The global pandemic has disrupted economies and markets across the globe, triggering many moments of never-before-seen market action. It’s fueled impressive gains in some pockets of the market and has brought some segments and companies to their knees.
Connor O’Brien, CEO of O’Shares ETFs, says this pandemic is going to have a “profound impact on how the world works” going forward. In investment lingo, that means that past winners may not be future leaders, and that’s nowhere more apparent than in the technology sector.
Here we discuss these topics and more.
ETF.com: How is your day-to-day as a small ETF issuer currently? When you look at the market right now, what are you focusing on?
Connor O’Brien: Our ETFs are driven by rules-based indexes, so there's no person making a macro call that influences any portfolio of our ETFs. They're differentiated because the indexes are not generic market-cap-weighted, but they're designed to achieve a different investment profile on the large cap side. It's quality dividends. So what we're doing each day, and putting a lot of time into, is talking to advisor clients.
We've been talking to advisors about things we think are changing now and are going to be different going forward. There are going to be some winners and some losers in different sectors.
But it’s been kind of interesting. In many ways, the world is very different, but the workflow for us is almost business as usual except that we're all working from a home office.
ETF.com: Is there a particular question you’re getting most from advisors? A recurring theme, perhaps? Anything that surprises you?
O’Brien: What’s been the most surprising is the relative calm. Compared to the scale of this problem we're all living through, I'm impressed with how calm so many of these advisors have been.
That doesn't mean they're complacent, but they're relatively calm. Part of the reason for it is that the Fed was very responsive very fast, and the rest of policymakers were also responsive with the payroll protection program and other initiatives that are going to be pumping trillions of dollars into the economy.
When you go back to the financial crisis, the Fed was really slow to act. The first round of medicine they came up with didn't work. There’s been a lot of learning from 10 years ago. That’s been a massive factor in calming advisors and enabling them to serve their clients well.
ETF.com: There’s no such thing as a one-size-fits-all strategy, but in these markets, what approach makes sense to you most? Stick with super broad diversification, dive into narrower themes, implement sector rotation? What?
O’Brien: I think “generic” investing is just as challenged as thematic investing. By “generic,” I mean investing in everything in market-cap weight and do a standardized mix of 50/50 or 60/40.
There are two major problems with that. Standard mix includes a lot of companies that are going to gradually be worse because the economy is going to change. How could it not change? Energy demand is going to be down for a very long time. Travel and lodging and restaurants and traditional retail are going to be very slow to recover; may never really recover to where it was.
All the digital-driven businesses—ecommerce, internet services, business-to-consumer and business-to-business—they’re going to benefit from this. The tech stocks and internet services stocks and an ETF like the O'Shares Global Internet Giants (OGIG) have massively outperformed the S&P 500 in the last few days and weeks, since this crisis. That’s to be expected because of the shifts expected in consumer behavior and business behavior.
Anyone who ignores that is ignoring that there's a transformation of the economy happening, accelerated by the coronavirus. Investors and advisors have to think about these things.
And with interest rates having gone so low, the future cannot be like the past. We’ve seen this massive trillions-of-dollars injection into the economy, which may be good for preserving socioeconomic stability, but it's very inflationary, because that money is thrown into the economy, not because the economy produced anything. And the economy is not going to produce very much for the next few months.
When it comes to investing, the general large cap world going through a recession is easier done if you're a business with strong profit margins and a strong balance sheet. But if you buy “generic” stuff, you're going to get a mix of above-average and below-average quality companies. And when you're going through uncertain times, quality companies might be the more comfortable ones to own.
The traditional asset allocation should be shifted in the direction of more equities and reducing bonds, certainly reducing duration. Bonds have done their job, rallying when equities sold off. Now it's time to rebalance. The asset mix rebalancing should be done proactively. Keep an eye on inflation risk, which is much greater now, and look for higher quality stocks.
ETF.com: It’s hard to argue against quality stocks. But what are the risks of focusing on quality? The O'Shares FTSE U.S. Quality Dividend ETF (OUSA) seems to have comparable portfolio P/E and performance to the Vanguard Total Stock Market ETF (VTI) now. What’s the risk?
O’Brien: Quality stocks have historically traded with a slight premium to the market, but rarely at a massive premium or discount. VTI has a favorable valuation comparison.
But the thing about OUSA that's worth knowing is it's a lower risk way to invest. When it comes to volatility, OUSA tends to be about 20-25% less volatile than the market. On market stress events, looking back, OUSA's index avoids almost a third of the downside if you average all of the down periods in recent years.
OUSA's designed to be a lower risk investment by avoiding the stocks that drop and don't come back. Quality stocks tend to be more resilient. It's not really "is it cheap; is it timely?" This is not a market timing type of investment—it’s long term.
ETF.com: Perhaps an ETF that fits that “timely” description is the O'Shares Global Internet Giants ETF (OGIG). All eyes are on cutting-edge tech, ecommerce and Internet.
O’Brien: OGIG is a nice complement to OUSA, and it fits what's happening this year with coronavirus—the trend towards more digital services, more ecommerce, more internet services, more of that entire ecosystem, not just a big few. And I think lots of people are underinvested in this area.
If you own this space through a broad, market-cap ETF, you’re going to own a little bit of everything but have a far greater weighting on the largest names, which have growth rates that are slowing.
When we built OGIG, it was essentially to answer this question that people ask: “What happened to the tech stocks?”
If you look at the tech sector, it has a weighted average revenue growth rate of less than 10%. It's actually lower than the S&P 500 stocks. It's because they’re nice companies, but old tech. Their businesses are solid, but they're producing stuff that they've been producing for decades, and their growth rate is chugging along at 8%, using Bloomberg data.
In OGIG, you own just the ecommerce, internet companies selected for revenue growth, as well as for profitability and strong balance sheets. Because they’re selected for revenue growth, you end up with a revenue growth rate across the portfolio that’s more on the order of magnitude of 38% on a trailing basis; 27% next year; compared to 8% for the tech sector.
Revenue growth is a really important indicator of how well a company will do. OGIG is built with one cornerstone being revenue growth. And that's how you end up with a portfolio that has very strong revenue growth across the diversified portfolio of about 70 stocks.
ETF.com: OGIG is one of three global internet ETFs. There's not a lot of competition in the space. Maybe this is one of the under-the-radar hidden gems of this new normal?
O’Brien: OGIG is extremely liquid—I say that because portfolio liquidity matters. The weighted average market cap of the 70 or so stocks is over $200 billion. The portfolio weighting is 65% U.S.-listed stocks and just over 20% Hong Kong-listed, and then rest-of-world, which includes companies like Shopify, a $50 billion market cap company that has revenue growth rate that’s double that of Amazon.
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
In OGIG, the top 10 names are mostly those you know. But when you get to the second 10, third 10, you're going to start saying, “I don't know any of those companies.”
But look at their financials and revenue growth rate and profitability and you say, “Wow.”—a lot of business-to-business cloud services companies; names like Zoom that everyone's now heard about, and so many others.
If you think along the lines of retail, only 11.4% of retail sales happened online versus traditional stores last year. If you exclude auto, restaurants and gasoline, it’s still a low 16%. But the growth rate is in the teens, and we think it’s going to accelerate, benefiting a lot of these high quality ecommerce, internet stocks. That's the DNA of OGIG.
Contact Cinthia Murphy at [email protected]