Many of the exchange-traded funds I review are on the cutting edge of investing trends and product design.
These products either have unique views on the market, or incorporate derivatives in innovative ways, providing investing products to retail investors that were previously only available to high, and ultra-high net worth individuals and institutions. Today, I'm going to take a look at a new fund that doesn't do any of that.
Global X is an issuer that has made a strong name for itself in the thematic investing space. Aside from some individual country funds like Nigeria, Portugal, Vietnam and Norway, Global X has never dabbled in strategies that are not thematic or that are not option overlay income plays -- until now.
Go With The (Cash) Flow
July 10 saw the launch of the strong ticker game Global X U.S. Cash Flow Kings 100 ETF (FLOW) . Despite falling into what would have been deemed a "Smart Beta"-type strategy, the firm has set the expense ratio for this fund at a mere 25 basis points (bps), so $1,000 invested over a calendar year would see $2.50 of that principle go to fees. As an aside, I find 25 bps an interesting price point because FLOW is an alpha-seeking strategy, which usually will come in north of 50 bps. But Global X is positioning this as a core holding (think S&P ETF (SPY) replacement), which you can get for 9.45 bps or cheaper, like the Vanguard 500 Index Fund ETF's (VOO) 3 bps fee. My point here is if they can convince investors to switch core positions to FLOW, there's a lot of potential assets under management in those two funds alone (almost $760 billion), so even convincing 1% to switch sees FLOW becoming a $7.6 billion fund. At 25 bps, that would mean $19 million in revenue, maybe $17 million to $18 million in profit after fund expenses and marketing. To be clear, this is the logic that every issuer uses to help justify the launch of funds that look to disrupt entrenched market leaders. I'm not saying they will or won't be successful, but there's a reason why they refer to assets like these as "sticky."
Like many good investment strategies, this approach is simple and laid out plainly in the fund name. While there are complex indexes out there the index that underlies this fund, the Global X U.S. Cash Flow Kings 100 Index, is not. The methodology guide spells out the security selection criteria as starting with the Mirae Asset US 1000 Index (Global X owner Mirae's answer to the Russell 1000 index), filtering out companies with negative Free Cash Flow (FCF) , and then ranking the remaining names on FCF Yield. This metric is calculated by dividing the trailing 12-month FCF by the current company enterprise value (EV). EV is defined as the current fully diluted market value plus total debt outstanding, less any cash and cash equivalents. The top 100 names are selected, with the limits on individual position size (2%), and overall sector (25%). In both cases, any excess weight is allocated on a pro-rata basis to names/sectors that are still below their respective cap. One point about the starting universe is that per the methodology, Financials are excluded. Real estate investment trusts (REITs) are included.
Current portfolio holdings include a number of familiar and diverse names including Builders FirstSource (BLDR) (2.25%), VMware (VMW) (2.17%), CVS Health Corp (CVS) (2.02%), Altria Group (MO) (1.99%), and Marathon Petroleum (MPC) (1.95%).
Wrap It Up
Overall, I like the back-to-basics approach here with FLOW. If you want to get a more in-depth explanation of the rationale for focusing on FCF, Global X does a good job laying it all out in this insights article about the strategy. Seeing as this is a U.S.-focused product, I would expect to see other versions (Europe, Asia, and world-wide) offered if this first product is successful. As we start to move on from the recent period of yet another narrowly focused rally, my take is that a traditional fundamental approach to evaluating companies will be beneficial to investors as we transition to the next part of the economic cycle. To paraphrase Warren Buffet, if the tide is indeed going out, we will be seeing who has been swimming naked, and hopefully, they're not any companies held in your portfolio.