PKW - PKW ETF: Limited Motivation To Go Long At This Juncture

2023-08-31 13:49:56 ET

Summary

• PKW tracks 315 US stocks that have effected a 5% net reduction in their shares outstanding over a 12-month period.
• We pick out some of the major themes that could weigh on PKW's prospects.
• The risk-reward on the charts does not look appealing.

ETF Profile

The Invesco BuyBack Achievers ETF ( PKW ) is a ~$1.8bn sized product that offers exposure to 315 odd stocks that have, over the past 12 months, effected a 5% net reduction in their shares outstanding. Since this is a modified market-weighted index, the tilting will inevitably be toward large-cap names.

Also note that unlike dividend track records which usually tend to be more reliable and definitive, these companies' buyback plans are typically quite capricious and are dependent on so many factors. This could involve gauging what the price and valuation quotient looks like, the level of free cash flow generation at any point in time, the M&A pipeline, regulatory restrictions, etc. Investors are also typically more forgiving when companies curtail their buyback plans (compared to a cut in dividends) and thus it is also less common to find a plethora of names that maintain a relentless quarterly track record of buying back shares over time.

In effect, what this also means is that PKW is likely to be susceptible to a lot of churn on an annual basis (the index is evaluated annually every Jan). Indeed, data from the prospectus points to some rather elevated turnover rates over the last 5 years. For context, the average turnover ratio of your average ETF is only 31%, but for PKW over the last 5 years, it has worked out 73% on average, meaning over 7 out of 10 stocks get turned over every other year. It is what it is, but a high turnover rate certainly doesn’t make this a very efficient product from a transaction charges perspective.

Separately, also note that PKW’s expense ratio is hardly cheap, at 0.62%, around 15bps higher than the industry (ex-Vanguard) average. If one includes Vanguard products which are the gold standard when it comes to cost efficiency, the overall industry differential versus PKW could be even wider.

Breaking Down The Key Cogs of PKW

Our current stance on PKW is quite mixed (with a negative bias) as we see some conflicting sub-plots that could tilt things either way.

Firstly, from a style viewpoint, it’s worth considering that this ETF is more oriented towards value plays rather than growth plays.

If you’ve followed our work over time, you'd note that we're always on the lookout for potential mean-reversion themes that look oversold at any point in time. Well in that regard, it's fair to say that the current value to growth positioning in the market bodes well for PKW's prospects. The image below highlights how value looked roughly on par with growth at the start of the year (close to the mid-point of the long-term range), but once again, that ratio has collapsed, opening up the opportunity for another mean-reversion trade in favor of the value theme.

Conversely, one other theme that could work against PKW is its low exposure to small-caps (small-caps only account for 17% of the portfolio whereas large-caps account for 45%). The image below highlights how overbought large-caps look relative to small-caps with the ratio currently at record highs and a long way off the mid-point of the long-term range.

With large caps looking so overextended, you're also looking at a fairly elevated valuation backdrop. The S&P500 is currently priced at an elevated P/E of 20.7x , translating to a 49% premium to the corresponding multiple of small caps. Now with the valuation picture already so high, corporations might feel less motivated to engage in buybacks.

So far, the pace of aggregate buybacks in 2023 may have given the impression that we could outpace the record highs (looking back to annual buyback data from 2007 , shows that this year could be the second highest on record), and that may well happen with 4 months still to go, but investors would do well to consider the outlook over the medium term.

Our primary concern revolves around US banks which have historically been the main drivers of the whole buyback theme. In keeping with their ambitions to get banks closer to the Basel III framework, the FDIC is currently driving an agenda that will require banks to keep more cash in hand, limiting the excess cash that could be deployed via buybacks. A study by Bloomberg estimates that these developments could wipe out close to $118bn of excess capital from these banks!

Besides banks, PKW is also keenly exposed to consumer cyclical stocks (23% exposure), whose outlook isn’t the most resplendent either. The trend of retail sales may suggest that everything is hunky dory with the US consumer, but we’d urge investors to track the rising delinquencies on store cards (the delinquent payers' share is now at 38% , up by 1500bps YoY) which traditionally have proven to be one of the early indicators of stress in the retail sector

Closing Thoughts

When we view PKW’s standalone weekly chart as well, we don’t feel too chuffed about staging an entry at this juncture. The price imprints over the past year and a half show us that historically whenever PKW hits the $93 mark and attempts to cross it, there tends to be an overdose of supply (yellow highlighted areas), preventing further momentum. The ETF may eventually break past this barrier, but given the historical track record, we think investors would have been better served entering somewhere closer to the upward sloping support (the black line). At current levels, we don't believe the reward to risk is too appealing.

Finally, even from a yield angle, there is no great incentive to rotate into PKW as its current yield is pretty much in line with what you normally get (1.18%).

For further details see: