FNGS - FNGS: Mega-Cap Fund Up 40% This Year

2023-04-06 01:16:36 ET

Summary

• The MicroSectors FANG+ Exchange Traded Notes are linked to the performance of the NYSE FANG+ Index.
• FNGS gives you equal weighted exposure to the 10 largest technology and consumer discretionary equities (basically the FAANG cohort plus a couple of additions).
• The equity market recovery in 2023 has been concentrated on a handful of stocks only, with the tech mega-caps being the main beneficiaries.
• With the near bankruptcy of Credit Suisse, an investor needs to understand FNGS is an ETN, not an ETF, thus exposed to the credit risk posed by the Bank of Montreal.

Thesis

2023 has been an interesting year so far. With Q1 now behind us, there are a couple of interesting developments that occurred worth talking about.

• Firstly the market did not collapse to a new low as widely anticipated by Morgan Stanley's bear M. Wilson, but instead traded in a range. Money was wasted on puts that did not pay off
• Secondly the VIX is trading at shockingly low levels, having hugged the 20 handle repeatedly
• Thirdly, and more importantly, mega-caps are back in vogue, posting eye-watering results in an otherwise drab quarter

Each year as investors we should set ourselves performance targets and align our portfolios to take advantage of prevailing trends. We are fans of simplicity, and in many cases simple, well aligned portfolios outperform significantly long term. However, one must identify the correct trend. What outperformed in Q1 2023 is represented by the most popular mega-caps out there, namely the famous FAANG cohort:

As per its literature:

The MicroSectors™ FANG+™ Exchange Traded Notes ( FNGS ) are linked to the performance of the NYSE FANG+™ Index. The ETNs offer investors a return based on changes in the level of the NYSE FANG+™ Index, before taking into account fees.

And the index which is referenced is a very simple equal weighted one:

The NYSE FANG+™ Index includes 10 highly liquid stocks that represent a segment of the technology and consumer discretionary sectors consisting of highly-traded growth stocks of technology and tech-enabled companies. The index’s underlying composition is equally weighted across all stocks. While the performance of indices weighted by market capitalization can be dominated by a few of the largest stocks, an equal-weighting allows for a more representative portfolio.

In plain English, FNGS gives you equal weighted exposure to the 10 largest technology and consumer discretionary equities (basically the FAANG cohort plus a couple of additions). As we can see from the chart above the ETN is up over +40% this year, talking about an underling market theme seen so far in 2023: the re-emergence of the tech mega-caps as a safe harbor.

This year's rally has not been a broad one, with the twenty largest stocks driving pretty much the entire S&P 500 performance:

FNGS takes an even more concentrated position, focusing on the ten largest ones. As a reminder, FNGS is not leveraged, which makes its 2023 performance even more shocking.

Holdings

The fund holds only ten names:

We can clearly see the difference here between FNGS and a market weighted fund - FNGS assigns roughly a 10% weight to each of its constituents, whereas the S&P 500 is market weighted towards the stocks with the largest market value.

ETN vs. ETF

Before we get lost in the acronyms let us spell out what an ETN is and what it entails for an investor. ETN stands for Exchange Traded Note, and in effect FNGS is a bond issued by Bank of Montreal that gives an investor the stated returns. An ETN has inherently increased risk as compared to an ETF because it is not bankruptcy remote. An investor buying FNGS would be fully exposed to the credit risk posed by Bank of Montreal. And in an outside scenario where Bank of Montreal would be taken over by a regulator / experience a bankruptcy event, an investor in FNGS would become a creditor to the estate.

The most famous case of a bank bankruptcy is Lehman, and in effect there were a number of Lehman sponsored ETNs that serve a cautionary tale for ETN investors. Always ensure you understand the difference between an ETN and an ETF and be comfortable with the ultimate sponsor.

The best way to think about an ETN is that it is an actual funding vehicle for the underlying bank (Bank of Montreal) in this case, and the institution is packaging a certain return profile within its bond so that it can i) fund itself, ii) gain certain management fees from the vehicle.

Performance

The fund is up over 40% this year versus 7% for the S&P 500 and 2% for the equal weighted Invesco S&P 500 Equal Weight ETF ( RSP ):

To note though that nothing comes for free, with FNGS having had a very deep drawdown last year:

We can see FNGS having been down as much as -40% last year in October. That is almost double the drawdown we saw in the S&P 500 index. FNGS represents a very concentrated position in a handful of stocks.

FNGS did very well in the 2020/2021 zero rates environment when gamma squeezes on the large tech names were in vogue:

Conclusion

FNGS is a fund that gives you equal weighted exposure to the 10 largest technology and consumer discretionary equities (basically the FAANG cohort plus a couple of additions). The vehicle is up over +40% this year, versus just 7% for the S&P 500, talking about the very concentrated recovery in equities this year. Investors seem to be back in tech mega-caps seeking a safe harbor. As a reminder FNGS is an ETN, not an ETF, thus exposed to the credit risk posed by the Bank of Montreal. Nothing comes for free in finance, with FNGS having experienced a very deep drawdown in 2022, drawdown which reached -40% in October 2022. We feel most of the move is now done, but FNGS is a good instrument to keep in mind when trying to exploit themes around the tech mega-caps.

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