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ETF News And Commentary

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The ETF industry continues to grow with total assets in US listed ETFs now close to $1.5 trillion and the total number of products close to the 1,470 mark. Apart from providing convenient, low-cost access to popular asset classes, ETFs can also help investors gain exposure to some niche markets or strategies that are otherwise not accessible to retail investors.

Some of these niche strategies are capable to delivering outsized returns to investors. Investing in spin-offs via an ETF--Guggenheim Spin-Off ETF (CSD - ETF report)--is one such strategy. (Read: Winning ETF Strategies for the second half)

What are Spin-offs?

Sometimes businesses create another independent firm from an existing business/division, when they believe that spun-off business would be more valuable as an independent entity than as a part of an existing business.

Such a spin-off is usually successful when the unit’s business differs from the parent’s business and by making it an independent entity, the parent can focus on its core business management while the new entity can focus on its goals.

In most cases spin-offs can unlock greater value for shareholders. The market can value two parts after the spin-off more than the value of the combined entity.

Do Spin-offs outperform their parents?

Research shows that spun-off entities generally outperform their parents and the broader market. They typically underperform in the first few weeks of trading--presumably due to selling by institutional investors, but they recover nicely subsequently and outperform by 22% in the first year.

One of the reasons could be that investors prefer focused smaller companies more than bigger diversified ones. (Read: Forget dividends, focus on buybacks)

According to Spin-Off Advisors, 2013 has seen 18 completed spin-offs so far, while more than 26 are on the dock.

What’s inside the ETF?

CSD tracks the Beacon Spin-off Index that includes companies that have been spun-off within the past 30 months but not more recently than six months prior to the applicable rebalancing date. Index constituents are primarily small- and mid-cap companies with capitalizations under $10 billion.

The product currently holds 27 securities in its basket, with an average market cap of just $5.9 million. (Read: Buy these uncorrelated ETFs in rocky markets)

The top holdings are Fortune Brands Home and Security, Exelis Inc., WPX Energy and Fiesta Restaurant Group. In terms of sector allocations, Energy (23.4%), Industrials (20.9%) and Consumer Discretionary (20.4%) occupy the top three spots.

The index is comprised of up to 40 highest-ranking stocks selected from a universe of spun-off companies, using a quantitative rules based methodology.  Each stock is given a modified market cap weighting with a maximum weight of 5%, resulting in a pretty diversified basket. The index is rebalanced semi- annually.

The product charges an expense ratio of 60 basis points annually. However investors should note that the volume is pretty light—just about 5,000 shares per day, which may result in wider bid-ask spreads.

CSD has outperformed the broader market significantly, with a 93.1% return over the past three years and 27.1% return year-to-date, versus 56.3% and 16.0% respectively for SPY.

Despite outperformance, the fund has not been very popular with investors and has managed to attract only $198 million is assets so far.

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