Stock Picker Copycat ETFs Show Dispersion

When it comes to replicating what smart money is doing, no two ETFs go about it the same way.

When it comes to replicating what hedge fund money is doing in an ETF wrapper, investors have an increasing number of so-called copycat funds that are built around the same principle—buy what famous stock pickers are buying. However, they deliver very different results.

As the Wall Street Journal reports that hedge fund managers are having a good year so far in 2015 in their quest to outperform the broad market, it’s quickly evident that no two hedge-fund copycat ETFs are built the same way, nor are they delivering the same returns to investors.

That’s because they go about making stock selections differently, and end up serving up portfolios that comprise totally different securities, and even more different sector exposures.

Consider these four ETFs as a sample of the funds in this segment:

• Global X Guru ETF (GURU | B-70)
• AlphaClone Alternative Alpha ETF (ALFA | C-63)
• Direxion iBillionaire ETF (IBLN | C-66)
• Validea Market Legends ETF (VALX | D-44)

Year-to-date, the dispersion between the best-performing of the bunch and the worst is a sizable 8.43 percentage points, as the chart below shows. Investors here could be practically flat year-to-date, or up about 8.5 percent. For context, the broad market as measured by the SPDR S&P 500 (SPY | A-98) is up about 3.5 percent in the same period. 

Chart courtesy of StockCharts.com

“They’re copycat ETFs, and they look primarily at holdings, but they differ from each other from there in terms of various screens for selection, such as manager quality, ‘stickiness’ of holdings; and weighting,” Paul Britt, ETF analyst at FactSet told ETF.com. “It’s OK to lump the copycats together in terms of concept, but differences in execution matter greatly.”

Looking Under The Hood

Here is a look at some of these key differences:

• ALFA, the top performer of the bunch, tracks an index that also aims to outperform the broad market by mimicking hedge funds’ positions in U.S. equities, and it, too, relies on lagging public filings. The fund, however, can hedge a drop in equities by going short—something GURU can’t do.

The source of its impressive outperformance so far this year relative to the other three funds rests on its keen stock selection and sector tilts. ALFA’s holdings are topped by a 7.3 percent allocation to Apple—a company that’s up about 17 percent year-to-date.

Valeant Pharmaceuticals, Horizon Pharma, Celgene and Biogen round out the top five, which together represent nearly 25 percent of the overall 83-holdings portfolio. In general, ALFA has picked better stocks so far this year than GURU has, Britt says.

Compared with GURU, ALFA also wins on larger allocation to health care, and on picking better stocks within the health-care sector. Health care is the S&P 500’s best-performing sector year-to-date. ALFA has had a similarly large allocation to info technology as GURU.

“The challenge with this approach is that fast-money hedge funds can change their positions on a dime,” ETF.com Analytics says of the fund. “ALFA has delivered high returns at times, but carries high volatility.”

Since it came to market in May 2012, it has gathered about $162 million in total assets. It carries a 0.95 percent expense ratio, and it trades with an average spread of 18 bps, putting the cost of holding this fund about $113 per $10,000 invested. That’s about 35 percent more than GURU’s total cost of ownership.

“Both sector allocation and stock selection within the sectors are key drivers here,” Britt said, noting that these strategies don’t set out to look at sector allocation when making stock selections based on stock pickers’ picks, but the resulting tilts matter.

• GURU, which is just barely beating SPY this year, tracks an index that sets out to mimic large hedge funds’ U.S.-listed equity positions that are made public in 13F filings quarterly. These holdings are equal-weighted, which means the performance of smaller securities impacts the portfolio just as much as larger-cap names.

“GURU selects firms using a copycat approach, piggybacking on accomplished stock pickers,” ETF.com Analytics says of the fund. “GURU's free-riding method is intuitive and transparent, but basing a portfolio on lagged quarterly snapshots of notoriously nimble hedge funds seems like a tough way to make a living.”

The fund, which came to market in June 2012, has gathered about $270 million in assets. Its top holdings are a diverse group of companies that include Horizon Pharma, Houghton Mifflin Harcourt, Baidu, LinkedIn and Facebook, each representing around 2.5 percent of the 54-name portfolio.

Just as important as which stocks it owns is the fund’s sector tilts. So far this year, GURU has liked information technology—about 30 percent of the fund—financials and consumer discretionary. These sector tilts have worked thus far if you consider that all of these sectors are in the green year-to-date, and tech and consumer discretionary are among the S&P 500’s top-three-performing sectors.

Beyond holdings, cost is an important consideration, because the more you are paying for a fund, the less you are pocketing in returns. GURU carries a 0.75 percent expense ratio, and it trades with an average spread of 9 bps, so investors are shelling out about $84 per $10,000 invested to own this fund.

• VALX, the second-best-performing of the four ETFs, is an actively managed fund that selects U.S.-listed stocks and American depositary receipts. The fund, which is global in scope, relies on a model that’s derived from the investing styles of several famous investors, like Warren Buffett and Ben Graham. In other words, this strategy has its own system for picking stocks instead of relying on 13F filings that have a 45-day delay.

Here, the secret sauce of these legends is somewhat preserved even in the ETF wrapper.

“VALX bets on the tried-and-true methods of a handful of ‘legendary’ investors in a bid to beat the market,” ETF.com Analytics says of the fund. “The precise methodology employed by VALX's manager is highly opaque, but we know that it's built on fundamental valuation metrics, rather than technical factors.”

The fund is relatively new, having come to market last December, and it has about $24 million in assets. Pricing wise, it’s somewhere in the middle, with an expense ratio of 0.79 percent, and an average trading spread of 22 bps. So investors are paying about $91 per $10,000 invested to own this fund.

Topping its 98 holdings is software technology firm Ebix Inc., followed by GW Pharmaceuticals, Silicon Motion Technology Corp ADR, Skyworks Solutions and AVG Technologies. Each of the securities represents between 1.2 and 1.5 percent of the portfolio. Here, the emphasis on pharma and tech has delivered the second-highest year-to-date performance of the four ETFs.

• IBLN, the worst-performing of the bunch so far this year—and the only one also underperforming SPY—relies on 13F filings to make allocation decisions. It, like GURU, is also an equal-weighted portfolio. Its distinguishing characteristic is that it looks for what billionaire investors and money managers are doing.

IBLN is the cheapest, with an expense ratio of 0.66 percent and an average trading spread of 11 bps, putting total cost of ownership at about $76 per $10,000 invested. That matters, because the less you pay, the more returns you keep.

Still, its performance has not impressed recently. That’s thanks to its stock choices, and sector weightings. Here, Google leads portfolio holdings, with a 7.1 percent allocation. Year-to-date, Google has eked out only 2.5 percent in gains.

HCA Holdings, Mohawk Industries, Dollar General and Facebook round out the top five, each with an allocation of nearly 4 percent. These securities have done better, all rallying anywhere from 11 to 23 percent so far this year.

“IBLN typically holds only 30 names, so the fund is very much a niche strategy, not a source for wide and deep coverage of the space,” ETF.com Analytics says of the fund. “To that end, we see significant sector, size, style and risk biases relative to the market—biases that may change in nature and magnitude.”

Since IBLN came to market last August, it has gathered $34 million in assets.