GURU - GURU: Promising Strategy Delivers Uninspiring Returns

2023-04-11 05:13:52 ET

Summary

• GURU is a passively-managed fund offering exposure to a basket of hedge-fund darlings picked from the 13F filings.
• Despite having a robust start, GURU has underperformed both IVV and QQQ since July 2012, with 2022 being especially sluggish.
• Thanks to equal weighting, GURU's portfolio currently has more or less adequate value exposure, which, unfortunately, comes with questionable quality; however, there is something to appreciate about its growth characteristics.
• Assuming burdensome fees of 75 bps and soft past performance, I believe the Hold rating should be appropriate.

Global X Guru Index ETF ( GURU ) is a passively-managed fund offering exposure to a basket of hedge-fund darlings picked from the Form 13F reports, which institutional managers with AUM of no less than $100 million must file on a quarterly basis.

Utilizing unique stock ideas of hedge funds is a promising strategy, but the reality is more of a disappointment as since its inception, the ETF has underperformed the market represented by the iShares Core S&P 500 ETF ( IVV ), let alone the growthier Invesco QQQ ETF ( QQQ ) that was much racier during the 2010s bull market. And 2022 was a mere calamity for GURU as it underperformed IVV by almost 10%.

Most likely, rather burdensome fees of 75 bps also ate into the total returns. Besides, the chronic underperformance might have something to do with the index's equal weighting schema and perhaps other index-specific issues. Interestingly, its peer Goldman Sachs Hedge Industry VIP ETF ( GVIP ), which also tracks an equally-weighted index, has delivered much more inspiring returns since its inception in November 2016, with one of the contributors likely being its more concentrated approach (i.e., 47 holdings in the current portfolio vs. GURU's 71).

Overall, due to the disadvantages, I would opt for a neutral stance today.

A quick strategy overview

The quarterly-rebalanced, equally-weighted Solactive Guru Index is at the crux of GURU's strategy. As described in the fact sheet available on its website , the index includes major "U.S. listed equity positions reported on Form 13F by a select group of entities that Solactive AG characterizes as hedge funds." These institutional investment managers "are selected from a pool of thousands of privately offered pooled investment vehicles based on the size of their reported equity holdings and the efficacy of replicating their publicly disclosed positions." Importantly, funds that "have high turnover rates for equity holdings" are crossed off the list using what the fact sheet describes as "additional filters." The selection process has a few other nuances; more specifically:

Only hedge funds with concentrated top holdings are included in the selection process. Once the hedge fund pool has been determined, the Index Provider utilizes 13F filings to compile the top stock holding from each of these hedge funds. The stocks are screened for liquidity and equal weighted.

For more details, I recommend reading the prospectus and other documents on GURU's website.

GURU's bleak performance reveals vulnerabilities

Incepted in June 2012, GURU ETF had a rather strong start, for example, outperforming IVV during the last six months of 2012 by almost 11% and by 15% in 2013 but it clearly lost steam closer to the middle of the previous decade, with most recent periods like 2022 and the first three full months of 2023 being totally lackluster. The table below covers the July 2012 - March 2023 period.

Created by the author using data from Portfolio Visualizer

As it can be seen, the compound annual growth rate of the GURU ETF is almost 4% lower than IVV's.

It is also of note that during the December 2016 - March 2023 period, GVIP beat GURU by over 3%; anyway, it still trailed IVV.

Created by the author using data from Portfolio Visualizer

What is inside at the moment? Taking a closer look at the factors

As of April 6, GURU had a portfolio of 71 hedge-fund darlings, with the key ten accounting for a modest 16.9% owing to equal weighting of the Solactive index. Healthcare, consumer discretionary, and IT were its favorite sectors, with 19.9%, 15.5%, and 7.6% weights, respectively.

Speaking about the weighting schema, this is something I believe investors should pay more attention to instead of focusing solely on the fact that GURU invests in stocks hedge funds are bullish on.

First, despite the fact that the ETF holds three $1 trillion league members like Apple ( AAPL ), Microsoft ( MSFT ), and Alphabet ( GOOG ), also having exposure to 14 companies valued at more than $100 billion, its weighted-average market capitalization has not become too bloated, currently standing at ~$160.7 billion, as per my calculations, as equal weighting secured a more balanced mix, with about 26% of the net assets allocated to mid and small caps.

As a consequence, the fund's portfolio currently has more or less adequate value exposure, which, unfortunately, comes with questionable quality; however, there is something to appreciate about its growth characteristics.

• First, the earnings yield is at ~5.4%, as per my calculations, which is higher compared to the S&P 500's ~4.8% (a P/E of 20.76x as shown on the SPDR Portfolio S&P 500 ETF ( SPLG ) website ). Please take note that the principal contributors to that result are Chesapeake Energy ( CHK ), Hertz Global ( HTZ ), and Avis Budget ( CAR ), with CAR's EY being as high as 32%. However, with a WA Price/Sales of 5.7x and over 58% of the holdings having a D+ Quant Valuation grade and lower, I would not say the portfolio is valued attractively.
• Second, despite having solid exposure to the large-cap echelon, the quality characteristics of this fund are overall uninspiring, at least for my taste. The share of holdings with a B- Quant Profitability grade or better is about 74%, a level more common among ETFs focusing on mid caps. Next, almost a fifth of the net assets are allocated to unprofitable names, which is exacerbated by about 16% outspending their net operating cash flows. Besides, the weighted-average Return on Assets is weak at 4.2%, while Return on Equity of about 15% (solidly influenced by a few biotech names like Cytokinetics ( CYTK ) which has an ROE of ~572% below zero) is also disappointing.
• And third, there is something to like on the growth side, as the EPS and revenue growth rates of ~12% and ~14.4%, respectively, are fairly adequate.

Nevertheless, the figures discussed above are mostly the consequence of weighting, with titans like AAPL having a contribution similar to mid caps like Golar LNG ( GLNG ). For better context, I have created two theoretical models with GURU's holdings re-weighted. The first one is based on a traditional market-cap approach (no sector constraints, etc.), the second one caps the weights of the three most expensive holdings (AAPL, MSFT, and GOOG) at 10%, with the excess weight distributed equally among the remaining 68 stocks.

Computed by the author using financial data from Seeking Alpha

Computed by the author using financial data from Seeking Alpha

As can be seen above, in both theoretical models, market-cap weighting secured much stronger quality (e.g., much higher ROE and ROA), yet value and growth exposure have both become smaller due to the fact the $1 trillion league members are all priced for perfection while their revenue and earnings growth rates are only modest.

Investor Takeaway

In sum, I believe passive equity strategies capitalizing on stocks popular with institutional managers are more of a damp squib. The most likely reasons for that might be weighting and timing issues. Overall, assuming burdensome fees of 75 bps and soft past performance, GURU is a Hold at best.

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