LBAY - LBAY: An ETF Unicorn Worth Knowing About

Summary

• LBAY is an ETF unicorn of sorts: it is an actively-managed, long-short ETF.
• LBAY focuses on being long stocks with high shareholder yield, and short stocks that its managers think are overpriced.
• I rate LBAY a Hold when looking at it in isolation, but acknowledge that it may have immediate viability as a role player in a broader portfolio.

by Rob Isbitts

Leatherback Long/Short Alt Yield ETF ( LBAY ) is one of the more unique ETFs around. That said, it does not run a unique strategy. However, it has brought to the ETF world something more commonly found in hedge funds and mutual funds. Namely, an actively-managed long-short strategy.

The ETF structure allows investors to see the managers' holdings on a daily basis, which has long been taboo in the hedge fund world. Fortunately, LBAY is more than just a rare structure for an ETF. It has performed. And, more important than its past performance is how it goes about generating that performance.

As a big part of the Modern Income Investor mission is to shine the spotlight on smaller ETFs that we think are worth a look, LBAY is now well into the "reviewable zone" for me. And I like what I see, just as I did a while back when it was only trading "by appointment" as the old Wall Street saying goes. We are adding it to our "undiscovered ETFs" watchlist and initiating our coverage of LBAY with a Hold rating. That said, while there may be some near-term headwinds, this ETF looks intriguing as a role player in a broader portfolio, as its methodology may represent a nice complement to a more traditional equity portfolio.

Strategy

LBAY is basically a long-short hedge fund in an ETF wrapper. Its goal is a combination of growth of principal and income, but it also emphasizes downside protection, using the short side of the portfolio and some covered call premium income to pursue this.

LBAY is actively-managed, not based on tracking a specific index, as is the case with the vast majority of ETFs. It invests in 2 primary ways under 1 roof:

1. Long positions in common stocks (and occasionally bonds or preferred stocks) that the managers think offer long-term "shareholder yield" (a combination of dividend payments, share buybacks and debt paydowns).

2. Short positions in stocks that the managers expect to decline in price.

LBAY aims to operate in a net exposure range (long exposure minus short exposure) of 75% - 110% long.

ETF Grades

• Offense/Defense: Offense

• Segment: Tactical

• Sub-Segment: Long-Short

Technical Ratings

• Short-Term (next 3 months): D

• Long-Term (next 12 months): D

Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor

For a detailed description of MII's proprietary technical rating system, see disclosures at bottom of this report.

Holding Analysis

With an actively-managed ETF like this one, analyzing holdings can be more of a moving target than with a low-turnover, automated, quarterly-rebalanced, annually-reconstituted index ETF. That said, the 73% historical turnover rate means that enough stays in place here to get a sense of what the managers are trying to do. Currently, the sector mix is anything but mundane, with Technology stocks at only about 3%, Financials accounting for the largest portion (19%) Healthcare at 15%, and Basic Materials, Consumer Discretionary and Consumer Cyclicals all weighted around 10-11%. That is a very un-S&P 500-like weighting, which fits with LBAY's largely go-anywhere approach within the equity market, at least within the mid-cap and larger company size. At the time of this writing, there were 35 long positions and 20 short positions. The longs accounted for about 122% of assets, and the shorts about 33%, putting LBAY at around 90% net long. There was a cash position of about 10%. This appears to be a fairly typical allocation, at a high level, based on the fund's net long range.

Strengths

I could take the easy way out and try to make a case for LBAY due to its strong performance, especially since the assets under management increased a year ago. Below is a chart of LBAY versus the SPY ETF. That is pretty dramatic outperformance, and it has a lot to do with how well the short side of the portfolio did in 2022's bear market. But it also has a lot to do with the low-tech allocation on the long side.

But as noted above, LBAY's past performance proves only that it did well last year, and not that it can do well in the future. The only thing we can guarantee about past performance of any ETF is this: unless you owned it in the past, you can't go back and get that performance. It is in the past!

So, while I'm happy to see that LBAY has shown potential to make money when most are not, my growing enthusiasm for this ETF is about its approach and structure. The long-short style appeals to me, and it appears that the short side of the portfolio tends to be dominated by some very over-hyped stocks. The way markets work today, when bubbly stock market segments fall, those declines can quickly take on a crash-like tone. That can potentially make the short side act as a bigger hedge to the larger long portion of this ETF. The bottom-line: outcomes like LBAY delivered in 2022. So, past performance is nice, but more importantly, the pairing of high shareholder yield stocks with overvalued, over-hyped short positions is what makes LBAY one to watch.

Weaknesses

The problem with markets these days is that they have this terrible habit of suspending reality. In other words, stocks that have no reason to be bid up, and up, and up, can stay up much longer than fundamental analysis would suggest. That can hurt LBAY both ways, as the short side of the portfolio melts down while the long side gains, but not vigorously, given that higher-quality stocks tend to be de-emphasized in the most "FOMO"-driven markets.

Opportunities

I have tracked this ETF from a distance since it was first launched in late 2020. My own history as a professional investor is in a related style, and so when I look for ETFs to invest in, I tend to look in some obscure places. A year ago, LBAY was about as obscure as it gets. A year ago, it had amassed only about $7mm in AUM. But the past year has seen a surge in assets to just about the $100mm mark as of this writing (see chart below). That makes LBAY a viable consideration.

Furthermore, the current chaotic equity market environment is likely to provide an opportunity to use this strategy either tactically or as an "alternative allocation" within a larger portfolio.

Threats

The current stock market is a threat to any strategy that includes stocks. That is, the combination of Fed-obsession, meme stocks, algorithmic trading and all of the new factors that make this "not your parents' stock market" are the biggest concerns any investor should have about an ETF like LBAY that aims to deliver a long-short portfolio based on what reasonably should happen: fundamentally-strong businesses that do well by their shareholders via strong shareholder yield are rewarded, while "zombie" companies that survive only on their ability to borrow more (i.e. increase or roll over their debt obligations) hang in for longer than Freddy Krueger of horror film fame. Will 2023 be more like 2022, when rationality won out, or more like 2021, when meme stocks were king? We'll see.

Conclusions

ETF Quality Opinion

LBAY has my attention. I will be tracking it closely. Fortunately, unlike hedge funds and hedged mutual funds, this hedged equity ETF discloses its holdings daily. So investors can watch and analyze on a daily basis if they wish.

ETF Investment Opinion

I rate LBAY a Hold for now, when looking at it the way I do in all of my ETF profiles on Seeking Alpha. That is, I am viewing it in isolation, not as part of a broader portfolio I might construct and manage. LBAY has appeal as a "role player" in a broader ETF portfolio, where that role is to add a non-traditional element that can capitalize on a variety of market conditions, not simply a bull market or bear market rally.

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