INVESTOR UPDATE | US Industry ETF Themes

As at the end of December 2021, the US industry or thematic ETF market was valued at US$836 billion with inflows totaling $107 billion. Industry ETFs represent about 15% of all US equity ETFs ($5,568 bn). Equity ETF inflows for 2021 were a record US$635bn.


The total universe of industry ETF includes around 345 names, excluding leveraged and short strategy EFTs. The technology sector commands the largest position with a market value of approximately $240 billion (29% of the total industry ETF market) and over 50 ETFs. Healthcare ETFs are valued at $106bn (12% of total) and includes 35 names. All sectors, with exception of consumer staples experienced inflows. The financial sector received the largest inflows as a percentage of assets with $23bn directed towards this sector. Materials also received large inflows (16% of total flows).


The average PE multiple (trailing) for all industry ETFs is 22x and the average dividend yield is 1.1% which is not excessive given current bond yields (US 10-year bond 1.40%). REITs (33x) and technology (28x) command the highest multiples. Value sectors continue to be materials (15x) and financials (14x).



TECHNOLOGY

The technology sector includes industries such as semiconductors, cloud services, AI & robotics, software, cybersecurity. Semiconductor ETFs were the top performers driven by strong industry demand in areas such as automotive applications (particularly EVs which are chip intensive), the stay-at-home economy driving demand for laptops and upgrading to 5G devices and IoT. The global chip shortage has resulted in industry players committing to major capital programs and investment by the big players including the likes of Intel, Taiwan Semiconductors, AMD in chip (FAB) plants which will exceed $300bn. We retain our exposure to this industry, which in the past has exhibited cyclical traits but is benefitting today from strong secular tail winds.


Cybersecurity ETFs have also performed strongly as growth in the stay-at-home economy and the shift to cloud centric software security and major ransomware attacks (eg Colonial Pipelines attack) has driven exceptional growth demand for cyber software. We remain very comfortable with the prospects for this US$110 billion industry as the secular drivers such as the shift to cloud and edge computing will require companies and institutions to allocate a greater portion of their IT spend to cybersecurity and governments face increased threats from Nation State attacks. As economies recover post covid, IT spend should also accelerate providing further impetus.


The wooden spoon in the tech sector went to the Chinese technology ETFs with the biggest ETF (KWEB) almost halving since the start of 2021. The larger technology companies – Ali Baba, Tencent, Didi, Baidu all faced greater scrutiny under Premier Xi Jingping’s more interventionist government. The shut-down of the for-profit education industry, the pulling of the AliPay IPO, limitations imposed on mobile gaming activity, significant fines placed on some of the Chinese tech giants and the likely de-listing of Didi (the Uber of China) from the NYSE after only six months of trading have crushed investor sentiment towards China tech.


SELECTED TECHNOLOGY ETFS

HEALTHCARE

industries within the healthcare sector include medical devices, pharmaceuticals, biotechnology, healthcare services and genomics. Cannabis ETFs are also included in this sector.


In 2021 the performance of the various industry ETFs was mixed. The biggest ETF is the broad health care index XLV ($33bn) which increased in value by 23%. Health care services (IHF) also performed strongly rising 22%. Genomic ETFs such as IDNA had a strong first half driven by growth in mRNA stocks but slipped in the second half of 2021. Biotech and cannabis ETFs were the worst performing ETFs - POTX declined 35% and ARKG -33%.


We increased our position in healthcare adding a broad healthcare ETF (VHT) to our holding in medical devices (IHI). We expect hospital admissions to increase as the pandemic subsides driven by a backlog in elective and other critical procedures. We are also encouraged by the development of new treatments and in particular the launch of new anti-viral drugs targeting covid strains (eg Pfizer’s Paxlovid).


SELECTED HEALTHCARE ETFS

FINANCIALS

The financial sector includes retail & commercial banks, investment banks, asset managers, credit cards, payments and insurance. XLF is the largest ETF (market value $43bn). The sector experienced $23bn of positive funds flow in 2021. Financial ETFs benefitted from macro tailwinds of rising inflation, expectations of monetary policy tightening (reduced QE and rate increases) and expanded fiscal programs caused by the pandemic which limited the bad debt cycle.


We expect a gradual increase in Interest rates over the next couple of years, improving loan growth from a very low base as economies recover and a continued relatively benign bad debt cycle. That should benefit both Insurance and Banks and offset some of the structural and competitive issues we see for the sector longer term. Additionally, investment banks (IAI) benefitted from booming equity raisings (via SPACS) and increase M&A activity.


The biggest financials EFT the XLF appreciated 38% in 2021. The worst performed financial ETFs were in the fintech space (FINX). Including payment services companies, Block (previously Square) and PayPal which downgraded expectations and regulators starting investigations into the burgeoning BNPL (Buy Now Pay Later) segment.


SELECTED FINANCIAL ETFS

INDUSTRIALS

The largest industrial ETF is the XLI which appreciated 18% in 2021. This ETF covers a broad collection of industries including aerospace and defense, transport, building and infrastructure, industrial products, water and environmental services, capital equipment and robotics.


Looking across these industries, the standout performers were construction & infrastructure (PAVE +33%), transport (XTN +29%) and water (FIW +29%) which benefitted from the expected enactment of the $2 trillion Built Back Better bill in the US and growth in parcel volumes from the stay-at-home economy. Laggards were aerospace & defense & robotics (ITA +6%) and (BOTZ +9%). Medium term we expect areas like Robotics and Ai to grow as manufactures continue to onshore, data becomes even more important and for them to remain competitive.


SELECTED INDUSTRIAL ETFS

COMMUNICATION SERVICES

Industries captured under this sector include telecommunications, social and traditional media, film/television and video streaming. The XLC ($14bn) is the largest ETF in this sector and includes companies such as Alphabet, Meta (previously Facebook) and Disney. After a strong first half performance, the XLC slipped in the second half to end up 14%. Social media companies experienced strong growth in revenue per user and the growth in video streaming, but social media faced increased regulatory scrutiny following a whistleblower event. In addition, significant investment (more than $10bn) by social media giant, Meta into metaverse applications spooked investors. The telecommunication ETFs lagged (IYZ +7%).


SELECTED COMMUNICATION ETFS

CONSUMER DISCRETIONARY

This is a sizeable sector ($43b) and includes gaming, sports betting, traditional and on-line retailing (Amazon), automotive (Tesla), home improvement. XLY is the biggest ETF ($23bn) and has a large holding in TSLA. This ETF appreciated 26% in 2021 in part benefitting from Tesla’s inclusion whose shares rose 45%. On-line retailing, video gaming and home improvement activity have all benefitted from remote working and growth in the stay-at-home economy. Gaming ETFs suffered from restrictions of gaming activity imposed by the Chinese government and large China based e-commerce companies such as Ali Baba which was also adversely affected by new regulations in China.


It is an interesting sector given the diversity of choice available. We are excited by prospects longer term for electric vehicles as an example however cautious about prospects for individual electric vehicle manufactures given valuations and so would prefer to get exposure to the growth via other sectors like semiconductors which stand to benefit enormously. We are also very interested in Travel and Travel related services which have recently taken a hit with the emergence of the Omicron variant which will profit from pent up demand as borders and economies reopen.


SELECTED CONSUMER DISCRETIONARY ETFs

CONSUMER STAPLES

This sector includes food & beverages (eg Pepsi), consumer goods (P&G, Nestle) and grocery retailers (Walmart, Costco). The largest ETF, the XLP ($13bn) underperformed the broader market despite rising 11%. However, with equity markets experiencing higher volatility in Q4 and growth stocks falling on the prospects of higher interest rates, there was a noticeable up-tick in the sector’s performance late in the year as investor strategies became more defensive.


SPDR CONSUMER STAPLES ETF

MATERIALS

This highly diverse set of mostly extractive industries including precious metals, base metals, steel, timber and agriculture. GDX (Van Eck Vectors Gold Miners) is the largest ETF in this sector ($13bn) and, reflecting a soft gold price, the ETF fell 14% over 2021. The broad materials ETF, the XLB appreciated 23%. The top performing ETFs were URA (uranium miners) rose 59% and REMX (rare earths, lithium miners) rose 74%. Silver and gold ETFs were off between 15% to 30%.


SELECTED MATERIALS ETFs

ENERGY

This sector encompasses oil & gas producers, coal, clean energy (solar, wind). The largest ETF – the XLE ($25b) experienced strong inflows ($4bn) and appreciated a healthy 50%, much in line with the rise in oil prices (+50%). Clean energy ETFs – the star performers in 2020, gave up more than 25%. Renewable energy, batteries and battery storage remain firmly on our radar.


SELECTED ENERGY ETFS

UTILITIES, INFRASTRUCTURE & REITS

Energy utilities, toll roads, airports and pipelines are the main industries represented by this sector. XLU is the largest ETF ($13b) which rose 15%. GRID a clean energy, smart grid ETF was the standout performer, rising 30%. Real estate investment trust (REIT) ETFs is a sizeable sector ($92bn) with VNQ the dominant ETF ($47bn). REIT ETFs experienced a strong rerating, with VNQ appreciating 35%. It is worth noting that the VNQ is only 12% above its prepandemic levels, compared to the MSCI (ACWI ETF) which is 26% higher than pre-pandemic levels. We note that low bond yields have supported inflows into high yield or income related sectors such as REITs and banks.


REITS & UTILITIES

LARGEST INDUSTRY ETFS BY SECTOR


THE PORTFOLIO

Sector Exposure (December, 2021)

Individual Look Through Stock Exposure (December, 2021)





















The Strategy

The Eight Bays Global ETF strategy is a portfolio of Exchange Traded Funds (ETFs) designed to complement domestic equity portfolios by investing in global growth industries and equities not available on the ASX. Due to the depth and liquidity of the US ETF market, we invest only in ETFs listed on US exchanges. The portfolio has a bias towards industry ETFs with sound growth prospects and attractive structural characteristics. The portfolio holds between 5 and 15 ETFs at any given time with a maximum cash weighting of 20%.


Investment Philosophy

We believe that industry factors are the primary driver of shareholder value over the longer term. Industry dynamics such as growth rates, fragmentation, concentration, disruptive forces and regulation are the major drivers of equity performance. We believe the most cost-effective way to invest in attractive industries is via an appropriate ETF.


Portfolio Guidelines










EQT Eight Bays Global Fund

The EQT Eight Bays Global Fund can be accessed by visiting the following websites: https://www.eightbays.com/invest

www.eqt.com.au/eightbay


DISCLAIMER : This report is intended as a source of information only. No reader should act on any matter without first obtaining professional advice which takes into acount an individual’s specific objectives and financial situation.

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