are the lessons we can draw from our most recent reports? Namely that the tech phenomenon is real enough, so much so that the demand for growth stocks, and Amazon in particular, is having a sort of crowding-out effect on our behavioral list. But the funds that are quickly climbing to the top are often heavily concentrated funds, making them vulnerable if a small blip in the market were to hit those tech names at the top of the S&P 500. So, enjoy the rally while it lasts, but remember that it’s like holding a wolf by the tail. You don’t like it but you don’t dare let go - living safely among the wolves!

Disclosure: I/we 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.

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