1st Blockchain ETFs Among New Launches

January 17, 2018

Today sees the debut of two ETFs focused on blockchain technology, the first funds of their kind. The actively managed Amplify Transformational Data Sharing ETF (BLOK) lists on the NYSE Arca and comes with an expense ratio of 0.70%, while the index-based Reality Shares Nasdaq NexGen Economy ETF (BLCN) lists on the Nasdaq and comes with an expense ratio of 0.68%.

Blockchain technology is currently in the spotlight due to public interest in bitcoin and other cryptocurrencies. Blockchain technology is really what makes the cryptocurrency world go round, and it has much wider application than just supporting digital money. It’s basically what’s referred to as a “distributed ledger” that provides a secure and unalterable record of transactions that have taken place and other key pieces of information, storing them in linked blocks of data.

Amplify’s Take On The Space

BLOK was actually the first blockchain ETF to go into registration. The fund can invest in domestic and non-U.S. securities, including depositary receipts, according to the prospectus. It will focus primarily on firms that are developing or using blockchain or similar technologies.

According to Christian Magoon, founder and CEO of Amplify ETFs, developments among the companies in his firm’s Amplify Online Retail ETF (IBUY) alerted him to the fact that cryptocurrency was an emerging trend.

“That started to get us interested in the blockchain equities side of things given the potential of blockchain technology to disrupt; it certainly seems to have potential that is almost similar to the internet’s,” Magoon said. 

The range of companies allowed in the portfolio covers those engaged in research and development, and the implementation of blockchain and similar technologies; those profiting directly and indirectly from demand for such technologies; those partnering with companies engaged in blockchain research, development and implementation; and those that belong to consortiums or groups formed to explore the potential of such technologies. Companies must also meet minimum size, price and liquidity thresholds.

Further, the portfolio managers consider the depth of the involvement of companies when selecting them for inclusion in the portfolio, classifying those that are selected as either “core” or “secondary” companies based on their activities, the prospectus said.

Magoon describes the fund’s strategy as “skating where the puck will be.”

“We think companies that are leaders today in researching, investing in or receiving revenue from blockchain are going to be well-positioned for tomorrow—similar to companies that engaged in internet technology early on,” he said.

Magoon’s firm offers actively managed and index-based ETFs, but he believes active management is particularly important for a fund such as BLOK.

“Our key differentiator is that we believe you have to be active when you engage in this space. In order to capture the upside and manage downside risk, you have to be, on a daily basis, looking at this and adjusting your portfolio,” he said, noting that a manager can slowly build or unwind positions, whereas index funds tend to make very binary decisions regarding including or selling a company. Further, while an index fund must wait until its scheduled rebalancing to reflect changes in the market, an active fund’s manager can react immediately.

Interestingly, the fund is managed by two subadvisers. Toroso Investments oversees the fund’s investment strategy, including its selection of holdings, while Exponential ETFs executes the necessary trades and actually constructs the portfolio.

Reality Of Blockchain
Reality Shares’ BLCN tracks an index from Nasdaq, the Reality Shares Nasdaq Blockchain Economy Index, which targets companies that commit “material resources” to research and development, innovation, implementation and support of the blockchain technology for in-house use and for provision to others.

“We could build a methodology that was robust, but it wouldn’t be robust enough because this technology is so new. So then we brought Nasdaq into the picture and brought on this blockchain advisory board,” said Eric Ervin, CEO of Reality Shares. He points out that the board, which evaluates companies for inclusion, includes members of academia, participants in the cryptocurrency space and even someone who worked on the original development of bitcoin.

The index provider determines the universe through its research and analysis. From there, companies included in the index must have market capitalizations of at least $200 million and meet minimum liquidity requirements.

Each company is assigned a proprietary “Blockchain Score” based on how much it is likely to benefit from the advancement and commercialization of blockchain technology. The 50 to 100 companies with the highest scores are included in the index and weighted based on their scores. The index is reconstituted every six months, the prospectus says.    

For Ervin, an index approach was the route to go.

“My view is that even with the best active manager, you could create a rules-based approach that does 99% of the work of the manager,” he said, pointing out that, with active, “you lose all that transparency and the certainty of how it’s going to work.”

The fund can include depositary receipts and common stocks, according to the prospectus, and currently includes companies representing emerging and developed markets in North America, Europe and Asia.

Blockchain’s Big Picture

Despite launching competing products, Magoon and Ervin agree on quite a bit. Both cite blockchain’s similarity to the internet in terms of the impact it could have. Both also draw parallels between email as the “killer app” that drove the spread of the internet, and bitcoin as the new killer app for the blockchain space.

They further cite the security of blockchain technology, which stores its data in a decentralized manner across a vast number of machines, making it incredibly difficult to hack.

And both men agree that the technology has the power to transform our society, in particular how we conduct transactions and store data. 

“Anywhere that there’s friction in the system because of an intermediary, the blockchain can solve most of those cases,” Ervin said.

Magoon and Ervin noted the technology’s power to streamline transactions by eliminating intermediaries and to store data more efficiently and securely.

Investors might notice that neither fund contains the word “blockchain” in its name. Apparently, the SEC raised concerns with the issuers late in the launch process regarding the accuracy of the blockchain label given that there aren’t really any companies that are purely focused on blockchain. As such, the regulator was concerned a fund labeled as a blockchain ETF could be considered misleading.

Affinity ETF Uses Smart-Beta Approach

Regents Park, the firm that brought out the Anfield Capital Diversified Alternatives ETF (DALT) in September, has rolled out the Affinity World Leaders Equity ETF (WLDR). WLDR is advised by Regents Park and subadvised by Affinity Investment Advisers.

The fund has an expense ratio of 0.47% and lists on the Cboe exchange. Cboe Global Markets is the parent company of ETF.com.

WLDR tracks an index that covers 150-250 companies selected for their strong global footprint, earnings quality, improving fundamentals, price momentum and valuations. The fund pulls its components from the Thomson Reuters Global Developed Index, excluding Greece and South Korea. Its underlying index can include equities selected from up to 20 markets but as few as the U.S. and three other countries, according to the prospectus.

Companies are actually sorted into two buckets: the U.S. and non-U.S. Each one is assigned an “Affinity Score” using a proprietary methodology that relies on the previously mentioned evaluation criteria and how they correlate with the stock’s long-term performance. The methodology generally selects the top decile of companies based on their rankings and removes the companies that rank outside the top quartile from the index. 

“[The methodology] is a combination of factors. Valuation is very important, but then we also look at changes in expectations. So we’re looking at positive changes in earnings and revenue estimates, earnings and revenue surprises,” said Gregory Lai, CEO of Affinity Investment Advisors.

“We don’t want to just buy cheap companies,” he added. “We want to buy cheap companies that have exhibited these positive fundamentals.”

The index is weighted based on a modified equal-weighting approach within each sector while aiming overall for overall neutral sector weightings. It also seeks to reflect the geographical distribution of the parent index.

Rebalanced and reconstituted twice a year, the underlying index had 171 components as of the end of Aug. 31.

Strategy Shares Launches 7HANDL Fund

White-label issuer Strategy Shares rolled out a multi-asset index-based ETF today that also incorporates leverage into its methodology.  The Strategy Shares Nasdaq 7HANDL Index ETF (HNDL) lists on the Nasdaq and has an expense ratio of 0.96%.

The fund will track an index of the same name that splits its portfolio 50/50 between two buckets. The index will also incorporate a level of leverage that equates to 23% of the fund’s total portfolio.

In one bucket is an assortment of domestically focused equity and fixed-income ETFs that allocates 30% of its weight to equity funds and 70% to fixed-income funds.

The fixed-income sleeve is equally weighted among the three largest U.S. aggregate bond ETFs, while the core equity sleeve allocates 50% of its weight to an equal-weighted subportfolio of the three largest large-cap U.S. ETFs, and the other 50% to the largest ETF tracking the Nasdaq-100 Index.

The other bucket represents alternative assets and is referred to in the prospectus as the “Explore Portfolio.” It contains 12 asset categories that are each represented by a single ETF that is usually the largest in that particular space. Those ETFs are weighted in their portion of HNDL’s portfolio using a proprietary methodology that is subject to certain weighting constraints.

The prospectus describes the fund’s underlying index as “broadly diversified,” and says it is designed to provide high levels of monthly distributions to the tune of a 7% annual distribution rate while also offering a stable net asset value over time. The document also notes that the 7% distribution rate is not guaranteed. The fund will target risk levels that coincide roughly with the U.S. capital markets.

Rational Advisors serves as the fund’s advisor.

Newcomer Rolls Out 2 ETFs

On Tuesday, American Century rolled out its first two ETFs. The American Century STOXX U.S. Quality Value ETF (VALQ) and the American Century Diversified Corporate Bond ETF (KORP) both list on the NYSE Arca exchange.

VALQ comes with an expense ratio of 0.29%. Its underlying index methodology screens the STOXX USA 900 Index to exclude the least desirable stocks based on profitability, earnings quality, management quality and earnings estimate revisions.

From there, the stocks that are still in the universe are screened based on income sustainability, with the lowest ranking stocks removed from the index universe. Finally, stocks are evaluated based on valuation and income scores. Those scores are used in conjunction with a portfolio optimization process to create a portfolio that seeks to strike a balance between risk and expected return, the prospectus says.

The document also notes that the index generally has between 200 and 300 component stocks. 

Meanwhile, actively managed KORP has an expense ratio of 0.45%. It targets corporate debt denominated in U.S. dollars, but securities can be issued by domestic or foreign companies, including supranational entities, according to the prospectus. 

Up to 35% of the portfolio can be invested in high-yield debt, but the rest is generally investment-grade securities.

Contact Heather Bell at [email protected]

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