QTUM - QTUM: A Quantum-Focused ETF With Powerful Optionality

2024-01-18 08:07:32 ET

Summary

• Quantum computing is a nascent field with substantial funding for existing projects as well as applications on the horizon.
• McKinsey's 2023 Technology Trends Outlook predicts growth in job postings and equity investments in quantum computing.
• The Defiance Quantum ETF (QTUM) provides exposure to companies benefiting from quantum computing and has performed well compared to the tech sector as a whole.

For those of us who aren’t so knowledgeable about the world of emerging technology, quantum computing might sound like a sci-fi buzzword. The reality is that while this is an extremely nascent field, quantum computers already exist, funding is being allocated for more research and development, and new applications are being explored. When there is the possibility for a new technology or disruptor to be profitable, typically a way to invest in it emerges. The Defiance Quantum ETF ( QTUM ) is exactly that, and even though the tech sector has just experienced a massive run-up, QTUM does enough in a novel and successful way for us to rate it a buy.

Become Familiar With an Unfamiliar Technology

Here’s a quick overview on quantum computing: Traditional computers hold data in bits, which is information stored as either a zero or one, but quantum computing uses quantum bits (qubits), which can store both zeros and ones simultaneously.

This new data structure effectively allows computers to process certain kinds of data wildly faster than traditional machines. Case in point: According to a 2019 CNN article , Google ( GOOGL ) announced that its quantum computer solved a problem in 200 seconds, something that would take a classic computer 10,000 years.

As we continue moving into a future of increasingly big data (cloud computing, AI applications, machine learning, and other applications that work with massive data sets), novel ways to process data quickly and more cheaply will naturally be of interest to all those involved. Quantum computing could potentially deliver on this and much more, and attention to the field is slowly growing. See the chart below which illustrates this magnitude of growth.

Quantum computing cracked the top 15 of McKinsey’s Technology Trends Outlook ( McKinsey Technology Trends Outlook 2023 ), showing a 12% increase in job postings and $2B in equity investment happening in 2022. While job postings show solid growth on a percent basis, the base numbers are quite low and progress in the field is still fairly slow. McKinsey estimates that by 2030, only 2000-5000 quantum computers will be operational. However, many large names like Google ( GOOG ), IBM ( IBM ), Amazon ( AMZN ), Microsoft ( MSFT ), and Intel ( INTC ), as well as newer, targeted start-ups are pushing development forward as interest in the space steadily ticks up.

Key Fund Attributes

The QTUM ETF is managed to track its underlying index, the BlueStar Quantum Computing and Machine Learning Index. Since quantum computing is a fairly small space, the index smartly doesn’t limit itself to pure play companies that produce quantum computers. Its scope is widened to include businesses that can benefit from the adoption of quantum computing and its applications, and as such provides exposure to names associated with machine learning, cloud computing, and other transformative computing technologies. Fund holdings such as Nvidia ( NVDA ), Advanced Micro Devices ( AMD ), Nokia Corp ( NOK ), Lockheed Martin ( LMT ), Honeywell ( HON ), and others are all examples of "pick and shovel" companies that will profit if quantum computing technology takes off.

Another interesting point is that the index, and therefore the ETF, are constructed to be equally weighted. The top ten of the 70 holdings make up about 17% of the total allocation. See the chart below for a breakdown of the top ten stocks.

The ETF construction slightly adjusts the final distribution based on liquidity to give less liquid equities a slightly lower allocation. The index is rules-based, and prerequisites for inclusion are: the stock is involved in quantum computing or adjacent businesses, has a market cap of at least $150M, a three-month average daily trading volume of $1M, and at least 250K shares traded per month.

Quantum Tech VS Big Tech

Since its inception, the ETF has kept pace with the QQQ, and recent metrics are favorable as well, especially the P/E ratio:

There are a couple of interesting observations here. First is the similarity in returns, even though the indices are radically different in both construction and composition. Second is that although 30% of QTUM's assets are in mid and small-cap companies, the standard deviation and maximum drawdown are almost the same as the QQQ ETF ( QQQ ).

It is worth pointing out that the standard deviation has recently converged, but looking at the value over time shows they generally move in tandem. And finally, the P/E ratio suggests that the fund is quite a bargain for the amount of earnings generated. All three of these points help us build confidence that QTUM is attractive on a risk-reward basis.

Looking Toward a Quantum Future

The real kicker, however, is the fact that QTUM has performed on par with the tech sector before quantum computing has even fully taken off. It has managed to generate returns without the same allocation to the larger and more expensive names in tech, all while holding on to its optionality. If quantum computing starts seeing faster growth, investment, and profitability, QTUM is in a prime position to reap the benefits.

Naturally, the primary risk we’re assuming in any quantum computing investment is that the sector doesn’t become crucial enough in its industry, or that our bet on a fledgling technology is too premature to make gains in a reasonable amount of time. While it’s incredibly difficult to predict the exact trajectory of quantum tech, we have seen QTUM's resilience in the current environment where quantum is not a dominating force.

Overall, QTUM's characteristics make it an attractive fund. It has thus far produced respectable returns, its equally-weighted portfolio gives meaningful exposure to a wider range of names, and its P/E suggests it is trading at a relative bargain compared to the tech sector as a whole. All of the above gives us the confidence to rate QTUM as a buy, especially as a great way to express a long-term bet that quantum computing is on its way to becoming a key part of the tech space.

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