Goats in benchmark clothing


VanEck lists two ETFs tracking Morningstar smart beta ETFs

VanEck is rolling out two new ETFs that gun after Morningstar’s proprietary indexes.

  • VanEck Vectors Morningstar Durable Dividend ETF (DURA)
  • VanEck Vectors Morningstar Global Wide Moat ETF (GOAT)

DURA will track the Morningstar US Dividend Valuation Index (which is different from the Morningstar US Dividend Growth Index – as tracked by iShares’ DGRO).

Morningstar picks companies with high dividend yields, strong financial health, and risk-adjusted valuation, the prospectus says. The index starts with every listed American and screens them for basic liquidity. The pool of eligible companies is then whittled down so as only to include:

(i)             the top 50% as by dividend yield;

(ii)            the top 50% of their peer group by its “distance to default score”;

(iii)          the top 70% of “Morningstar’s star score”.

“Distance to default” measures how likely a company is to run into trouble. Morningstar uses option pricing theory to evaluate the risk that the value of a company’s assets will turn out to be less than the sum of its liabilities, Morningstar says in the index factsheet.

Morningstar’s star score analyses companies’ fair value. Morningstar does this by getting its analysts to run discounted cash flow models in conjunction with qualitative assessments of companies moats.

Companies are then weighted based on “the available-dividend model”: where dividend per share is multiplied by the number of free float shares. “This retains the primary benefits of market-cap weighting (low turnover and scalable investment capacity), while also maximizing yield,” Morningstar says. No company can take more than 5% of the index’s weight.

As of June 30, 2018, there were 98 companies in the index, which rebalances twice a year. The fund will charge up to 0.38%. (Index factsheet here).


Analysis – Will VanEck’s GOAT eat grass?

If past experience is a guide, these Morningstar indexes will track be closet trackers. Morningstar already has dividend and wide moat indexes – both of which are tracked by ETFs (iShares DGRO, touched on above, and VanEck’s MOAT). DGRO is basically a carbon copy of the S&P 500, while MOAT, with its quality and blue-chip tilt, is a virtual copy of the Dow.

What was also curious for us while conducting the research for this piece was the contradictory index methodologies. DURA’s index methodology says that infrequent rebalancing (like market capitalisation weighted indexes) are great because they mean lower transaction costs. Meanwhile, GOAT’s index methodology says frequent rebalancing is great because it gives more opportunities to “hunt for bargains”. Presumably, these are either/or benefits.

We were also puzzled by using options pricing theory to investigate dividend robustness. This is not a strategy we’re familiar with. Andrew Lapthorne, arguably Europe’s top quant, suggests looking at balance sheet strength when looking at sustainable dividends. While most value managers we’ve spoken to suggest free cash flow. Morningstar’s analysts are doubtless better quants than we are. (That’s a low bar to clear). We’re also open to the fact that options prices can be proxies for other things. But we’d like to see the approach justified.

JPMorgan lists actively managed municipal bond ETFs

As part of its far-reaching ETF roll out, JP Morgan is listing a new actively managed municipal bond ETF that looks quite like an ETF version of its existing mutual fund. The JPMorgan Municipal ETF (JMUB) will invest in a portfolio of municipal bonds issued by local governments to raise money for various public and private purposes (building schools, etc.) JMUB will mostly invest in investment grade bonds, while up to 10% of the fund’s total assets may be invested in junk.

JP Morgan will use both top-down and bottom-up analyses to pick bonds. The fund will take a long-term value-oriented approach and look for bonds “it believes will perform well over market cycles”. The average dollar-weighted maturity of the Fund’s portfolio is expected to be between three and ten years. It will charge a maximum of 0.47%.

Analysis – rising rates; mutual fund fees

You can tell a good ETF prospectus because it teaches you things. Some of the things we learned from the JMUB prospectus include the risks of bond investing during times of rising rates. These include extension risk, “which is the risk that the expected maturity of [a bond] will lengthen… due to a decrease in prepayments. As a result… the Fund may exhibit additional volatility.”

As well as the (relatively) declining capacity of bond dealers’ to market make. This is because their market making capacity has not kept pace with the growth of the global bond market, meaning “liquidity and valuation risk may be magnified in a rising interest rate environment”.

If we had an issue with the fund it’s the performance and fees of the original mutual fund. According to JP Morgan’s website, the mutual fund version of this ETF charges a maximum of 1.04% (more than double the ETF). The high fee comes despite it getting trounced by its benchmark almost every year since inception. The good news is that with an ETF version, fees will be lower and the chance of beating the benchmark proportionately higher.