2023-06-13 22:45:06 ET
Summary
- LOUP is a concentrated mix of top-growth global frontier tech names with cutting-edge products. It has no exposure to the $1 trillion league.
- LOUP has solid growth characteristics, with valuation expectedly stretched. Its quality is comparatively acceptable (while around 44% of the holdings are loss-making, only 13.4% are cash flow negative).
- It did not beat QQQ during the September 2018 - May 2023 period.
- Despite long-duration equities recovering amid the seemingly fading inflation, I still recommend paying due attention to valuation-related risks. And LOUP earns a Hold rating.
Continuing my series of articles discussing exchange-traded funds targeting the innovation and similar tech-heavy investment themes, today I would like to take a closer look at the Innovator Deepwater Frontier Tech ETF ( LOUP ), a relatively small concentrated play with just 30 equity holdings and approximately $40.4 million in assets under management, which is about a third of its pandemic-era peak level. The ETF was incepted in July 2018 and before April 2023 was known as Innovator Loup Frontier Tech ETF.
LOUP has what I would call an unapologetic growth investment philosophy with an ultra-minimalist, high-conviction approach to a global equity portfolio management. As it seems the market is already past peak skepticism, with bulls now in charge and the most recent U.S. inflation data looking supportive of more gains for stocks, it makes sense to consider buying into a portfolio with a weighted-average forward revenue growth rate of ~18.9%. However, there are additional factors on the valuation, quality, and FX risk fronts that investors should understand. I will give more color on that shortly.
As described in the prospectus , its strategy is based on the monthly rebalanced and reconstituted Deepwater Frontier Tech Index. The idea at its crux is to select developed and emerging market players "on the frontier of the development of new technologies that have the potential to have an outsized influence on the future." The sub-themes targeted stretch from artificial intelligence and robotics to augmented reality, etc. No less than half of revenues must be derived from a certain sub-theme to qualify for inclusion, unless a company's revenue and/or opex, and/or capex related to at least one sub-theme have risen by a quarter or even faster YoY in the most recent calendar year.
Revenue growth and revenue growth acceleration are both important parameters assessed, with stocks with top scores selected for inclusion, with a target being 30 constituents. The key five high-conviction names have their weights capped at 5% and other constituents have a 3% maximum weight.
As of June 11, Unity Software ( U ) was LOUP's main holding with a 5.6% weight. Though U's bottom line is swamped with red ink, its forward revenue growth rate of 32.2% easily explains why it has qualified for LOUP's portfolio of the worthiest tech stories. Other top five companies are shown below, with data from the fund and Seeking Alpha. For LG Energy Solution, which does not have an ADR, the data were pulled from its IR materials, with the market cap adjusted using the relevant KRW/USD exchange rate.
Quant data as of June 11 (The author's work with data from the fund, Seeking Alpha, and LG's reports)
Established in 2020, this Korean mega-cap name has likely qualified as a representative of the autonomous and electric vehicles sub-theme owing to its advanced automotive battery portfolio.
Unlike numerous innovation/disruption/tech ETFs that are NVIDIA ( NVDA ) heavy (AB Disruptors ETF ( FWD ) is one example ), due to the index setting the maximum market cap for potential constituents at $500 billion, LOUP currently has no exposure to this stock.
However, as the schedule of investments (as of 31 October 2022) on page 36 of the annual report illustrates, it held shares in this heavyweight GPU name in the past when it was valued less generously.
I completely understand the rationale behind ignoring the most expensive mega caps. The idea here is likely to make the mix growthier, tilted towards large caps with a stronger potential for future capital appreciation. However, there are downsides as well. With NVDA removed, it seems the fund missed out on a solid deal of its AI enthusiasm-related price gains. And another issue with its skepticism about over $500 billion companies is that it also misses out on the portion of Microsoft's ( MSFT ) future capital appreciation story connected to its AI pursuits.
Adequate quality and robust growth stories are expectedly not cheap
When looking inside an ETF portfolio, what I would like to understand in the first place is what growth prospects and quality profile its valuation reflects. The weighted-average earnings yield is an almost universal metric for equity ETF analysis and perhaps the simplest tool to assess all these factors quickly. Unfortunately, it is useless in the case of LOUP as my model returns a negative result, principally influenced by almost 44% of the holdings being loss-making, with ams-OSRAM AG ( AMSSY ), a Premstätten, Austria-based company being the primary detractor, with an EY of negative 31.9%.
ams-OSRAM has a leading position in the global optical solutions market with a focus on lighting and sensing technologies, with power management ICs, sensor interfaces, color light-emitting diodes (LEDs), infrared LEDs, etc., among the products it is offering for the consumer, industrial, automotive, and medical end-markets with unquestionably solid growth potential. The issue here is that it has seen revenue decline since the peak touched in September 2021, with softness in China's automotive market last year being one of the challenges impacting sales. Its margins were also under pressure; IFRS LTM net income is currently negative. On the positive side, its cash flow is still above zero, so we can value LOUP using the net cash flow yield. My calculations show it at ~4%, but please take notice that with over 32% of the holdings being non-U.S., IFRS cash reporting rules might artificially boost the yield as they allow to classify interest payments as financing activities, thus resulting in higher net CFFO.
Country allocation (innovatoretfs.com)
Still, juxtaposed with the tech sector's median of almost 5%, the CY looks bleak. Also, the weighted-average Price/Sales, a useful metric for high-growth but profitless companies, is at ~7.3x, which is evidently expensive. Besides, ~67% of the holdings have Quant Valuation grade of D+ or lower.
But this expensiveness comes with robust growth rates. EPS is forecast to grow at 11.4% portfolio-wise, but please remember loss-making companies do not contribute to this result. Regarding revenues, the table I created using pundits' estimates returns a 18.8% forward growth rate, with the major contributors presented below (Adyen's Amsterdam ticker was replaced with the ADR ( ADYEY )).
Quant data as of June 11 (The author's work with data from the fund and Seeking Alpha)
Performance analysis
During the September 2018 - May 2023 period, LOUP demonstrated a rather decent performance, with the compound annual growth rate ahead of ARKK (which had a much more challenging 2022 losing ~67% while LOUP was down by 46%) and XITK.
Portfolio | Innovator Deepwater Frontier Tech ETF ( LOUP ) | Invesco QQQ ETF ( QQQ ) | ARK Innovation ETF ( ARKK ) | SPDR FactSet Innovative Technology ETF ( XITK ) | iShares Core S&P 500 ETF ( IVV ) |
Initial Balance | $10,000 | $10,000 | $10,000 | $10,000 | $10,000 |
Final Balance | $13,887 | $19,255 | $8,650 | $11,853 | $15,620 |
CAGR | 7.16% | 14.79% | -3.01% | 3.64% | 9.84% |
Stdev | 31.69% | 22.75% | 41.83% | 28.78% | 19.01% |
Best Year | 86.25% | 48.40% | 152.82% | 90.22% | 31.25% |
Worst Year | -46.00% | -32.58% | -66.97% | -47.45% | -18.16% |
Max. Drawdown | -53.93% | -32.58% | -77.08% | -56.98% | -23.93% |
Sharpe Ratio | 0.33 | 0.66 | 0.1 | 0.21 | 0.51 |
Sortino Ratio | 0.49 | 1.03 | 0.15 | 0.32 | 0.76 |
Market Correlation | 0.85 | 0.92 | 0.77 | 0.78 | 1 |
Created by the author using data from Portfolio Visualizer
This year, LOUP has the second strongest price return in this group.
On the negative side, even though LOUP delivered a 86.3% total return in 2020 vs. QQQ's 48.4%, the Invesco fund still confidently outperformed all the selected ETFs during the September 2018 - May 2023 period, with the highest CAGR and the strongest risk-adjusted returns (Sharpe, Sortino ratios). Besides, the Innovator ETF underperformed the market represented by IVV, with the key reason being the S&P 500's value portion which allowed to avoid deeper losses.
Conclusion
LOUP is a concentrated mix of top-growth global frontier tech names with cutting-edge products. It has no exposure to the $1 trillion league, with the weighted-average market cap of the portfolio at ~$77.8 billion as of my analysis. At this juncture, the fund has solid growth characteristics, with valuation expectedly stretched. The portfolio's quality is comparatively acceptable (while around 44% of the holdings are loss-making, only 13.4% are cash flow negative).
In sum, despite long-duration equities recovering amid the seemingly fading inflation, I still recommend paying due attention to valuation-related risks. And LOUP earns a Hold rating.
For further details see:
LOUP: High-Conviction Growth Portfolio With Valuation Risks