Choppy Seas For ETF-Of-ETF Industry

The ETF market has welcomed more than 230 new ETFs this year, boasting now almost 2,200 ETFs listed in the U.S. It has also seen total assets under management (AUM) grow to about $3.6 trillion, with year-to-date net creations on par with previous record years.

By all measures, the ETF industry is growing and hitting on all cylinders.

The ETF-of-ETF market, the ETF Industry Exposure & Financial Services ETF (TETF), however, is down 4% in 2018. TETF is currently underperforming the S&P 500 index significantly (as measured by returns of the SPDR S&P 500 ETF Trust (SPY) below).

Why? Put simply, because the current market environment has been no friend to asset managers.

TETF, with $7.3 million in AUM, sets out to capture the entire ETF ecosystem, from issuers to liquidity providers to index providers and everyone in between. However, the asset management side of the business (sponsors) is impacting TETF’s overall returns most this year.

As market volatility picked up, and a fear of rising rates dampened anticipated returns for money managers, new risk was introduced into TETF’s returns, according to Mike Venuto, chief investment officer and co-founder of Toroso Investments, the company behind TETF’s index.

That risk has caused TETF’s correlation to U.S. ETF asset growth to get off track. Remember that this fund is designed to closely track ETF asset growth, a job it has done well since inception until recently, when TETF performance has actually fallen behind, even as ETF assets grew.

“The financial sector has been hurting recently, and the market has not yet digested well some of the merger and acquisition activity in the ETF market,” Venuto said. “Given this environment, it’s not surprising that TETF’s correlation to asset growth has come off a bit.”

Among TETF’s portfolio buckets, it’s ETF sponsors that have fared worse this year. As a segment, index providers are up on average about 15% year-to-date; exchanges are up 12%; but ETF issuers have faced average losses of about 20% in 2018, dragging down TETF’s overall returns, according to Toroso data.

Consider WisdomTree Investments, the only publicly listed pure-play ETF sponsor and TETF’s top holding, with an allocation of about 6.7%. The company’s stock is down 43% in 2018.

Other ETF issuers found among the fund’s top 10 holdings—BlackRock, Charles Schwab, State Street, and Invesco, which has gone through a round of mergers and acquisitions this year—are all struggling this year.

The exception is J.P. Morgan, which is up about 5% following a notable year of internal asset shifts into what’s now a very successful lineup of BetaBuilder ETFs.

Charts courtesy of Stockchart.com

As a group, ETF sponsors are the biggest bucket in TETF, representing about 48% of the portfolio. That weight is why TETF has felt the pinch among issuers so clearly this year.

But this type of performance seen in 2018 is why Venuto says the “ETF of the ETF industry” focuses on the entire ecosystem and not just on ETF issuers. It’s diversification within an industry meant to mitigate some of the inherent risks associated with equity investing when the market goes down.

Contact Cinthia Murphy at [email protected]