iBillionaire ETF Buyers: Beware Of Bear

Snickering aside, IBLN is likely going to pull in the assets.

Snickering aside, IBLN is likely going to pull in the assets.

It’s easy to be a cynic—in fact, I’ve been accused of either being a professional cheerleader or a professional cynic for most of my career (an odd dichotomy I still can’t figure out). And when someone launches a fund called the “Billionaire ETF,” it’s almost like someone showed up with a prewritten script for a late-night TV monologue.

But the thing is, the Direxion iBillionaire ETF (IBLN) is actually part of two waves of investing at the same time.

The first wave is the “smart” wave. We’ve seen a rash of “smart beta” launches, most based on models that algorithmically try to rebuild traditional pools of asset—like large-cap stock—using market-beating rules. But there’s another version of these smart products—the ones that are trying to tap other investors’ acumen.

The most notable example is the Global X Guru ETF (GURU | B-58). Guru builds a portfolio based on the filings of large hedge funds, as reported in 13F filings. It’s another snickerworth idea, but naysayers are really the ones who should be snickered at here: The fund has pulled in nearly $500 million in just two years, while crushing the S&P 500 by more than 22 percent.

But that’s not the only successful example: Van Eck launched the Market Vectors Wide Moat ETF (MOAT | A-48) in 2012 as well, based on the picks of the Morningstar equity analyst team, and it’s also beaten the S&P since its 2012 inception, by 4.56 percent.

IBLN takes things one step more active than either GURU or MOAT—it trolls through 13F filings for the personal holdings of the world’s wealthiest investors. The theory is, I suppose, that the 19 rich white guys they’re following all got at least the “rich” part from being smarter than the rest of Wall Street.

All three funds are really just vehicles for tapping a different kind of active management—one based on a “wise men” model rather than a hot-shot stock-picker model perhaps, and one that sticks the picks into an index before rolling them into a fund; but mostly, that’s splitting hairs.

The second wave all of these ETFs are part of, however, is the one I actually find more interesting: equal weighting. All three of the ETFs mentioned here take their best ideas from their different methodologies and equal-weight them, rebalancing occasionally.

Equal weighting is the simplest-to-implement version of the “anything but market cap” approach to smarter investing, and despite the implied higher trading costs, it’s actually been a consistent winner during this bull market.

Consider the returns just of the Guggenheim S&P 500 Equal Weight (RSP | A-79) versus the SPDR S&P 500 (SPY | A-98):

That’s a nearly 20 percent gain over the naive S&P 500 in five years.

Now, there are lots of academic reasons why equal weighting has outperformed—it’s not magic. It’s overweight smaller-cap stocks, which have juiced its beta by about 8 percent. That increased beta means it goes up more when the market is up and down more when the market is down. We’ve been mostly in an up market. It’s not a free lunch—it’s a tool to tweak your exposure.

So let’s consider how these other equal-weighted, “wise men” focused funds have done (substituting in indexes where the actual fund history isn’t long enough).

Charts courtesy of Bloomberg

You’re starting to see the appeal of “anything but market cap” in a bull market. Every one of these strategies beat the pants off the S&P 500 over the five-year window, with iBillionaire on top. I don’t find that particularly surprising—the index was only introduced in November last year, and let’s be honest, nobody has ever introduced a “smart” index that looks bad on the backtest.

But I’m left with more than one concern:

The first is simply that I remain, as always, enormously skeptical of active management. IBLN certainly looks good on paper right now, but it hasn’t actually been tested in a live bear market.

And the thing you’d expect these “wise men” to do if they were really geniuses managing your money would be to get out of a falling market faster than everyone else—precisely what IBLN cannot possibly do, since it’s dealing with data lagged from these gentleman by 45 days through the 13F filing process.

The second is that I’m not convinced folks will understand that a significant portion of the “magic” here comes from simply equal weighting a large-cap portfolio. That magic serves mostly just to boost the beta of the underlying selection of stocks.

That works great in upmarkets, and can really hurt in downmarkets. In the terrible year leading up to the March bottom in 2009, for instance, equal-weighted S&P underperformed the S&P by an extra 5 percent—rough justice in a period where the S&P was down 45.5 percent already.

My prediction, however, is that despite all the snickering, we’ll continue to see strong flows into IBLN, GURU and their inevitable copycats. No matter how many regressions I run, or how many statistics I can trot out, nobody wants to be average, and the belief that the rich guys must be smart is so fundamentally American that it’s an easy sell.

At least when the market’s up.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].