2023-05-27 01:36:40 ET
Summary
- I would like to provide the sentiment update on RYJ, a quasi-actively managed fairly expensive high-turnover fund I previously covered in March, with an overall skeptical tone.
- Despite meaningful changes in the mix and the fact that RYJ has underperformed the S&P 500 by ~12% since previous coverage, there is no reason to upgrade it.
- Valuation still does not appeal to me, even though I should acknowledge that the abating inflation narrative has rendered multiples less relevant than last year.
- Although portfolio-wise quality is not outright terrible, the share of cash-burning companies of ~17% is not the one I would tolerate.
Today I would like to provide the sentiment update on the Invesco Raymond James SB-1 Equity ETF ( RYJ ), a quasi-actively managed fairly expensive high-turnover fund I previously covered in March, with an overall skeptical tone. The essential reasons undergirding my skepticism were 1) mixed past performance, the fund being unable to beat the iShares Core S&P 500 ETF ( IVV ) over certain periods, 2) the burdensome expense ratio of 81 bps that would look justified in case RYJ has had much stronger performance, and 3) the portfolio being burdened by mid-size stocks with lofty valuations, a questionable combination, to say the least.
To recap, according to the RYJ website , the fund's strategy is centered on tracking the Raymond James SB-1 Equity Index, which is composed of the U.S. listed names boasting a Strong Buy rating from that Raymond James & Associates, Inc. For more details, I recommend reading the prospectus.
Seeking Alpha
There are a few reasons why I call this strategy 'quasi-active.' Let me quote the previous note:
This high-turnover strategy falls into the quasi-active category in my personal classification due to the fact that 1) its constituents are hand-picked and 2) it is rebalanced semi-monthly as noted on the RYJ website.
In my view, despite meaningful changes in securities mix and the fact that RYJ has underperformed the S&P 500 by about 12% since the previous coverage, which could have been supportive of valuations inside the portfolio normalizing or at least not becoming not that outright bloated (more on that shortly), alas, a strong enough reason to upgrade it to a Buy has not emerged yet. Valuation still does not appeal to me (even though I should acknowledge that the abating inflation narrative has rendered multiples less relevant than last year), and although portfolio-wise quality is not outright awful, the share of cash-burning companies approaching 17% is not a one I would tolerate.
Now let me discuss in greater depth what was summarized above.
Delving deeper into portfolio mix: Valuation deteriorated, quality remains mediocre
As of May 24, RYJ was long 185 common stocks, ADRs, REITs, and units (there are currencies and a taxable money market fund in this portfolio as well), which represents an increase from the March 2 level of 176 names. Small wonder for a fund tracking an index rebalanced every two weeks.
More specifically, the current version contains 25 newcomers with a combined weight of ~13.8%; the 16 holdings that dropped from the Strong Buy list and were ousted from the fund accounted for ~8.8% as of March 2. I believe the most notable on that list are Seagen ( SGEN ), Radius Global Infrastructure ( RADI ), and CubeSmart ( CUBE ) which had 66 bps, 65 bps, and 63 bps weight, respectively.
Rebalancing resulted in minor changes in the sector mix, with, for example, energy gaining about 1.5% and consumer discretionary losing close to 2%.
The full list of additions is presented below. As it can be seen, most newcomers are from the energy (6 stocks, 3.33% weight) and financial (also 6 stocks, but ~3.34% weight) sectors; the latter might be the consequence of Raymond James analysts seeing more opportunities in the sector amid the banking crisis (which appeared to be mild for now) which took its toll also on a few names that are much more resilient than traders were suggesting, making them underpriced and thus alluring.
Holding | Ticker | Sector | Weight |
Advanced Micro Devices Inc | ( AMD ) | Information Technology | 0.66% |
Comerica Inc | ( CMA ) | Financials | 0.59% |
Wells Fargo & Co | ( WFC ) | Financials | 0.59% |
NVIDIA Corp | ( NVDA ) | Information Technology | 0.58% |
AeroVironment Inc | ( AVAV ) | Industrials | 0.58% |
Plains All American Pipeline LP | ( PAA ) | Energy | 0.57% |
Plains GP Holdings LP | ( PAGP ) | Energy | 0.57% |
Columbia Banking System Inc | ( COLB ) | Financials | 0.57% |
New York Community Bancorp Inc | ( NYCB ) | Financials | 0.57% |
Select Water Solutions Inc | ( WTTR ) | Energy | 0.57% |
Capri Holdings Ltd | ( CPRI ) | Consumer Discretionary | 0.56% |
Relay Therapeutics Inc | ( RLAY ) | Health Care | 0.56% |
Alaska Air Group Inc | ( ALK ) | Industrials | 0.56% |
Atlas Energy Solutions Inc | ( AESI ) | Energy | 0.55% |
Ciena Corp | ( CIEN ) | Information Technology | 0.55% |
Primerica Inc | ( PRI ) | Financials | 0.54% |
Weatherford International PLC | ( WFRD ) | Energy | 0.54% |
UnitedHealth Group Inc | ( UNH ) | Health Care | 0.53% |
DexCom Inc | ( DXCM ) | Health Care | 0.53% |
Dyne Therapeutics Inc | ( DYN ) | Health Care | 0.53% |
The Cigna Group | ( CI ) | Health Care | 0.52% |
TXO Partners LP | ( TXO ) | Energy | 0.52% |
Extra Space Storage Inc | ( EXR ) | Real Estate | 0.52% |
AlTi Global Inc | ( ALTI ) | Financials | 0.47% |
Frontier Communications Parent Inc | ( FYBR ) | Communication Services | 0.43% |
Created by the author using data from Invesco
Since the previous coverage, despite the fund performing poorly, the weighted-average market capitalization has risen to ~$26 billion from almost $20 billion, while the earnings yield has declined a few bps to 1.89%, as per my estimates (the data as of May 25). My dear readers might justly point out here that capitalizing on value in the current market conditions is a losing strategy, and the value/quality mixes (i.e., high-profitability stocks with a margin of safety) are no longer the top priority, better to be replaced by quality growth or even quality-agnostic growth mixes as the inflation worries are no longer contributing to the theoretical cost of capital investors are pricing in and, as a consequence, growth premia are gradually becoming fatter across the board, even with a recession looming on the horizon.
Here, I would concur, but only partly.
- First, an ~53x weighted-average P/E should be supported by outstanding, stellar portfolio-wise growth profile, and even though, precisely like in March, there is a solid share of companies with forward revenue growth rate of no less than 20% (over 24% now vs. about 26% previously), weighted-average figures look robust, but not exceptional, with WA forward revenue at 14%. Also, the P/E is influenced by a large group of unprofitable players.
- Second, stocks looking undervalued from a Quant perspective (a Quant Valuation grade of B- and higher) account for only around 27% (25% in March).
- Third, I am of the opinion there is always an elevated risk inherent to expensive low-quality mixes regardless of the market environment. I fully understand that the reasons behind an SB rating might stretch a long way beyond multiples, margins, returns on capital, etc. As I surmised in the previous note, the analyst team might have an entirely different opinion on a company's intrinsic value, while catalysts might be factored in as well. Nevertheless, my opinion here is that in terms of the profitability factor, RYJ's basket does not look like the one shielded from strife in case a recession will dent risk appetite. The problem here is that only 61% of the holdings have a B- Quant Profitability rating or higher (slightly below 64% as of the previous note); this is acceptable but not ideal, especially considering over a quarter of the holdings are struggling to turn even a microscopic profit. EBITDA perspective offers little solace as ~12.7% has that figure also negative. Biotech stocks represent a lion's share of those on that troubled list. Similarly, they also account for the bulk of those incapable of delivering positive net operating cash flow.
- Besides, the quality problem is aggravated by the fact that WA Return on Equity, as per my analysis, is just 8.9%, while Return on Assets is negative 20 bps (5.5% and 10 bps as of the previous note).
As a minor remark, amongst 21 healthcare stocks that were both in the May and March versions of the portfolio that I analyzed, the median one-month price return is negative 3.2% as 14 stocks have been struggling seriously, with the worst-performing name being Avidity Biosciences ( RNA ). Yet it should be noted that in fairness, analysts correctly identified robust winners as well, with Blueprint Medicines ( BPMC ) that gained about 21% in a month and over 23.9% since the beginning of the year being the principal name worth mentioning.
A fresh look at performance numbers
In my March note, I warned that RYJ's ebullient start to 2023 is hardly a justification for a bullish thesis. The chart below perfectly encapsulates what happened next.
The following table provides an updated view on RYJ's performance compared to the previous note, with the period covered being October 2008 - April 2023 (October 2008 - February 2023 previously). The reason why I use this period is because "the Guggenheim predecessor fund acquired the Claymore/Raymond James SB-1 Equity Fund" in September 2008 as clarified in the fact sheet. Here, it is benchmarked against IVV and the SPDR S&P MidCap 400 ETF Trust ( MDY ).
Portfolio | RYJ | IVV | MDY |
Initial Balance | $10,000 | $10,000 | $10,000 |
Final Balance | $40,063 | $47,620 | $41,376 |
CAGR | 9.98% | 11.30% | 10.23% |
Stdev | 22.28% | 16.06% | 19.07% |
Best Year | 56.34% | 32.30% | 37.58% |
Worst Year | -28.41% | -22.10% | -25.85% |
Max. Drawdown | -40.79% | -35.99% | -37.33% |
Sharpe Ratio | 0.51 | 0.71 | 0.57 |
Sortino Ratio | 0.75 | 1.06 | 0.84 |
Market Correlation | 0.92 | 1 | 0.96 |
Created by the author using data from Portfolio Visualizer
As it can be seen, the compound annual growth rate and risk-adjusted return (Sharpe, Sortino ratios) were the lowest, while the standard deviation was the highest.
Final thoughts
In summary, I am not a huge believer in quasi-active high-turnover ETF strategies as they typically lag the market despite being alluring upon cursory inspection. RYJ is hardly an exception as its past performance and current factor exposure are simply unconvincing. The fund holds a few stocks I would personally consider rather promising at this point, like Copa Holdings ( CPA ) or Wabash National Corporation ( WNC ) that possess both value and quality characteristics, but this alone certainly does not make the entire basket worth investing in. That is to say, this time, I would again opt for a conservative Hold rating.
For further details see:
RYJ: Overcrowded By Low-Quality Stocks, With Unrealistic Valuations Being A Risk