Buyback ETFs Usually Outperform

March 15, 2016

Corporate buybacks are approaching record levels, but the companies engaged in the most buying are underperforming―a puzzling phenomenon.

A new Bloomberg report says that companies in the S&P 500 are on track to purchase $165 billion of their own shares this quarter, just shy of the record from 2007.

The increase in buybacks comes despite the fact that corporate earnings are expected to decline for a fourth-straight quarter in Q1.

Some say that buybacks signal confidence on the part of companies about the prospects for their businesses and the economy in general. Others say just the opposite—that they indicate a lack of opportunity on the part of companies to invest and grow their core businesses.

Buyback ETFs Lag During Past Year

In either case, buybacks should have a positive effect on stock prices, all else equal. Like anything else, prices for stocks are set by supply and demand. As demand rises from corporations buying their own stocks, that should give a lift to prices―at least in theory.

A look at the numbers reveals that, recently, the theory isn't matching up with reality. Over the past year, the PowerShares Buyback Achievers ETF (PKW | B-82)―which tracks a market-cap-weighted basket of firms that repurchased at least 5% of their outstanding shares in the past year―lost more than 8.4%, compared with a 0.8% loss for the SPDR S&P 500 ETF (SPY | A-97).

Meanwhile, the SPDR S&P 500 Buyback ETF (SPYB | F-71), which tracks an equal-weighted basket of 100 companies in the S&P 500 with the highest buyback ratio, fell by 9.2% in the period.

1-Year Returns For SPY, PKW, SPYB

Significant Outperformance Longer Term

The size of the recent underperformance in the buyback ETFs is notable, but it could just be noise. Since inception in December 2006, PKW has handily outperformed SPY, with a gain of 94.8% compared with 71.5%.

SPYB has only been around since 2015, but its underlying index, the S&P 500 Buyback Index, has been around for a long time, and it has also outperformed the broader market.

According to a research report from S&P, the buyback index outperformed the S&P 500 in 17 of 20 years through March 2014. In that 20-year period, the S&P Buyback Index returned 15.1% annually compared with 9.1% for the S&P 500 and 11.5% for the S&P 500 Equal Weight Index.

"Over a long investment horizon, buyback portfolios generated positive excess returns over their parent indices in the U.S., Canada, Europe and global markets," said the report. "All of the buyback portfolios tested generated higher average monthly excess returns over their parent indices in down markets than in up markets, no matter which weighting schemes were employed in the portfolio construction."

Opportunity To Consider ETFs

While past performance is no guarantee of future results, it certainly looks like there is merit to the buyback strategy. If that is the case, the data indicating that buybacks are nearing record levels this quarter should be looked upon in a positive light.

Likewise, with PKW and SPYB lagging the broader market during the past year, now may be a good opportunity to take a closer look at the funds.

Going forward, they may fare relatively well even if the market pulls back. As S&P points out, buyback indexes don't necessarily underperform in downmarkets.

For example, the maximum drawdown in the S&P Buyback Index during the past 20 years was 46.3% compared with 46.4% for the S&P 500.

Contact Sumit Roy at [email protected].

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