U.S. stocks started this year on a weak note, with major indexes recording losses in the month of January but the situation has changed this month. With new signals from the Fed that the interest rate hike is not coming anytime soon and announcement of an aggressive stimulus by the ECB, stocks have marched to new highs. A resolution to the Greek debt crisis, albeit temporary, and some stability in the oil markets further aided the gains.
The background for stocks still remains positive as the U.S. economy looks set to gain momentum and central banks around the world continue to inject liquidity into the system in order to juice growth. While Greek bailout situation still remains challenging, the fact is due to many effective measures taken by the ECB since 2012, the Euro-zone is now in a much better position to weather the Greek storm.
At the same time, after almost seven years of bull-run, overall stock market gains are likely to be rather lackluster this year. We may however continue to see rotation from rate sensitive sectors like Utilities into economically sensitive sectors like Technology, if the economy continues to perk up.
In this market environment, investors could look at some of the innovative ETF launched very recently, that invest in disruptive technologies and have the potential to produce outsized returns. In fact, even though these were launched recently, they have already rewarded their early investors with market-beating returns. These could be held as satellite holdings in the portfolio, in order to spice up returns.
ALPS Medical Breakthroughs ETF (SBIO)
The fund tracks the Poliwogg Medical Breakthroughs Index. It invests mainly in mid and small cap stocks with market cap between $200 million and $5 billion. The index screens the U.S. listed biotech and pharma companies with one or more drugs in Phase II or Phase III FDA clinical trials. The index also screens for liquidity (average daily trading volume more than $1 million) and sustainability (cash for at least 2 years at their normal burn rate).
Per ALPS, due to “patent cliff”, many blockbuster drugs from the 1990s and 2000s have been losing patent protection and large drug companies are struggling to replenish their pipelines. Further, due to time-consuming procedure and an alarming rate of failure for drug development, the big/well-known companies normally rely on new therapies processed by smaller firms that spend a lot more on R&D compared to larger companies.
This fund holds 75 stocks with Akorn, Pacira Pharma and Seattle Genetics being the top 3 holdings. The product charges 50 bps in fees. Company specific risk is limited due to modified market cap weighting with maximum 4.5% of assets. It was launched on 12/31/14 and has surged almost 16% this year.
PureFunds Cyber Security ETF (HACK)
This ETF provides exposure to a diverse group of hardware and software companies in the cybersecurity industry. As our world is becoming increasingly digital, cyber security threats and cyber attacks are on the rise. Consequences of hacking can be huge and in most cases, the full extent of damage is almost impossible to be quantified and may not be known for many years.
The product charges an expense ratio of 75 basis points. It made its debut in November last year and has already managed to gain more than $320 million in assets, thanks mainly to some high profile cyber attacks of late.
The ETF holds 30 securities in its portfolio and is well spread out across holdings, with the top security assigned just 6.61% of total assets. CyberArk, Fireeye and Qualys are the top three holdings currently. The product is up about 18% since its inception.
ARK Web x.0 ETF (ARKW)
ARKW invests in companies that are expected to benefit from the shift of technology infrastructure from hardware and software to the cloud. These companies will primarily focus on areas like Cloud Computing, Wearable Technology, Big Data, Internet of Things, Social Media, Services and Data Mining and Digital Education. These disruptive technologies no doubt have immense growth potential in future.
The fund is actively managed and holds about 40–50 securities in its portfolio, with weighted average market cap of $80 billion, as of now. Netflix, Twitter and Athenahealth are the top three holdings currently.
The product is a bit expensive due to active management—charging 95 basis points in annual expenses. It has been able to justify its expenses so far, with about 12% return since its inception on 9/30/2014.
The Bottom-Line
The funds mentioned above are high-risk, high-reward plays and should be used as small holdings in the portfolio and also, investors should be prepared for likely higher volatility associated with these investments. However, given immense potential of unique, disruptive innovations that these ETFs focus on, they are definitely worthy of investors’ attention. Further, ETFs are a better way of investing in these potentially game-changing but risky areas.