Thematic ETFs can quickly gather steam if a theme catches investors’ imagination. Blockchain ETFs are the latest in hot themes served up in ETF wrappers.
In a matter of days last month, ETF investors gained access to four different blockchain ETFs. The rush to capture the investment case of the digital ledger technology behind cryptocurrencies (such as bitcoin) is on. In less than a month, nearly $300 million in new assets have flowed to these funds.
Truly accessing a theme is no a easy task, as you can’t easily isolate a revenue stream associated with a specific theme in a company’s numbers. Blockchain is no different.
Finding pure-play companies in blockchain is practically impossible, according to Spencer Bogart, partner at Blockchain Capital. Most people don’t even fully understand how it works.
“There’s simply no pure-play public company exposure to the space,” Bogart said. “Even for the publicly traded companies that have exposure to crypto and/or blockchain, it’s likely a small percentage of their overall business.”
“I’m not opposed to issuers trying to create thematic ETFs based around blockchain and crypto, but these are early days from a public markets perspective,” he added. “Prospective buyers should really understand the actual exposure they’re buying.”
Each issuer is going about accessing the blockchain theme differently. These are competing funds that are built very differently.
The good news is they all screen for liquidity, making sure these are securities you can easily get in and out of—that can sometimes be a challenge in thematic ETFs. They also screen out the companies that are making headlines simply by adding “blockchain” to their name or to their “strategic initiatives” as a quick ploy to boost stock prices.
And they all have their price tags in the same ballpark, around 0.65-0.70% in expense ratio.
Here’s a quick look under the hood at these ETFs:
Launched: Jan. 16, 2018
Expense ratio: 0.70%
AUM: $162 million
BLOK is a global-in scope portfolio of companies, but what’s unique about BLOK is that it’s the only actively managed blockchain ETF. The decision to go active centers on the issuer’s belief that blockchain is still an emerging technology, and one that’s changing too quickly to be best accessed through an index that reconstitutes twice a year.
The fund seeks companies that match one of three criteria: those that are leading in collecting revenue from blockchain; those that are leading in research efforts; and those that are leading investment in private companies in this segment.
The active management approach allows the fund to pursue that purity more nimbly, Christian Magoon, head of Amplify, told ETF.com. BLOK also dips into smaller-cap companies for exposure.
The portfolio, as one might expect, is heavy on tech names, but also offers exposure to sectors such as financials and health care/biotech. Top 10 holdings include names like Taiwan Semiconductors, Overstock, Nvidia and HIVE Blockchain Technologies, each representing about 4 to 6% of the mix.
Here’s what the portfolio looks like right now:
Launched: Jan. 17, 2018
Expense ratio: 0.68%
AUM: $104 million
BLCN is an index-based strategy that owns companies that are likely to see blockchain-related growth. It tracks the Reality Shares Nasdaq Blockchain Economy Index. The methodology uses what the company calls the Blockchain Score to hone in on companies that either will benefit the most from blockchain technology or those that are “developing the underlying technologies behind blockchain innovation,” according to Reality Shares.
More granularly, the Blockchain Score consists of quantitative factors that ultimately assess how developed a company’s blockchain technology is, how much it spends on developing it, how innovative it is, and how economically significant or crucial that company is in the overall blockchain segment.
What’s unique about BLCN’s index-based approach is that even though the methodology is rules-based, the index committee has wide discretion in determining which companies are eligible for inclusion.
The 59-stock portfolio is global in scope and diverse across industries. Here’s a portfolio breakdown, courtesy of Reality Shares:
Source: Reality Shares
Launched: Jan. 30, 2018
Expense ratio: 0.65%
AUM: $4.8 million
KOIN is index-based with a twist: The index uses artificial intelligence (AI) to pick stocks. The reliance on AI speaks to the challenge of identifying a theme in a company’s balance sheet. According to Innovation Shares, to invest in blockchain as a theme requires something other than a traditional, fundamentals approach based on a company’s financials.
Specifically, the “natural language process algorithm,” or the AI element to this, identifies stocks globally that have a relationship with the blockchain through certain keywords. The algorithm reads stories from the media and uncovers stocks that have an association with these keywords.
It then generates a sentiment score to establish how strong the relationship is between that company and the theme. In a way, it’s a strategy that relies on the collective wisdom of the media.
The stocks are then put into four stakeholder categories: cryptocurrency/payment; mining enablers; solution providers; and adopters. Each category can’t represent more than 40% of the index, and individual stock weighting is capped at 7%.
The end mix of 42 securities is sector diverse—it includes names like Amazon, Visa and Tencent, but also the likes of shipping company Maersk, UPS, FedEx, Sprint and Dish Network. The mix reconstitutes twice a year.
“Blockchain, like other themes, is a multidecade theme,” said Innovation Shares’ Managing Director Matt Markiewicz. “You invest in themes, you don’t trade them. Themes take a while to play out.”
Here’s a look at the portfolio:
For a larger view, please click on the image above.
Launched: Jan. 24, 2018
Expense ratio: 0.65%
AUM: $14 million
LEGR is an index-based strategy, tracking the Indxx Blockchain Index. The decision to go the index route versus an actively managed route was deliberate, and reflected what First Trust sees as the newness of blockchain as a theme.
“We specifically sought to make this a passive fund because an active fund needs a leader in the space, a specialist to lead stock selection,” said Ryan Issakainen, senior VP and ETF Strategist at First Trust. “In a theme like blockchain, we weren’t confident there was an experienced manager out there to really add value in an active strategy.”
That relative newness is what First Trust sees as the challenge to finding pure-play companies in a theme that’s neither mature nor a bona fide industry yet. From an index perspective, investing in blockchain requires significant analysis to identify companies that belong in a portfolio.
The methodology here looks for companies that benefit from providing products and services that relate to blockchain. Companies leveraging blockchain to make their business more efficient and competitive are also considered. It’s a two-tier approach in a way.
Bucket one is what First Trust calls “active enablers”—firms akin to being pick axes to miners, as Issakainen puts it. Names here include IBM, Microsoft and NVIDIA. There are 14 companies in this bucket right now, representing 50% of the overall portfolio.
The second bucket consists of blockchain users, a larger group of companies that are sector diverse. There are more than 50 names in this part of the portfolio sharing the other 50% of the portfolio, so companies incorporating blockchain to their business in search of better efficiencies and competitiveness individually carry less weighting in the overall portfolio. Securities are equally weighted within their buckets.
According to First Trust, enablers will have bigger impact on the blockchain industry as a whole as they lead innovation and development; so, allocating more heavily to them makes sense.
Like most of these ETFs, LEGR is tech-heavy, but it also offers sector exposure to financials, consumer staples and discretionary. As blockchain, as an industry matures, sector representation should widen.
Here’s a snapshot of the portfolio today:
Source: First Trust
For a larger view, please click on the image above.
Commit Or Not Commit?
Themes take time to develop and evolve. Issuers will tell you time horizon matters in thematic investing, which also means there’s often volatility along the way. Asset flows will go in and out as investors react to that volatility.
A long-term time commitment to the theme from both an investor’s and issuer’s perspective—their willingness to stick to a fund that may see assets ebb and flow—will both be key to thematic investing in spaces like blockchain.
Contact Cinthia Murphy at [email protected]