Hidden Gem ETFs

December 01, 2017

[This article appears in our December issue of ETF Report.]

The ETF industry is all about innovation. Ours is a disruptive industry, constantly pushing the boundaries to create better outcomes for investors.

But almost 25 years into the ETF experiment, it’s getting harder and harder for the best new ideas to break through. The largest ETFs get the bulk of the flows, and platforms and wire houses are making it increasingly hard for small funds to compete. In the fog, some truly exceptional funds are being overlooked.

We want to change that.

Earlier this year, we put out a call to ETF issuers to submit their “Hidden Gems” to us—funds with less than $300 million in assets that offered exceptional exposures to the market. We promised to choose 10 (we ended up with 11—we just couldn’t resist!) to highlight both in this supplement and at our upcoming Inside ETFs conference. We wanted to shine a light on the best innovation taking place within ETFs.

Read the profiles that follow carefully. These are truly exceptional products. Let’s not let these gems stay hidden any longer.

Best regards,


Matt Hougan
CEO, Inside ETFs

ALPS Medical Breakthroughs ETF

Biotech is one of the hottest themes on the planet. All the long-heralded promise of the genomics revolution seems to be bearing fruit, with incredible breakthroughs coming at a furious pace. But the biotech sector has changed. What was once a niche market dominated by small-cap companies looking to cure the world has become a top-heavy market dominated by firms generating billions of dollars in revenue.

SBIO lets you refocus your biotech hopes and dreams on the pointy edge of the spear. By focusing on small- and midcap names with at least one drug in phase ii or phase iii clinical trials, it hits directly at the heart of biotech r&d. It’s the exciting part of biotech, and it’s worth a look.

Matt Hougan, CEO, Inside ETFs: What drove you to develop SBIO?
Mike Akins, Head of ETFs, ALPS: Obviously, biotech is an attractive space. But more importantly, we felt there was an opportunity to differentiate SBIO from competing funds given the disruption we are seeing in the space.

Today the bulk of the R&D being done in biotech is being done by smaller companies, while larger companies have evolved into distribution- driven, pharmaceutical-like firms. Those larger companies are replacing their drug lineups by using capital to either do joint ventures or buy smaller companies.

How does your methodology differ from a more traditional, market- cap-weighted biotech ETF?
Really it does so in three ways. The first is size. We look at companies only in the $200 million to $5 billion market-cap range. It’s still a large, liquid space—it captures about 250 companies and $200 billion of market capitalization—but it helps us focus on R&D-led companies.

The second piece is where we’ve partnered with S-Network and Poliwogg Indexes. Poliwogg is a financial technology firm developing unique investment products in the health care/biotech/life sciences sectors.

We were able to utilize their expertise to create a unique screen that only focuses on companies that have at least one drug in Phase II or Phase III of the clinical trial process. Phase II and Phase III drugs have a much higher success rate than preclinical or Phase I drugs. The screen lets us focus on companies that have made some progress in getting a drug to market.

Finally, what gives us a higher success rate than the overall market is the cash overlay. We insist that companies have at least two years of cash on the balance sheet at their current burn rate.

In the end, you get companies that are the right size to be working on real R&D; that have proven they can get past at least Phase I of the clinical trial process; and that have enough cash to where you think they will be able to see the process through.

A lot of people think of biotech as small startup companies. What kind of companies are you excluding with your size screen?
The largest ETF in biotech follows the Nasdaq Biotech Index, which is a straight market-cap-weighted biotech index. It has companies in the $200 million to $300 billion market-cap range.

There is great opportunity in larger companies, but we wanted to capture the R&D side of the equation, and create a product that can add value in the portfolio construction process. We often work with RIAs who blend our product with something like the Nasdaq Biotech Index. While that index allocates 55% of its weight to names already held in XLV, the Health Care Select Sector SPDR Fund, SBIO currently has zero names in common.

How has performance been?
Performance has been strong on an absolute and relative basis since inception, but it has also been volatile. In 2015, we were the No. 1 performer in biotech by a long shot. In 2016, with changes in the political environment, we went down more than the large-cap-focused indexes. In 2017, with political head winds related to drug pricing taking a back seat to more stock specific stories, we’re having another very strong year. We are highly correlated with the sector overall, of course. We’ve been coming in with a beta of 1.3-1.4 to the biotech sector as a whole.

When will this strategy beat a market- cap-weighted biotech index?
It’s going to perform best when you see a focus on the micro and not the macro. It also does very well when M&A activity picks up. In 2016, approximately 15% of our portfolio was acquired.

Do you expect that M&A activity to continue?
We do. We actually think one of the big potential catalysts for this portfolio would be some sort of tax reform that includes the repatriation of foreign cash. A lot of the big biotech companies have some of the largest amounts of cash sitting overseas. Bringing that back stateside would be a big potential catalyst for increased M&A activity.

What’s the expense ratio, and how did you price it?
We looked at the median average of biotech ETFs and priced ours slightly below that, at 0.50%.

Importantly, though, we look at SBIO as a stock replacement story. Biotech as a whole has proven to be a very difficult place to pick securities. It’s tough to determine who will be first to market with a given drug. And critically, the distribution of returns in biotech is tail-oriented: You have a lot of companies that will go bankrupt and a lot of companies that will be two-baggers, four-baggers or even 10-baggers. You don’t have a lot in the middle. So picking any one stock in the space is very risky. SBIO provides a diversified alternative at a reasonable fee.

If you had to sum up SBIO in one sentence, what would you say?
It’s a stock replacement story that provides investors the ability to add alpha through a very promising theme.

WisdomTree Emerging Markets Ex-State-Owned Enterprises Fund

Emerging markets have been the consensus trade of 2017. Investors entered the year significantly underweight emerging markets in their portfolios, and those that added exposure early were rewarded, with major emerging market indexes rising 35% or more in the first 10 months of the year.

But at Inside ETFs, we’re convinced most emerging market investors own the wrong funds. they pay too much for the wrong kind of stocks, often ending up in quasi-government-owned companies that do more for the politburo than they do for your portfolio.

XSOE caught our eye for this exact reason. By excluding state-owned enterprises, it offers exposure to the kind of emerging market companies that investors actually want … you know, the ones trying to change the world and deliver significant returns to shareholders. XSOE is the emerging market fund you always wanted to own.

Matt Hougan, CEO, Inside ETFs: Why did you launch XSOE?
Luciano Siracusano, Chief Investment Strategist, WisdomTree: WisdomTree wanted to create a way for investors to get broad exposure to emerging markets without owning state-owned enterprises. XSOE is a broad-based emerging markets fund that screens out companies when governments own at least 20% of their stock. We like to think of it as a way to get beta exposure to the private sector companies of emerging markets.

What’s wrong with state-owned enterprises?
It’s hard for managers to serve two masters at once. If you’re trying to maximize shareholder value and serve public interests at the same time, sometimes you can run into conflict. We like the idea of creating an index that is focused on the companies, sectors and countries that are most primed to compete globally.

Coincidentally, when you do that, you exclude some of the Chinese banks, Russian energy companies, and Brazilian energy and telecom companies that many people are worried about in emerging markets portfolios. Instead, you get exposure to sectors and stocks that are globally competitive and, frankly, those that are more focused on the emerging markets consumer.

You would assume this kind of portfolio would be heavily overweight tech and underweight banks and energy. Is that true?
With XSOE, we were explicitly trying to create a fund that gives you a country and sector exposure that’s very similar to what you find in a cap-weighted index, so we control for those under- and overweights.

To do that, we start by looking at the universe on a float-adjusted, cap-weighted basis. Then, we remove state-owned enterprises, which typically represent about 25% of the weight of a typical benchmark. Once that’s done, we go back into those countries that had stocks removed and we replace the holdings we took out until we end up with a country weight that’s very similar to the original, cap-weighted benchmark.

Once that’s done, we look at the sector weights across the globe and try to be within 3% of the cap-weighted sector weight at our annual rebalance.

Our goal is to not make a big bet on the country or sector exposure; our big bet is on private companies outperforming government-controlled entities.

What does XSOE replace in an investor’s portfolio?
We think it can replace an investor’s core emerging markets exposure. We think it’s a way to get beta exposure to the true private sector of emerging markets.

Isn’t XSOE riskier than a traditional emerging market ETF (which would own state-owned enterprises)?
The data doesn’t support that. For the three years that the index has been live, its beta has actually been slightly lower than the MSCI Emerging Markets Index, and its volatility has been slightly lower as well.*

Is the fund liquid enough to trade?
XSOE is a newer fund, and right now it only has about $30 million in assets. But the fund is primarily made up of large-cap companies that are very liquid, so when you look at the implied liquidity of the underlying basket, we think there is the ability to trade about 1.6 million shares a day. That’s obviously much higher than the average volume, so we feel there is plenty of liquidity in the underlying stocks.

Many smaller ETFs have high expense ratios; yours is only 32 basis points (0.32%). How did you set the pricing of the fund?
The fund is cheaper than a fund like the iShares MSCI Emerging Markets ETF (EEM), which charges 0.70%, but more expensive than the cheapest emerging markets ETF. We priced XSOE competitively in the environment we are in today.

How has performance been?
The fund has been around for nearly three years, and it’s been able to generate about 200 basis points of annualized excess return over the MSCI Emerging Markets Index and about 300 basis points of annualized return over the FTSE Emerging Markets Index.*

One notable thing about the fund is it includes A-shares. Why did you make the decision to include domestically listed Chinese stocks?
The index industry is moving gradually towards the adoption of A-shares in all emerging markets portfolios. FTSE is already there, and MSCI has announced its intention to add A-shares as well.

We think that’s where the industry is going, and we want to be a forward- looking emerging markets ETF. We’ll evaluate each year what the right weight of A-shares in the portfolio should be. Right now, it’s 5%, and we think that’s right. It’s another part of the story that people find appealing.

If you had to sum up XSOE in one sentence, what would you say?
It’s the emerging markets exposure you always wanted, with companies that are actually trying to make a profit.


*Source:
WisdomTree data as of 11/1/2017; www.wisdomtree.com/etfs/equity/ xsoe

American Customer Satisfaction Core Alpha ETF

Edge. it’s the hardest thing find in today’s market. With the rise of big data, full disclosure and mass competition, finding a way to beat the market is incredibly hard.

That’s where ACSI comes in. ACSI draws on proprietary information that only it has—data on how much customers like or dislike the products of different companies—to pick stocks it thinks will outperform.

A “systematic informational advantage,” as chief strategist Kevin Quigg calls it. Access to those insights used to be available only in a hedge fund, but now it’s available in an ETF.

Matt Hougan, CEO, Inside ETFs: Why did you develop ACSI?
Kevin Quigg, Chief Strategist, ACSI Exponential ETFs: We felt that, with the direction the market was moving, many investors were looking for active share. We feel that the future of active management lies in utilizing active insights in an efficient ETF structure to create a win-win for investors. We wanted to give investors a super-efficient way to access what we feel is our systematic informational advantage over the market.

What is that systematic informational advantage?
One of the downsides of the proliferation of technology and the availability of data is that everyone has access to the same publicly available information. Since 1994, the ACSI has been developing our proprietary outlook on companies using the sentiments and thoughts of the people who buy goods and services from those companies.

We derive our internal view of companies as a combination of data we collect from those organizations plus our econometric models. We’re trying to identify companies that provide people with goods and services that they love, because historically that tends to be a tremendous predictor of future earnings surprises.

How do you actually build the portfolio?
Our informational advantage has been utilized for over 20 years in our proprietary hedge fund product, but since hedge funds have risk parameters that make them unsuitable for the average investor, we wanted to build a responsible investment vehicle for the masses.

We start out with the U.S. large-cap universe as defined by the S&P 500, and then within each S&P sector, we maintain a 10% band around those sectors. We then overlay our proprietary insights to overweight companies whose customer satisfaction is strong, and underweight companies whose customer satisfaction is less strong. We have about 167 companies in our portfolio.

Give me an example.
The best example would be Amazon. com. [CEO] Jeff Bezos would be the first person to tell you that Amazon is a customer-led organization. By focusing on the people who consume their goods and services, Amazon has come to dominate the space. It’s a perfect example of “satisfaction in action” as we call it, and Amazon is our No. 1 position and an overweight in our portfolio.

How does ACSI fit in an advisor’s portfolio? What does it replace?
I would describe it two ways. The primary way it fits is as a replacement for your core U.S. equity position. That’s by design, because of the sector-based diversification. The other thing it does is, in conjunction with traditional cap-weighted strategies, it acts as a portfolio buffer. Because none of our insights are linked to traditional financial metrics, ACSI is a very good complement to a traditional portfolio. We’re not in lockstep with metrics like dividends, momentum, value, etc.

When does it perform particularly well, and when does it lag the market?
ACSI is designed to provide incremental performance over the market. Over the long term, it tends to do pretty well in up markets, but it really comes into its own during down markets.

That’s intuitive: If you usually go to three restaurants a week and something happens that causes you to cut back to one, you’re going to go to the one you like the best—the one that gives you the most satisfaction. If you magnify that out to an entire economy, the companies that have the best satisfaction tend to weather storms best.

The times it doesn’t work well is when there is some sort of exogenous market impact that weakens the link between company performance and satisfaction. For instance, last year, the portfolio underperformed right up until the last month of the year. We surmised that this was related to uncertainty around the election. And in the week after the election, ACSI was up 6%, which was 2% more than the market, because that stress had been removed.

How did you price the fund?
We charge 0.65%. Our proprietary information has a cost to it. We have to conduct 100,000 interviews a year, maintain the database, etc. So our costs necessarily have to be higher than plain market beta.

At the same time, we wanted to find a space between the cost of traditional active mutual funds and increasingly active exchange-traded funds. We think it’s a sweet spot that’s more expensive than pure beta but cheaper than traditional active, and we think it provides good value to investors.

Is the fund liquid and easy to trade?
The underlying securities are, for the most part, large-cap securities, so they are extremely liquid. By utilizing a liquidity provider, you’re able to tap into that when you trade. The fund itself trades about 7,000 shares per day, which is increasing in recent months, so that liquidity supports the fund as well.

If you had to sum up ACSI in one sentence, what would you say?
Companies whose customers are satisfied with their goods and services will outperform companies whose customers are less satisfied.

GraniteShares Gold Trust

Gold is fundamental. It has, for millennia, been the world’s agreed-upon store of value. More recently, it’s found a key role in diversifying portfolios, rising in times of crisis when everything else falls apart. But one important fact about gold is that it’s fungible. Gold is gold is gold. That’s why we were so excited when we saw bar, the graniteshares gold trust ETF—because it offered investors exposure to gold at half the price of its largest competitor, with extremely tight trading spreads. Gold exposure at half the cost is a no-brainer. And for now, a hidden gem.

Matt Hougan, CEO, Inside ETFs: What’s the idea behind BAR?
Will Rhind, Founder and CEO, GraniteShares: We looked around and felt the existing market for gold ETFs—the largest ETF category in commodities—hadn’t been disrupted from a price perspective the way equities and fixed income had been. It was behind the times.

You had legacy funds that had been around for 12 years charging a management fee that was out of step with the rest of the market. We thought there was an opportunity to create a low-cost gold ETF.

So how did you price BAR?
BAR is the lowest-cost gold ETF on the market. Its expense ratio is 20 basis points, or 0.20% per year. That’s half the fee charged by the largest gold ETF, the SPDR Gold Trust (GLD), which charges 0.40%. It’s also cheaper than the iShares Gold Trust (IAU), which charges 0.25% and is much more expensive to trade.

BAR also uses a different custodian and different vault than GLD or IAU, adding a diversification benefit for those with existing gold ETF holdings who are worried about single- vault risk. BAR’s gold is all allocated gold, meaning it’s assigned to BAR and not lent out to anybody. BAR is 100% physically backed, and the gold vault is audited twice a year, including one time on a random basis.

Aside from the impact of expenses, will the pattern of returns for BAR be identical to GLD and IAU?
It will actually be higher. All things equal, the way gold ETFs work is that you start on day 1 with a certain amount of gold per share; in our case, each share of BAR started as 1/10th of an ounce of gold. But that 1/10th of an ounce decays over time, because it’s what is used to pay the expenses of the fund.

The net result is that today, because it’s both newer and cheaper, BAR holds a higher amount of gold per share compared to both GLD and IAU, and so, BAR will track the price of gold better on a pure charting basis.

You mentioned single-vault risk and allocated gold; is security a legitimate concern for gold ETFs?
It really all comes down to transparency— or rather, the lack of transparency from the legacy funds. We’re trying to be as transparent as possible with the gold holdings in our fund. We’re even trying to get more people into the vault and potentially offer a semi-live video feed of the gold, so you can literally see which bars BAR owns.

Where is gold in the market cycle now?
Gold is roughly 30% off its all-time high, which is very unusual given that other major asset classes are at or near all-time highs. We’ve seen the price of gold increase this year off the back of the peak dollar trade, as we’ve started to see U.S. dollar weakness. A weakening dollar really helps the price of gold, and most experts expect that dollar weakness to continue.

In short, gold is well off its highs at a time when almost everything else is at the top, but it’s starting to trend up.

Where does gold fit in investors’ portfolios?
The most important thing for people to realize is that they need investments in their portfolios that are uncorrelated to equities and bonds. Gold benefits from a flight-to-quality element when equity and bond markets correct.

Since the financial crisis, we’ve seen a big run-up in risk assets—an almost unprecedented run-up—to the point where many portfolios are more heavily tilted toward risk than they should be. Gold is really the only major asset class that has both liquidity and countercorrelation to equity and fixed-income markets, so it’s a great hedge for portfolios against a market correction.

BAR is a new fund. Is it liquid?
ETF liquidity 101 dictates that an ETF is as liquid as its underlying, and the underlying for gold is very liquid. You see this in the spread of BAR, which trades tighter than IAU on most days, and nearly as tight as GLD. All three funds hold the exact same underlying and all three are very liquid. One thing that helps is that the exact same market-making firms that make markets in GLD and IAU also make markets in BAR. As a result, you see the same kind of pricing.

Specifically, we trade at spreads of 0.02-0.05%, on average. That’s cheaper than IAU, which trades at spreads of 0.08-0.10% on average, because it has a larger handle, and in line with GLD, which trades at spreads of 0.01-0.03%.

Compared to GLD, BAR costs essentially the same to trade and is way cheaper to own. Compared to IAU, BAR is way cheaper to trade and also cheaper to own. It’s a no-brainer.

If you had to sum up BAR in one sentence, what would you say?
The lowest-cost gold ETF, BAR none!

BUZZ US Sentiment Leaders ETF

Artificial intelligence and machine learning is the last, best hope for active management. The idea is that infinitely powerful computers, ruthlessly trained on the market, will be able to deliver excess returns in ways no humans could.

But it’s not just an idea; it’s already happening.

The buzz us sentiment leaders ETF (BUZ) uses natural language processing and artificial intelligence techniques to scan the market for real-time sentiment around leading U.S. large-cap securities. developed by hedge fund experts, it’s a true AI ETF that’s handily outperformed the s&p 500 since it launched in April 2016. the most exciting news? according to Jamie Wise, founder and CEO of buzz indexes, it’s only going to get better.

Matt Hougan, CEO, Inside ETFs: Why did you develop BUZ?
Jamie Wise, Founder and CEO, Buzz Indexes: We’ve always known that sentiment impacts stock price returns. For decades, we’ve relied on proxies to try to measure sentiment: investor surveys, market-based indicators, investor flows, etc. Each had its flaws. The failures led many to believe that sentiment couldn’t deliver; indeed, some said it was a contrarian indicator to stock price performance.

Our view was that, with the explosion in activity of people talking about stocks online, we had a new opportunity. We now, for the first time, had people independently volunteering their views on the prospects of different securities. If we could apply the latest technologies to listen to those conversations, we could understand sentiment down to the individual stock level on a real-time basis, and use that information as a predictive indicator of returns.

How does that practically work? Walk me through the process from me tweeting about Tesla to you building a portfolio.
The general view is that no one expert—whether that’s a research analyst, media personality or star portfolio manager—has the absolute authority to know what’s going to happen with a stock.

The wisdom of crowds suggests that if you have a diverse group of people who are all independently talking about a similar topic, and if they have an incentive to tell the truth (and people do online), then the consensus view of that crowd will typically be more accurate than any one “expert” within that crowd. With BUZ, we’re measuring the sentiment expressed in the conversations people are having about stocks and their investment portfolios. Our view is that those sentiments are more predictive of stock price returns than the opinions of any individual expert.

Which stocks do you look at?
We focus on large-cap U.S. equities, for a few reasons. First, doing so results in a portfolio of stocks that’s familiar to investors. Second, it creates a portfolio that’s both investable and liquid. Third, by focusing on large-caps, you reduce the chances of bad actors—people who are deliberately engaging in online stock promotion. Large-cap equities have so much conversation around them that promotional activity is more easily recognized, filtered out and unlikely to influence overall sentiment.

Beyond that—and this is unique to BUZ—we focus only on those stocks that have exhibited the highest degree of consistency and diversity in their conversation online over the past year. It’s much more significant to us if we note a change in sentiment for a stock that has 50,000 people consistently mentioning it than if we saw a change in sentiment for a stock that only has 50 people talking about it.

Right now, roughly 250 names meet our criteria for the most-discussed large-cap U.S. equities. We set this as our eligible investment universe. When we first launched the index in 2016, that investable universe was just 150 names. But because more and more people are talking about stocks online each day, that universe has expanded and is only continuing to grow.

How do you build the portfolio?
We look at our eligible universe of stocks and rank them monthly on sentiment from highest to lowest. We include the 75 most positively talked-about names in the index, with a 3% maximum weight to make sure we’re sufficiently diversified.

Where does BUZ fit in an investor’s portfolio?
We think of it as a large-cap replacement and a complement to any traditional beta you have. It’s a rules-based approach to active management.

How has it performed?
We’ve beaten the market as a whole since inception, and that gap has increased recently. We think there are two reasons for our strong recent performance.

First, as the eligible investment universe expands, the opportunities to source additional stocks for alpha generation increase.

Second, the model gets smarter over time. That’s one of the hallmarks of AI and machine learning. With more data and experience, the model is able to continually refine and adapt to changing trends, delivering more relevant insights with better accuracy.

When does BUZ do particularly well, and when will it lag the market?
We’ve found that the index does a nice job of outperforming the market when markets are positive, and holds its own in falling markets. That’s the asymmetric return we’re looking for, and it makes sense: If you focus on companies that people are most positive about, they should be cushioned in falling markets, as people should want to buy more as they get cheaper.

If you had to describe BUZ in one paragraph, what would it be?
BUZ lets you access the same leading- edge investment insights that are currently being deployed by the world’s leading quantitative hedge funds. Advancements in artificial intelligence and machine learning, trained to the huge amount of online stock-specific discussion, means you can finally harness the sentiment premia that’s always been present in stock prices.

Goldman Sachs Hedge Industry VIP ETF

Hedge funds have historically been good stock pickers. They’re staffed with some of the smartest traders and analysts on wall street who’ve earned their stripes in fundamental stock research. The problem is, their fees are sky-high. Moreover, you must be a qualified investor to invest… and a well-connected investor to access the very best funds on the market.

What if, instead, you could own their best ideas—in a liquid wrapper—for cheap? That’s the idea behind GVIP, which owns the 50 most popular hedge fund holdings and charges just 0.45% a year to do it. For the full year ending Nov. 1, 2017, that approach has translated into more than 750 basis points of outperformance versus the s&p 500. Not bad!

Finding alpha is hard, especially in today’s market. But if you’re going to search it out, working with goldman sachs to tap into the top stock picks of leading hedge funds doesn’t sound like such a crazy idea.

Matt Hougan, CEO, Inside ETFs: Why did you develop GVIP?
Eric Halper, Vice President and ETF Specialist, Goldman Sachs Asset Management (GSAM): Goldman Sachs has been a leader in hedge fund research for many years. We developed GVIP to offer investors access to our firm’s analysis of hedge fund positioning. This is consistent with our strategy as an ETF issuer more broadly. We continue to deliver solutions in areas where we have unique capabilities that we believe will add value to client portfolios.

What’s the actual methodology like?
Using 13-F filings, we identify the top 10 long equity positions of each manager within our universe of over 600 fundamentally driven hedge fund managers. We then select the 50 stocks that appear most often as a top 10, and equally weight the portfolio.

The idea is to “crowd-source” high-conviction themes from hedge funds, all through a rules-based strategy. Research suggests that hedge funds have been successful with their long positions, even while their shorts and hedges may have detracted from performance. Focusing on their long positions has proven to deliver alpha over time.

How does an investor use GVIP in a portfolio?
We think GVIP is best used as a complement to an investor’s core U.S. equity allocation. Roughly 70% of the portfolio is large-cap and 30% is small/midcap. If you’re in a risk-on frame of mind, allocating to GVIP is a way to add an inexpensive source of potential alpha.

GVIP is also a good diversifier. Over time, its excess returns have had low or negative correlation to the excess returns of a universe of large-cap managers, and most of its alpha can’t be explained by common factors like value, size or even momentum.

There are other hedge fund replication ETFs out there. How does GVIP compete?
To be clear, GVIP is not a hedge fund replication strategy: It provides access to high-conviction themes of hedge funds. When looking at our competitive universe, it’s really important to look just at funds that focus on the long side of hedge funds, and within that space, there are only a few competitors.

The key differentiator for us is that our approach builds upon many years of experience researching hedge fund trends and positioning. This is not new to us. Hedge funds themselves follow our approach to identify their peers’ most important positions, which we think speaks volumes.

One criticism of 13-F-driven portfolios is that there is a lag between when funds take positions and when they show up in quarterly filings. Aren’t we getting these holdings late, after the trade has already happened?
There is a 45-day lag between quarter-end and when filings are due, but historically there’s been only 25- 30% turnover during each of GVIP’s quarterly rebalances. Said differently, 70-75% of the names remain top hedge fund positions quarter over quarter, which we believe validates our approach for targeting hedge fund favorites.

And perhaps most importantly, it’s worked—there has been outperformance tied to longs based solely on 13-F filings. With a management fee of 0.45%, you’re getting low-cost, efficient access to the positions that matter most to hedge funds.

When will this product perform better than the overall market, and when will it perform worse?
When hedge funds make the right sector and security selections on the long side, it will outperform, and when they make the wrong bets, it will underperform. The strategy has no constraints on sector or style. For instance, the universe of hedge funds we pull from has been overweight technology for some time, and that has been a great driver of recent outperformance.

How has the recent performance been?
For the full year ending Nov. 1, 2017, GVIP is up 32%, outperforming the S&P 500 by over 750 basis points. This strong performance has resulted in the fund being recognized as a Large Cap Core Category King by the Wall Street Journal. GVIP’s Index has seen compelling performance over longer periods as well.

How did you decide on the 0.45% fee?
One of the key tenets of our philosophy as an ETF issuer here at GSAM is to leverage the scale of Goldman Sachs and be very competitive on fees. GVIP is the least expensive strategy that focuses on the long side of fundamental hedge funds.

How liquid is it?
The underlying portfolio of GVIP is made up of mostly large-cap U.S. stocks. If you look at the underlying liquidity metrics on Bloomberg, about $470 million can be traded without representing 25% of the average daily volume of any of the names. We think there’s a lot of liquidity there, and we have an industry- leading capital markets team to help investors source that liquidity.

Any particular companies that tell a story about the kind of stocks that get selected?
We’ve owned the FANGs [Facebook, Amazon, Netflix and Google] for some time, and that’s certainly helped performance. We’ve owned some of the Chinese internet companies like Alibaba and JD.com via their ADRs, which have also been drivers of performance.

We also own lesser-known small-cap companies, which might surprise investors by being a popular hedge fund position. For example, Nexstar Media Group is a $3 billion company that came into the portfolio at the last rebalance. It owns affiliated TV stations.

If you had to sum up GVIP in one sentence, what would you say?
GVIP provides low-cost, efficient access to the most important positions of what many consider to be the best stock pickers in the world.

Elkhorn Fundamental Commodity Strategy

The global commodity markets are in year seven of a massive bear market; some have even called it a commodity depression. But commodity markets tend to move in waves, spending years with small returns only to suddenly surge higher as they enter a new supercycle.

RCOM is the fund for investors who want to be well-positioned when that next supercycle appears. Leveraging cutting-edge research from research affiliates—and a nifty structure that helps it avoid issuing a k-1—it’s a version 2.0 commodity product that is a perfect fit for today’s markets.

Right now, not many investors are thinking about commodities, but with global growth picking up, that could change in a heartbeat. RCOM is a product for that moment.

Matt Hougan, CEO, Inside ETFs: Why did you develop RCOM?
Ben Fulton, Founder and CEO, Elkhorn: A little over a decade ago, I had the pleasure of working with Deutsche Bank to create the first series of commodity ETFs. At that time, we looked long and hard at all the commodity indexes out there. The index we settled on had some nice advantages: It wasn’t production weighted and therefore overweight oil like the S&P GSCI; it wasn’t equal weighted like the CCI; and it took into consideration the roll curve of commodities, which helped its performance. But while it was a good index, I’m not sure it’s a great index.

A decade later, I was sitting through a presentation with Research Affiliates about commodities. I wondered what their take would be coming into the meeting, because Research Affiliates is known for “fundamental weighting” and you can’t really fundamentally weight commodities.

But they took a very analytical approach to figuring out the best way to build a great commodity index. They identified and isolated certain things that worked in commodities, including momentum, roll yield and more. It struck me as a really great index. So I asked them if I could bring an ETF to market based on their index.

We are in the middle of a commodity depression. At some point, we’re going to come out of it. People are going to want a better index when we do. The Research Affiliates Index … and RCOM … is it.

What’s different about RCOM’s index versus other indexes?
Research Affiliates looked at three key factors when figuring out how to build the index: liquidity, momentum and implied roll yield. Liquidity is almost a proxy for production, and it helps ensure the strategy is representative of the commodity space and has high investment capacity. The other two factors are key drivers of performance. When you step back from it, what stands out is that it’s an index that was developed for its investment merit, and not for measuring the output of commodities. It’s an investment- driven index.

The other key benefit of the fund is that it does not issue a K-1 to shareholders. How do you avoid issuing one?
The first generation of commodity ETFs were structured in a way that they had to provide investors with a K-1 tax bill at the end of the year— something no investor wants. K-1s are often late and they’re always a pain to manage.

The problem is that the income created by commodity futures is not sanctioned by the Internal Revenue Service as eligible income. Newer commodity products—not just RCOM, but almost all newer commodity products—have figured out how to use a Cayman Island Trust to hold 25% of the portfolio, including the commodity futures contracts. The Cayman then provides an income stream to the fund that is viewed as eligible income by the IRS. This lets you get the commodities exposure you need but avoid a K-1; instead, the fund generates a normal 1099. It’s an elegant answer to an unsightly problem.

When will the fund beat a traditional commodity index, and when will it lag?
When you have an oil-led commodity market—and particularly if you get a spike in oil prices—RCOM will lag a production-weighted commodity index like the S&P GSCI, because those indexes are so heavily weighted in oil. Over time, however, the index RCOM tracks has performed extremely well. Year-to-date through Oct. 31, for instance, we are the No. 1-performing broad commodity ETF.

If we’re in a commodity depression, what are the benefits of owning RCOM?
If you look at a portfolio over the last five to 10 years, starting with a 60/40 portfolio, adding a 15% weight in RCOM would have boosted your risk-adjusted performance. Spot commodity prices are down, but we’ve had a very strong roll curve during that time, and commodities have played a nice diversifying role in the portfolio.

Is the fund liquid?
Because we’re in the early days and the fund is small, there is this misperception that the fund must not be liquid. But the largest holders of the funds are actually institutions, and they tended to come in at larger sizes with no issue. The futures contracts in the portfolio were selected for their liquidity. You could add tens of millions of dollars a day to the fund and have no impact on the trading.

If you had to sum up RCOM in one paragraph, what would you say?
Advisors need to go back to basics. They need exposure in their portfolios beyond equities and fixed income. We are facing a sustained low-return market for equities and a very low-yielding market for fixed income. Real estate may be near its peak.

Commodities is the one area that’s languished. But to take advantage of the recovery when it comes, you need a product that will benefit you while you wait. This has been a good index to do just that. And when the commodities market finally starts to turn, what’s good will become great. RCOM is the good-to-great portfolio.

Republican Policies Fund (GOP) & Democratic Policies Fund (DEMS)

We hear the term all the time: the trump portfolio. We know, intuitively, that what happens in Washington has a major impact on stock returns. But until recently, there wasn’t much we could do about it, except cherry-pick individual stocks and hope for the best.

That’s where GOP and DEMS come in. with a thoughtful design and outstanding research to back it up, GOP and DEMS allow investors to position their portfolios for the places where new policy initiatives are taking us. Think the republicans will get NAFTA revoked? GOP is ready for that. Think resurgent democrats will put healthcare expansion back on the table? DEMS has you covered.

These are two high-quality funds worthy of your consideration.

Matt Hougan, CEO, Inside ETFs: What drove you to develop these funds and, indeed, to launch EventShares?
Ben Phillips, Chief Investment Officer, EventShares: In the run-up to the last presidential election, the founders of EventShares were looking at the potential Trump vs. Hillary outcome and realized there was going to be a clear-cut set of companies that would benefit if Trump got to the White House and another that would benefit if Hillary got to the White House. We saw that policy differences would really drive investment choices in the future and we thought, why is no one building these portfolios for investors to utilize?

How do policy ideas translate into stock performance?
When we think of the GOP and DEMS funds, we think about the top five policy priorities for each party over the coming years that are going to impact markets. For the GOP fund, that means defense and border protection, deregulation, infrastructure, U.S. energy independence and tax reform. For DEMS, it’s health care expansion, environmentally conscious, social good, educational access and finance reform.

Once we’ve selected the policy priorities, we drill down into industry and conduct individual security analysis to find stocks we think will outperform, and short positions that we think will experience a price decline. As an example, in GOP, with energy independence, we’re long Cheniere (LNG), which benefits from U.S. natural gas production, less stringent environmental regulation and improved competitive positions for LNG exports. These are GOP-policy-driven initiatives.

On the short side within GOP, we’re short KSU, or Kansas City Southern. Half of its revenue comes from Mexico. On the day after Trump was elected, KSU was down 11%. As NAFTA [the North American Free Trade Agreement] has the potential to be renegotiated, you could see a material impact on KSU’s business.

What about DEMS?
In the DEMS fund, we own a lot of health care stocks, and particularly ones that are focused on reducing weight and improving the efficiency of the system.

On the short side, we are short some financials including Goldman Sachs (GS). Goldman is an investment bank that converted into a bank holding company. To the extent there is continued regulatory focus on banks from Democratic policy efforts, we’d expect that to impact Goldman’s proprietary trading activities and its use of leverage.

Why go long/short and not long-only?
We wanted to identify potential winners and losers. We saw in the case of Kansas City Southern that there are clear-cut winners and losers from these policy enactments.

The ability to go short gives you the flexibility to position the portfolio appropriately.

What is the potential short weighting and the current short weighting?
We can short up to one-third of the portfolio. Currently, we’re around 6%.

Where do these funds fit in investor portfolios?
We think first and foremost that the portfolios stand on their own as potential core holdings. We look for solid companies that play out with the policy trends that are driving them in the future. The funds fit as a general large-cap allocation with an embedded policy catalyst.

How do I decide which fund to buy?
Don’t I just buy the GOP portfolio today because that’s who’s in office? Investors should look at their overall portfolios and ask themselves, am I overexposed to one party’s policies? It’s an important consideration that investors haven’t been asking but should. Alternatively, if you want to be overweight one side, use our fund to make that bet as well.

You’ve invested a lot in your website and providing great research. Why is that research important?
We intend to be thought leaders in this space, and want to provide educational resources to anyone who wants to better understand the way policy impacts their portfolio. We launched the firm because there really wasn’t a product out there that helped you make sure you had the right policy balance in your portfolio. We want to be the hub for that research process.

Will you be evaluating and replacing the policy themes in the GOP and DEMS portfolios, or are they fixed?
They are definitely not fixed. We will change them as policy priorities evolve. We aim to be thoughtfully active. Take tax reform as an example. It drives 20% of the GOP fund. If tax reform goes through, I think we would let that play out in the portfolio over a number of years. But if we determine it had played out, we would look to perhaps reallocate that part of the portfolio to another GOP policy priority. We want to be both forward-thinking and long-term oriented.

How do you weight stocks in the portfolio?
We rebalance to equal weight every quarter.

What if there’s gridlock? How do you invest these portfolios if Washington isn’t getting anything done?
The stock market is forward-looking. Shifting probabilities on different policies impacts stock prices.

If you had to sum up GOP and DEMS in one paragraph, what would you say?
Every investor should consider the impact of policies and policymaking on their portfolios, and they should understand where they are over- and underexposed. GOP and DEMS offer a way to respond to what they find.

 

[Editor's Note: The graphic below erroneously lists these two funds as having launched Oct. 17, 2016. They launched Oct. 17, 2017.]

NuShares Enhanced Yield 1-5 Year U.S. Aggregate Bond ETF

The traditional way of weighting fixed-income portfolios makes no sense. Indexes assign the highest weight to the most indebted countries or companies, loading up on the exact names that should be avoided. NUSA is part of a new generation of bond ETFs that aim to fix that. Using a smarter methodology, it takes a risk-controlled approach to tweaking short-term fixed-income exposure, ratcheting up its yield without making big sector bets. It turns out that matters, because yield is actually the true driver of fixed-income returns.

With rising rates on the horizon, investors are looking to shorten duration. NUSA is perfectly positioned for that. It’s bond indexing 2.0, and you might just want some in your portfolio.

Matt Hougan, CEO, Inside ETFs: Why did you develop NUSA?
Martin Kremenstein, Senior Managing Director, Nushares ETFs: This is a follow-on from NUAG [the Nushares Enhanced Yield U.S. Aggregate Bond ETF], which was a re-imagining and reinvention of the aggregate bond index. In both NUAG and NUSA portfolios, you start with the representative aggregate bond index and then move away from issuance weighting and towards the yield factor. NUSA is aimed at advisors and investors who are looking to shorten their duration while enhancing their yield.

How does NUSA’s return differ from the return of a 1- to 5-year slice of the aggregate index?
It’s designed to garner a higher yield—somewhere around 25-35% higher—by overweighting the higher- yielding parts of the 1- to 5-year aggregate bond index (“Index”) and underweighting the lower-yielding parts. You end up with higher corporate bond and asset-backed bond exposures and a lower Treasury exposure.

How do you build the portfolio?
To start, you take the Index and then divide it into a number of different buckets. You divide it into its constituent asset classes—Treasuries, agencies, securitized products and corporates; you divide corporates into sectors—industrials, utilities and financials; you break down maturities into the 1- to 3-year and 3- to 5-year buckets; and within each slice, you look at different credit ratings: AAA, AA, and so on.

Then, for each of those slices, you can move the weighting up or down by a certain amount based on yield. For instance, you can move BBB-rated financials up or down by 5% against their weight in the Index, and 1- to 3-year Treasuries up or down by 20%, and so on.

You’re overweighting the highest- yielding slices versus the lowest- yielding, but you’re doing so while constraining risk so that it roughly aligns with that of the Index. You’re nudging the portfolio towards a very risk-managed yield weighting, which emphasizes spread return versus duration return.

Why would an advisor want to emphasize spread return over duration return in today’s environment?
The environment doesn’t actually matter. Since the broad aggregate index’s inception in 1976, 94% of the return has come from the yield, and that was during the greatest bull market ever for fixed income. Now that the bull market has come to an end, the return available from price appreciation has nearly evaporated. Now you need to make sure you get the right yield to compensate you for the duration risk you’re taking.

What’s the ideal environment for this fund to deliver on its promise of better total return, and what’s the environment where it suffers?
In any environment where you don’t get a blowout in investment-grade spreads, NUSA should do better than the Index. We keep the duration within 1/8th of a year of the Index, and we keep key rate durations very close as well. So whether rates go up or the yield curve shifts, it should not deviate too much from the Index. You should win by realizing the higher yield.

In an environment where spreads tighten, NUSA could likely outperform the Index. In an environment where spreads remain the same, it should also outperform the Index. If spreads blow out, it’s a question of how long it takes to recover with its higher yield. It’s important to remember that NUSA is not invested in high yield, so the opportunity for a true blowout is substantially reduced.

What is the expense ratio, and how did you price it?
The fund charges 0.20% per year. It’s pretty cheap given the extra yield it’s designed to deliver compared to issuance-weighted funds on the market.

How is the liquidity? What’s your advice to people who want to trade it?
I always advise people to use limit orders. We’ve seen big trades go off without any problem, and just as importantly, midsized trades go off as well. If you have a trade that your block order desk would usually look at, you should have the desk take a look at it. If you usually speak to a market maker, use a market maker; if you usually use limit orders, use a limit order. As long as you are not using a market order, you’re going to be fine. The underlying securities are extremely liquid.

Is there any reason someone would buy the traditional 1- to 5-year Agg, given the improvements in NUSA?
I can’t think of one.

If you had to sum up NUSA in one paragraph, what would you say?
NUSA offers controlled yield enhancement for your short-term fixed-income needs. It’s a complex algorithm to build the portfolio, but it’s actually a very simple story, both in terms of what it does and how it fits in investor portfolios.

Fidelity Dividend ETF for Rising Rates

What do you do about the threat of rising rates? It’s a question investors are asking themselves over and over right now. Unfortunately, the answer isn’t always apparent. Rotating into lower-duration fixed-income securities helps on the bond side, but what do you do on stocks?

Enter FDRR. If there’s one thing we love about this ETF, it’s that it puts the actual problem it’s trying to solve right there in the name. It’s a dividend ETF for rising rates.

But it’s more than that. With its careful constraints, FDRR works as a new core holding for investors. And with a clever design, it’s definitely a hidden gem.

Matt Hougan, CEO, Inside ETFs: What drove you to develop FDRR?
Matt Goulet, ETF Investment Strategy, Fidelity Investments: FDRR really came from our customers. We constantly heard from investors and advisors that they were searching for income but were concerned about the risks that came with other dividend strategies, particularly the impact of rising interest rates.

Dividend ETFs have been on the market for almost 15 years. At the time they launched, the 10-year Treasury was yielding somewhere between 3.5-5%. Many of the early ETFs had methodologies that relied heavily on the history of the underlying stocks, and specifically looked for stocks that had increased their dividend for many consecutive years—5, 10, 20, etc. They also had different weighting schemes.

What’s wrong with that?
Well, the question is, what’s changed? And the answer is, bank stocks that had long histories of paying dividends didn’t hold up so well in 2007 and 2008, and on top of that, technology companies started to pay dividends in recent years.

Some of the more mature tech names like Cisco yielded less than 1% five years ago; today, Cisco is yielding north of 3%. We are in a different dividend environment. When our product group got together with our Equity & High Income Quantitative Research team, we thought we could develop something better. So, when we were designing FDRR, we started by capturing that new dividend reality, and then incorporated the risk we kept hearing about: rising rates.

Is there something about dividend ETFs that makes them uniquely exposed to rising rates?
Many dividend ETFs are exposed to rising rates because of their significant tilts toward sectors and industries that are very interest rate sensitive—such as utilities or REITs. There is a big dispersion between competing dividend ETFs, because most of them are unconstrained. There is nothing to govern sector and industry overweights.

With FDRR, we make sure it’s sector- neutral versus a market benchmark; it’s size neutral versus a market benchmark; and all the individual securities bets are constrained. You don’t see FDRR making massive sector, size or individual company bets versus the market.

How does it fit in an investor’s portfolio?
We feel it can be a core holding for income-oriented portfolios. If you look at the tracking error versus the Russell 1000 for FDRR, it’s low. Other dividend ETFs will exhibit tracking error of 5-10% per year versus the Russell 1000; FDRR will likely be much tighter than that based on our constraints. FDRR works for investors searching for yield, and can play a core role in such an investor’s equity allocation.

What does it typically replace in investor portfolios?
Many think of ETFs as taking assets away from traditional active funds, but we see a lot of money coming from both dividend ETFs launched in the early 2000s and also individual blue chip stocks. It’s not just people selling mutual funds and buying ETFs; it’s people ditching individual stocks and buying dividend ETFs instead.

What does it yield today versus the S&P 500?
FDRR has a yield of 3%, and the weighted yield of the underlying companies is 3.6%; the market overall is about 2%.

When does the fund perform well versus the market as a whole, and when does it perform poorly?
Broadly speaking, FDRR will do well against the market as a whole when dividend stocks are outperforming the market or when cheap stocks are outperforming the market, because value and dividends are closely related.

Another way to address this question is, how will it work versus dividend ETF peers? Compared to peers, FDRR will likely outperform other dividend ETFs in a rising rate environment.

It will underperform other dividend ETFs when rate-sensitive sectors like utilities and telecom are performing well. We only have a 3% weight to utilities and a 2% weight to telecom. Meanwhile, some of our competitors are 30-40% utilities and 10-20% telecom. It’s a sizable difference.

What drives that difference?
We’re not underweight utilities versus the market; we’re sector neutral. The overall market is only 3% utilities and 2% telecom. We pick names within a sector for yield, but the weight of the overall sector is matched to the weight of that sector in the overall market at the annual rebalance.

What’s the expense ratio, and how did you set that?
The expense ratio is 0.29%. If you look across the smart-beta and factor space today, we priced it below where most funds are priced. Given that it incorporates a lot of insights from our investment team and is priced below many peers, we think it’s a strong value.

If you had to sum up FDRR in one paragraph, what would you say?
FDRR is the second era of dividend ETFs. Just when you think ETFs have reached their peak and there is no more room for innovation, we see firms like Fidelity and our competitors coming up with new ideas.

You hear the term “solutions” thrown around our industry a lot, but with FDRR, we’re actually providing a real solution. We identified a need, thoughtfully designed the product, and then we were explicit about what it does. We put the term “for rising rates” in the name. People often ask what ETFs do; we tried to make that clear. It’s a true solution for an advisor or an investor.

BlueStar TA-BIGITech Israel Technology ETF

Israeli technology. The two words evoke a very specific image. Cutting edge. Market leading. The future of the future.

You start to think of specific companies; startups like Waze—acquired by google in 2013—and established global leaders like check point software, amdocs and nice systems.

But the funny thing is, most investors have no exposure to these companies. Due to a quirk in listing practices and index construction, major indexes in Israel—along with U.S. and global tech indexes like the nasdaq-100—miss huge swaths of the Israeli tech industry altogether. These companies—some of the most innovative in the world—literally fall into an indexing gap.

ITEQ fills that gap. Tracking a proprietary index, the bluestar ta-bigitech Israel technology ETFcaptures all of the Israeli tech industry, making it a critical component of any carefully considered global tech investing strategy.

If you want cutting-edge technology, you want Israeli tech. And if you want Israeli tech, you want ITEQ.

Matt Hougan, CEO, Inside ETFs: Why did you develop ITEQ?
Steven Schoenfeld, Founder and Chief Investment Officer, BlueStar Indexes: To fill a need for investors. The TA-BIGITech index that ITEQ tracks is the only index of Israeli technology companies listed worldwide.

Israel is well-known as the “startup nation.” It has the highest percentage of technology startups per capita in the world; its tech ecosystem is second only to Silicon Valley in absolute terms; and almost every major global technology company has a major R&D center in Israel or has done major acquisitions here. But despite Israel’s prominent role in global tech—and particularly the cutting-edge, transformational technology that is changing our world—before ITEQ, there was no ETF providing exposure to the complete Israeli tech opportunity set.

But don’t I get exposure through my U.S. and other international indexes?
That’s the thing; the answer is no. Israeli companies don’t quite make it into the U.S. or global tech indexes, and ironically they’re not in the local Israeli technology indexes either.

Why not?
The primary benchmarks in Israel are calculated by the Tel Aviv Stock Exchange, or TASE. TASE indexes only include companies listed in Tel Aviv, but most Israeli technology tends to list on global markets like NYSE, Nasdaq or the LSE, to assure better analyst coverage.

The problem is, if they’re listed only abroad, they don’t qualify for the local indexes. Check Point, Amdocs, Verint, Wix.com and dozens more aren’t listed in Tel Aviv, so they’re not in the benchmark for investors.

Where does ITEQ fit in an investor’s portfolio?
If you’re an advisor who has interest in technology, you should have exposure to Israel. and you’re likely not currently getting it. They fall in an “indexing gap,” so unless you take a proactive step, you miss out on some of the most innovative companies in the world.

Israeli tech companies generally don’t make it into either U.S. tech indexes tracked by ETFs, or many global indexes. There is only one Israeli company in the Nasdaq-100, just a handful in key biotechnology indexes and none in the S&P Global 1200.

Thus investors should consider a dedicated allocation to ITEQ within their U.S. and global technology exposure, both to “fill the gap” and to benefit from the innovation of leading Israeli companies. Furthermore, as tech is generally a lower weight in developed international than in the U.S. or emerging markets, ITEQ can be used to increase technology exposure to an EAFE/world ex-U.S.- benchmarked allocation

How do you define what is an Israeli tech company?
First, we take a very broad, deep and complete approach to defining technology. We include cybersecurity, IT hardware and software, big data, defense and security, 3D printing, biotech, medical devices, agritech and more.

We also have a rigorous methodology for defining an Israeli company. Some of the metrics are quantitative: Is it legally incorporated in Israel? Is it paying taxes in Israel? Those are black and white.

Then, there are more qualitative or subjective metrics: Does the company have a significant amount of its R&D or intellectual property in Israel? are a significant number of its employees in Israel? Do key management functions take place in Israel? In the qualitative areas, a firm can’t qualify with just one criteria; it has to meet at least two criteria.

Why is Israel such a hub for technology?
There have been books written about this, including “Start-Up Nation,” which explores exactly that question: How does a country about the size of New Jersey, with less than 9 million people, become so prominent in technological innovation?

Part of the reason is that Israel itself is a startup nation. It’s turning 70 years old this spring; it was built out of swamp and desert; developed under adversity—having fought five major wars in its first 40 years—and it’s a country of immigrants from all around the world. That’s a good foundation for entrepreneurism. Israel also has a very-well-educated population, world-class research universities.

Vitally, it also has a culture that accepts risk and failure. Most Israeli citizens, by law, must serve in the military after high school. Thus, before university, they learn about responsibility and risk-taking. When you’re a 19- or 20-year-old leading a platoon into battle, and five years later you’re leading a startup, your perception of risk is very different than your peers in Silicon Valley.

And finally, you have a solid ecosystem. U.S. companies like Intel, Apple and Microsoft have major R&D centers in Israel. The Israeli government provided major incentives to foster the venture capital community in the 1990s, and out of that grew a number of very successful companies and entrepreneurs.

There are now many examples of startups that’ve gone on to be world-leading companies, and they’re contributing back to the system, along with global tech companies active in Israel. It’s has become a virtuous circle.

If you had to explain in one sentence why every investor should look at ITEQ, what would you say?
You can’t be a serious global technology investor without including Israeli tech stocks, and ITEQ is the efficient way to get exposure to them.

 

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