GURU - GURU: Equally Weighted Hedge Fund Darlings Underperform

2023-06-28 11:53:16 ET

Summary

• GURU is a passively managed, U.S.-focused ETF offering exposure to hedge fund darlings weighted equally.
• The GURU portfolio has seen a few meaningful changes since April 6. The equity basket has become leaner, with minor improvements on EPS growth and quality fronts.
• Its performance is mostly a disappointment. This year, it has been recovering at a glacial pace, underperforming IVV again.
• Factor exposure changes are insufficient for a more bullish take, in my view. The Hold rating is maintained.

Hedge funds might be associated with leading research expertise, timely trades, and steady, consistently above-market returns. But I see two meaningful issues here. First, certainly not all institutional players systematically beat the market, and oftentimes they get the market direction ghastly wrong. And second, passive ETF strategies designed to benefit from the insights of institutional players using the famous Form 13F reports and achieve alpha by betting on hedge-fund darlings mostly underperform in the long run. One of the examples is the Global X Guru Index ETF (GURU), a fund I previously covered in April.

The fund's investment mandate since its inception in June 2012 is to track the equal-weighted Solactive Guru Index that follows a quarterly rebalancing schedule. The idea behind this benchmark is to represent a cohort of high-conviction hedge-fund U.S. picks selected using the Form 13F reports. As mentioned in the index methodology summary , the group of institutional asset managers is constructed using Morningstar's hedge-fund list among others. For potential constituents, there are listing, market cap, and liquidity eligibility criteria. More details on the methodology can be found in the respective documents on the GURU website .

Today, I would like to provide an overview of GURU's portfolio changes since the previous note. I will also discuss its performance to elaborate on why I am still struggling to find an adequate reason to upgrade this vehicle to a Buy.

How has the GURU portfolio changed?

Looking under the hood, the GURU portfolio has seen a few meaningful changes since April 6. In short, the equity basket has become leaner, with minor improvements on EPS growth and quality fronts.

More specifically, the portfolio has only 64 equities now vs. 71 in April as ten names accounting for almost 16% (as of June 17) were added, with the most notable being NVIDIA (NVDA), accounting for 2.1%. Small wonder it qualified for inclusion as heavyweight institutional managers were attempting to benefit from the AI hype that has catapulted its stock price this year. Another info tech hedge-fund darling also potentially with an AI ingredient in its valuation that was added to the basket is Workday (WDAY), accounting for 1.8%.

Did that result in profound shifts in sector and factor exposure? The balance changed, but only a little.

1. Regarding the sector mix, consumer discretionary players have replaced healthcare as a main allocation with a 16% weight. Healthcare, in turn, retreated to second place, partly owing to institutional players becoming more skeptical about UnitedHealth Group ( UNH ) and the pandemic era star Moderna ( MRNA ), with both removed from GURU as a consequence. Industrials replaced IT as the third largest sector group, with Rentokil Initial ( RTO ) (1.4% weight) being among main representatives.
2. GURU's weighted-average market cap has risen by more than $10 billion to $170.5 billion, as per my estimates. NVDA, the $1 trillion league debutant, is obviously the most prominent contributor.
3. With this GPU name and seemingly the major generative artificial intelligence beneficiary trading at almost 39x Price/Sales, which evidently carries an enormous AI premium, no coincidence the fund's weighted-average ratio has increased by ~13.4% to 6.45x. To contextualize, Snowflake ( SNOW ), the third most expensive stock on a P/S basis in the GURU portfolio, is forecast to deliver a 44.1% forward revenue growth rate while trading with only a 24x P/S; NVDA's forward rate is forecast at 24.6% .
4. Marginal compression in the earnings yield by 20 bps to 5.2% is also worth mentioning. Anyway, GURU is still priced at a discount to the S&P 500, which offers an EY of ~4.4%. In the previous note, I mentioned Chesapeake Energy ( CHK ), Hertz Global ( HTZ ), and Avis Budget ( CAR ) as the principal contributors to this yield, which has not changed. However, Rivian ( RIVN ) and Rocket Pharmaceuticals ( RCKT ) are no longer the most remarkable detractors as the fund removed them from the basket; Ascendis Pharma ( ASND ) and International Flavors & Fragrances ( IFF ) now have the weakest EYs, in the negative low double digits.
5. GURU has become modestly heavier in stocks that are trading at a premium to their sectors and historical averages as 62.5% now have a Quant Valuation rating of D+ or worse vs. 58.2% previously.
6. Minor changes in portfolio-wide growth rates are observable as well. The forward EPS rate is approaching 14% vs. 12% previously, while forward sales are now anticipated to grow by 13.2% vs. 14.4% in April.
7. Quality has improved, with over 80% of the net assets now allocated to companies with a B- Quant Profitability rating or higher, a more than 6% increase, with Salesforce ( CRM ) and Sanofi ( SNY ) that were added since April being among the major contributors. The minor disappointment is that Return on Assets remains rather subdued at 5.2% despite a 1% improvement from the April level.

Final thoughts

In the previous article, I said that index-based equity strategies designed to benefit from hedge fund equity research expertise "are more of a damp squib," with the culprits being "weighting and timing issues." I have little to add here as my opinion has not changed. The Form 13F report certainly contains a great deal of hedge-fund wisdom. But to achieve alpha, investing in equally-weighted market darlings found in these filings is simply not enough, even with the asset size and turnover filters applied during the screening process.

In fact, there is a significant gap between expectations and reality as GURU has been unable to keep pace with the market proxied iShares Core S&P 500 ETF ( IVV ) since its inception, let alone the Invesco QQQ ETF ( QQQ ). To corroborate, below is the comparison of their returns over the July 2012 - May 2023 period.

Data from Portfolio Visualizer

In fairness, GURU did spectacularly in 2020, but during the capital rotation of 2021 and the interest rates-driven bear market of 2022, its performance was lackluster, which is reflected in the CAGR above. Another issue is the ETF's 75 bps expense ratio that ate into the total returns.

Data from Portfolio Visualizer

Interestingly, its peer Goldman Sachs Hedge Industry VIP ETF ( GVIP ) did much better during the December 2016 - May 2023 period (incepted in November 2016), yet it also failed to beat IVV or QQQ.

Data from Portfolio Visualizer

Though with seemingly similar methodologies, I suppose it is worth noting that my calculations show the GVIP/GURU holdings overlap is at ~29%, which means only 18 holdings from the GVIP basket are present in GURU, including NVDA and WDAY.

Interestingly, the GURU fund not only bore the brunt of the market sell-off in 2022, but also has been recovering at a rather glacial pace this year, in contrast to GVIP. And it has underperformed the S&P 500 index since my April note as well.

Besides, factor exposure changes are insufficient for a more bullish take in my view. In sum, the Hold rating is maintained.

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