Index Choice Is Key For Spinoff ETFs

Out of the funds we classify as "Alpha-Seeking ETFs" here at ETF.com, the Guggenheim Spin-Off ETF (CSD | D-51) was one of a kind, until recently. Launched nearly 9 1/2 years ago, CSD was the only ETF focused on spinoffs until the Market Vectors Global Spin-Off ETF (SPUN) came to market last year.

Still, CSD remains the leader in the space, with $238 million in assets compared with a mere $2.8 million for SPUN.

We'll soon find out whether there's room for two spinoff products in the crowded ETF field. While CSD's asset base is respectable, the spinoff strategy has yet to catch on with investors.

Should investors be taking a closer look at CSD and SPUN?

Performance Lags S&P 500, Beats Russell 2000

The thesis behind these ETFs is that a spun-off company is likely to create value by becoming more focused on its core business following the split from its parent.

Within a conglomerate, the individual business was just one of many, but following the spinoff, it is the focus―at least that's the theory.

The reality for CSD is near-identical performance to the S&P 500. In the period since its inception on Dec. 15, 2006, the fund is up 74.6%, compared with a return of 76.9% for the SPDR S&P 500 ETF (SPY | A-98).

On the other hand, CSD has outperformed the 62.9% return for the iShares Russell 2000 ETF (IWM | A-91), which some may argue is the more appropriate benchmark for a fund filled with smaller-cap companies.

Returns For CSD, SPY, IWM Since Dec. 15, 2006

Meanwhile, SPUN has only been around since June 10 of last year. Since then, it is down 8.6%, below the 0.6% return for SPY, similar to the 9.4% decline for IWM and better than CSD's 15.1% loss in that period.

CSD Switching Indexes

All things considered, the return for these spinoff ETFs has been mixed, at best. Now the question is whether they can outperform going forward.

Guggenheim, the issuer of CSD, hopes that by changing the underlying index for its ETF from the Beacon Spin-off Index to the S&P U.S. Spin-Off Index, it will have a positive effect on returns. The change goes into effect on May 20.

Under the current Beacon index, the ETF holds companies that spun off within a two-year period of 30 months ago to six months ago. The index rebalances semiannually, and holdings are ranked based on a multifactor process, with a maximum weighting of 4.5% for any individual stock.

New Index Has Outperformed

In contrast, the new S&P index will include companies that have spun off within the last four years, and it is rebalanced monthly. Additionally, the index is market-cap-weighted. All stocks in the index must have a market cap of at least $1 billion, and the maximum weighting for any individual name is 7.5%.

The current top holdings for the S&P U.S. Spin-Off Index include Baxalta Inc., Hewlett Packard Enterprise Co. and The Kraft Heinz Co. On the other hand, the top holdings for the Beacon Spin-Off Index are Allegion PLC, Brookfield Property Partners and Liberty Media Corp.

While it may not seem like a drastic change, the new index for CSD could have a significant impact on returns going forward. Consider what's happened in the past: Since 2007, the return for the S&P index is a whopping 2.6 times what it is for the Beacon index.

Returns For S&P US SpinOff Index & Beacon SpinOff Index Since 2007

The S&P index is also significantly outperforming in the year-to-date period, with a gain of more than 6%, compared to 3% for the Beacon index.

SPUN Uses Global Index

Meanwhile, the newcomer to the space, SPUN, uses a third, completely different index to dictate its holdings―the Horizon Kinetics Global Spin-Off Index. As the name implies, this index holds shares of spun-off companies from around the world, including the U.S., Western Europe and developed Asia.

The Horizon index holds spun-off companies for five years and equal-weights them.

Year-to-date and over the past decade, SPUN's Horizon Index is beating the CSD's current Beacon Index. But it's been no match for the S&P index, which is at the top of the pack.

CSD Has Leg Up On SPUN

Of course, past performance is no guarantee of future results. For investors attracted to the spinoff strategies of CSD and SPUN, they must make a choice between two ETFs with distinct underlying indexes.

CSD gets a leg up based on the winning history of the S&P U.S. Spin-Off Index and the fund's much deeper liquidity. SPUN, which currently has anemic trading volume and few assets, must prove that it and the Horizon Spin-Off Index are the better bet for investors.

Contact Sumit Roy at [email protected].