Kevin O'Leary's OUSA: Why It Doesn't Belong In Your Portfolio

Summary

• Quality might be in the name, but low volatility is the real theme, and investors should be cautious if considering OUSA as a core holding.
• Despite a pandemic that has re-shaped global markets, fund managers felt it necessary to add just 6.26% worth of new holdings when it reconstituted in September.
• Unfortunately, the added stocks underperformed the deleted stocks by 4.87% since the reconstitution, putting into question the fund's stock-picking abilities.
• While OUSA's current sector allocations are reasonable, this article will demonstrate why low-volatility stocks are the last thing you should want once markets bottom out.
• I'm neutral only because of its high allocations to Consumer Staples and Health Care stocks, but am recommending investors avoid OUSA so they aren't caught in a bad market cycle.

Photo by dima_sidelnikov/iStock via Getty Images

Investment Thesis

Nearly six years ago, Kevin O'Leary launched the O’Shares U.S. Quality Dividend ETF (BATS:OUSA) in what remains a crowded U.S. dividend ETF space. The strategy focuses on stocks with good dividend growth rates, low payout ratios, and low historical volatility. However, as this article will show, the low-volatility piece has been the fund's major weakness in the current stock market recovery. OUSA only rebalances once per year, hardly makes any meaningful trades when it does, and still charges much higher fees than many of its better-performing competitors. Even though I slightly favor the fund's sector allocations today, I don't see the point in making this ETF a core holding. It may perform above-average in the short term, but if the market corrects again, I recommend staying away from OUSA.

ETF Profile And Sector Allocations

OUSA was launched on July 14, 2015, and markets itself as a high-quality, low-volatility dividend ETF meant to serve as a core holding in investors' portfolios. As of June 2020, the target index changed to the O’Shares U.S. Quality Dividend Index but still maintains a 5% single security cap weight. The fund is rebalanced quarterly, reconstitutes annually at the end of September, and charges an annual fee of 0.48%.

OUSA currently invests in eight sectors with a lean toward Information Technology and Health Care Stocks. At its last reconstitution, it added more Health Care and Consumer Staples stocks at the expense of those in the Consumer Discretionary and Financials sectors.

Source: Created By Author Using Information From O'Shares ETFs

O'Shares also lists its holdings daily, with the top ten shown below.

Source: O'Shares ETFs

In his pitch found on the fund's website, Kevin O'Leary touts that OUSA experiences 30% less downside than the S&P 500 during stress events. As I will discuss later, though, it's just as important to mention the underperformance it experiences during recoveries if Mr. Wonderful wants you to think of OUSA as a core holding.

OUSA Dividend Details

The dividend yield of 1.76% is low for a dividend-ETF, especially compared to its peers. Out of the five comparators below, its yield is only higher than the Vanguard Dividend Appreciation ETF (VIG).

Source: Seeking Alpha

Based on the fund's current holdings, here are some additional weighted-average dividend metrics. There is undoubtedly an emphasis on dividend safety, with both the trailing and forward payout ratios under 50% and a strong dividend growth track record of around 10% per year in the last five years.

Source: Created By Author Using Data From Seeking Alpha

Annual Reconstitution: Performance of Additions and Deletions

OUSA's annual portfolio turnover ratio was only 15%, suggesting that its managers aren't very active. Effective September 20, 2020, OUSA added 25 new stocks to its portfolio as part of its annual reconstitution. While 25 may seem like a lot, almost all of these will have minimal impact on the fund going forward. The table below shows the performance of each of these stocks (including dividends) since they were added.

Source: Created By Author

As shown, the 25 stocks only total 6.26% of the current portfolio. Despite these stocks generating a return of 21.39% since September 20, they've only added 1.34% to OUSA's total return.

OUSA also deleted 24 stocks from its tracked index in September. The table below gives the same performance summary of these stocks.

Source: Created By Author Using Data From Archived Version Of OUSA Profile

Most of the action taken was on the deletions side, with 13.67% of the fund being removed at reconstitution. Unfortunately, this group of stocks has performed better than the group that was added - 26.26% since September 20 vs. 21.39%. This weighed on the fund's total returns by 3.59% in these last six and a half months.

I found this lack of activity to be quite surprising. The implication is that COVID-19 has not fundamentally changed the definition of "high-quality" in the fund managers' minds nor the factor models they manage. I'm afraid I have to disagree with this, as I think a pandemic is a once-in-a-lifetime event, and the markets will treat it as such.

OUSA Historical Performance

While no one should ever buy or sell an ETF based on such a short performance time frame, OUSA does have a six-year history, so let's compare its performance to two popular low-cost dividend ETFs: the iShares Core Dividend Growth ETF (DGRO) and the Schwab U.S. Dividend Equity ETF (SCHD).

In total, OUSA has badly lagged these two ETFs as well as the broader S&P 500 (SPY), but the underperformance only began in Q4 2020. As I have highlighted in the image, they were very close at Q3 2020. Since October, OUSA has returned 12.61% compared to 24.75% for DGRO and 35.99% for SCHD. Since the impact of the additions and deletions only explains a small fraction of these differences, something must be fundamentally wrong with the way OUSA selects its constituents.

The annual standard deviation of 13.65% is low, which aligns with the fund's objectives. I have calculated OUSA's current weighted-average five-year beta to be 0.81, which puts it into the low-volatility category. I recently summarized the pre and post-pandemic performance of low-volatility ETFs in my article on the Legg Mason Low Volatility High Dividend ETF (LVHD) and concluded that the majority of these funds performed about average as the market crashed last March and then went on to massively underperform during the recovery. Here is the same updated table from the article, but with OUSA included. The pre-crash returns are from April 2019 to March 2020, and the post-crash returns are from April 2020 to the present.

Source: Created By Author Using Data From Portfolio Visualizer

As you can see, OUSA performed similarly to other low-volatility ETFs in the last two years. Unfortunately, this meant underperforming the S&P 500 ETF by 23.32%. As I discussed in my article on LVHD, low-volatility strategies do not work when unpredictable crashes occur. They may offer modest protection on the way down but will likely miss out on the best-value stocks in a recovery.

Investment Recommendation And Conclusion

OUSA's biggest weakness is its low-volatility theme, which, along with its passive management style, leaves investors vulnerable if a market crash and recovery happens to occur many months before its subsequent reconstitution. For example, the fund lagged the S&P 500 by over 18% since April 2020.

The idea of a low-volatility ETF is that it will protect you during market stress events, as Kevin O'Leary puts it. The protection was minimal at best, though, with OUSA losing 11.07% in March 2020 compared to the S&P 500's 12.46% loss. I expect this pattern to repeat during the next market crash, as value investors don't tend to place big bets on low-volatile "quality" stocks when they are reasonably sure a bottom has hit. Instead, they will go after deep-value, highly volatile, and often-times high-yielding stocks that have been impacted the most. As I showed in my article on DGRO, the top 10% of dividend-paying stocks made a comeback in 2020, reversing a six-year trend. OUSA won't ever select these types of stocks because it has an unwavering commitment to dividend safety. My view is that a balance between safe and high-potential stocks is a smarter strategy.

As a core holding, I would not recommend OUSA. There are simply many other better and cheaper options available such as DGRO and SCHD that make meaningful changes at reconstitution time to reflect the latest market conditions. If it weren't for the fund's overweighting on the Consumer Staples and Health Care sectors, which I am both bullish on, I'd have rated it as bearish. Instead, it gets a neutral rating due to its potential for good short term performance. Just don't expect quality returns during the next market disruption, though.

Analyst’s 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.