Tag Archives: hot stocks

HACKing the ETF Market (03/04/2015)

Recently I have come across an interesting example of the ETF industry catering to the “needs” of the investing public.

There has been a number of high-profile security breaches in the past few months, including Home Depot , J.P. Morgan Chase and Target. To address the growing concern about cyber security and provide an investment vehicle for it, a tiny ETF company launched PureFunds ISE Cyber Security ETF (HACK) on November 12, 2014.

Then two weeks later, Sony Pictures was hacked and the story received a huge amount of media coverage. Adding fuel to the fire, in early February 2015, there was a major data breach at a number two U.S. health insurer Anthem – it involved a database containing personal info about 80 million customers. Furthermore, President Obama addressed cyber threats extensively in his State of the Union Address and then led a cyber-security summit at Stanford University.

There is plenty of long-term potential for the companies in the index – according to PureFunds, each year cyber security incidents cost the global economy $400 billion and the rate of such incidents has been growing at a compound annual growth rate of 66% since 2009. J.P. Morgan Chase alone plans to double its annual cyber security spending to $500 million within the next five years.

With all this attention, ETF is up 16.8% from its launch compared to +4.5% for the S&P 500 (Exhibit 1). Lest you get all excited and plow into the fund, this is a very short track record. As a cautionary tale, take a look at how HACK’s largest holding has behaved since its IPO in September 2013 (Exhibit 2). FireEye Inc (FEYE) started out strong driven by wild optimism about future growth and the post-IPO return reached 165% by March 2014. Then as the excitement died down, it came back to earth and is currently neck-in-neck with the S&P 500. Keep in mind that this is a company that is growing revenues at triple digit rates, but still loses money every quarter. The point I’m trying to make is don’t get carried away with this exciting space.

Exhibit 1 – HACK Performance Since Launch vs. S&P 500


Source: Stockcharts.com, PlanByNumbers

Exhibit 2 – FEYE Performance Since IPO vs. S&P 500


Source: Stockcharts.com, PlanByNumbers

Business Perspective

We have seen this tale many times before – most recently with companies involved in solar energy, social media, and biotech. What I find more interesting is the business case for the ETF itself. From that perspective, PureFunds has hit a jackpot with a fashionable little corner of the market. I collected a history of Assets Under Management (AUM) figures for the fund from various news articles and press releases. Exhibit 3 shows how AUM has skyrocketed with each news story. It reached $100m in early January, just 55 days after launch. It has been going up in leaps and bounds (literally) and has almost doubled in the last two weeks alone! That is quite remarkable for a niche sector ETF sponsored by a tiny upstart. Good for them though, a little initiative and luck will still get you places in this business. With current AUM PureFunds stands to make over $3 million a year on the management fees – not bad for a few guys in Jersey.

Exhibit 3


Source: Yahoo! Finance, PlanByNumbers

Fund Composition and ETF.com data

Apparently, HACK has been in the making for couple of years. The universe of companies needed to grow to support market cap and trading volume for an ETF. The fund is currently composed of 31 stocks, mostly from USA and Israel and is dominated by small / micro-cap companies. Keep in mind that this space is still a tiny niche. All of the U.S.-based companies in the fund weigh in at only 0.95% of the Total U.S. Stock Market and 0.65% of that is due to CSCO alone.

You can find detailed stats on ETF.com’s Fund Report – it’s my new favorite source of data on ETFs.

I plan on doing a series of posts based on their fund database to analyze recent ETF launches and industry trends.


How Come I Don’t Have Any… Tesla, Netflix or Facebook?

One of the most frustrating common questions financial advisors get from clients is “Why didn’t you buy that XYZ hot stock for my account?”  People watch the hype on CNBC or read financial press and get all excited about Elon Musk (Tesla) or Twitter IPO.  By the time these companies become household names in many cases the big run is largely over and the volatility goes through the roof.

I prefer to invest in domestic stocks through index ETFs as opposed to actively-managed funds.  There are many reasons for this including lower expense ratios, persistence of performance and style drift.  I won’t get into the detail of that here, but one of the “side effects” of investing in index funds is that you DO end up owning every stock in the market, including the hot performers.

Let’s make a few assumptions and see what a typical investor might own in their index portfolio.  For this example, we will take a total of $1,000,000 invested in a 60/40 portfolio.  Let’s assume 2/3 of equity allocation is invested in domestic stocks and that it’s split 70/30 between large and small cap ETFs (Exhibit 1).

Exhibit 1 – Equity Ownership of Sample Portfolio


I typically use Schwab ETFs in client portfolios because they have the lowest expense ratios and are free to trade in Schwab accounts (which happens to be our custodian).  The analysis of resulting domestic stock portion is shown in Exhibit 2.  The 70/30 split has expense ratio of 5 basis points, about 2,500 holdings, 58% large cap stocks and is slightly tilted towards growth stocks (per Morningstar classification).  The numbers for U.S. Broad Market ETF are also shown for reference.

Exhibit 2 – Characteristics of Combined ETF Holdings


Now let’s pick 10 hot stocks that get a lot of attention due to their performance and media popularity (subjectively selected by me).  With our $400,000 position in domestic stocks, here is what we own: $250 of TSLA, almost $400 of NFLX and $1,700 of FB (Exhibit 3).  We even have $56 worth of Twitter or one entire share.  TWTR went public on November 7, 2013 and was added to SCHX on December 23.

Exhibit 3 – Ownership of Popular Stocks in Schwab ETFs


Exhibit 4 shows the top performers among U.S. stocks with market cap over two billion dollars.  You can see in my prior post reviewing 2013 that the best areas to invest in lately have been Solar, Biotech, and Social Media/Internet.  Out of 20 big gainers only four are well-followed names from Exhibit 3 (highlighted in grey).  The rest are small companies heavily concentrated in biotech and technology areas.  A year ago, how many of you could have picked Intercept Pharmaceuticals, Rite Aid or MGIC Investment to be big winners?  I know I couldn’t!  In the interest of full disclosure, by indexing you also own the biggest losers in the market, such as a nice bouquet of gold and coal miners that have lost 30-60% in the past year.  The upshot of that is that yesterday’s losers often become tomorrow’s darlings and vice versa.

Exhibit 4 – Ownership of Top Performing Stocks


The “Bottom 99%” Note

The beauty of this approach is that you don’t need a million-dollar portfolio to own any and all stocks.  Index investing is a very democratic and [almost] anyone can open a Charles Schwab account with a minimum deposit of $1,000.  After that you can buy Schwab ETFs with ZERO commission in one-share increments (about $50).  (Note: I am not promoting Charles Schwab in particular, just using them as example since we are looking at their ETFs).

Exhibit 5 shows the exposure for the same portfolio as above but with only $10,000 overall investment.  Google (GOOG) is a twelve hundred dollar stock, but you can still own 0.044 shares worth $52.70.  Similarly, you would own 56 cents worth of Twitter stock giving you a tiny ownership in the [potentially] next big thing!

Exhibit 5 – $10,000 Portfolio Example