I've written about funds from Harbor Capital recently and another new launch caught my eye: The April 26 launch of the Harbor Small Cap Explorer ETF (QWST) . While the fund is benchmarked to the small-cap Russell 2000 index, it is not a passive product. Further, it is also not advised by just one firm but by five.
The five subadvisors for QWST include Connacht Asset Management ($95 million in assets under management), Copeland Capital Management ($4 billion in AUM), Granahan Investment Management ($3.3 billion in AUM, Huber Capital Management ($416.6 million AUM), and Reinhart Partners ($1.6 billion in AUM). Each subadvisor has its own distinct investment style and will act independently from the other subadvisors but will be focused on the small-cap equity space as defined. Generally, account minimums for these firms are $1 million, although Copeland Capital requires at least $250,000 and Huber Capital minimums are set at $20 million for all strategies. Let's take a look at how Harbor Capital has structured this fund.
A Fund Called QWST
As the fund is actively managed, let's take a look at the Summary Prospectus to find out about the security selection process. The prospectus outlines that the selection universe is defined by companies that have a market capitalization based on the range of capitalizations found in the Russell 2500 index, excluding the top 250 names by market cap. The document states that as of March 15 "that range was $3.96 million to $6.03 billion." I pulled down the holdings for the iShares Russell 2500 ETF (SMMD) and, based on those holdings, the upper end of that range has moved a little, to $6.3 billion. Imagine my surprise when I saw that just over 19% of QWST was allocated to names with market capitalizations greater than $6.3 billion, with the largest names including Northrup Grumman (NOC) ($70 billion), FedEx (FDX) ($58 billion), Truist Financial Corp (TFC) ($42 billion) and 55 others that exceed this threshold. Now, per the letter of the Securities and Exchange Commission's so-called "Name Rule," this and any other fund is permitted to invest up to 20% of a fund's assets away from the fund's stated investment exposure so no harm, no foul. That being said, this new information got me thinking about the $4 billion capacity claim made on the issuer's website.
Given the current holdings, if the fund had $4 billion in assets under management, it would on average own 0.78% of each of its 250 holdings with the highest being Carter Bancshares (CARE) as the fund would own 6.46% of shares outstanding. If I restrict the holdings to those under the $6.3 billion threshold, the fund would own 8.14% of Carter Bancshares and there would be three more companies that the fund would hold more than 5% of outstanding shares. The average shares held in all holdings would increase to 1.22%. In reality, those 55 names would be replaced with other conforming names and the figures I calculated would not be as egregious, but you get the idea.
While it may seem like I'm taking this fund to the woodshed, it's not my intent. In the same way that I often write about thematic products that say one thing and do another, I'm applying that discipline here.
This active multi-manager approach is one that I first saw used by Krane Shares (before it became the Krane Shares we know today) more than a decade ago and was presented as a solution to have an actively managed ETF and still protect managers' intellectual property by combining all manager positions into a single portfolio. It made sense to me then and still does now. I would just like this fund a lot more if its contents matched the packaging.
Wrap It Up
The last article I wrote had a section about issuer conflicts of interest that I thought was interesting and perhaps unique. As it turns out, I was only half right. After doing some more checking, I found that just about any fund that involves a separate account manager has these types of caveats and this fund is no exception. This fund's conflict of interest disclosure regarding Advisor relationships includes accounts that generate more fees, either because they are much larger than the fund's managed sleeve or are bespoke such that the account charged fees are higher than the sub-advised fund sleeve. Other conflicts may include the timing of the delivery of model trading signals and when various parties may start acting on those signals. The whole section in the statement of additional information (SAI) is an interesting read and I suggest you review it before making any decision to invest in this or any other ETF that is launched by or utilizes asset managers that also manage assets other than those associated with the ETF.
Again, the goal here is to educate investors about how funds work as well as give them insight into what exposures they may be in store for after putting their money to work.
