I've recently written about the trend of exchange-traded fund issuers launching funds with highly concentrated exposures. At the end of that article, I mentioned that I felt portfolios with five or six holdings might be too concentrated. To put it in slightly "quanty" terms, many traders are looking for that perfect high-variance trade but, long-term investors are, or at least should be, looking for something that isn't going to blow up their portfolio. Still, the market wants what the market wants, and the latest issuer to attempt to fill those high variance needs is none other than the bank that has lent a portion of its balance sheet to exchange-traded note (ETN) issuer MicroSectors, the Bank of Montreal (BMO) . Interestingly, it looks like BMO is starting to flex its muscles in the US marketplace with the launch of two new 3X levered products, four if you consider both the levered and inverse levered versions. Let's take a look.
Planes, Trains & Automobiles
Well, two out of three ain't bad, right? The strategies, launched June 23 and June 30 are the MAX Airlines 3X Leveraged ETNs (JETU) , (JETD) , and the MAX Auto Industry 3X Leveraged ETNs (CARU) , (CARD) . Both of these strategies track indexes provided by independent index provider Prime Indexes who in turn outsources the calculation and management of the indexes to Frankfurt-based Solactive.
The methodology guide for the Prime Airlines Index lays out the security selection criteria plainly, and while I have an idea as to why they have decided to exclude companies headquartered in China, I'm a little puzzled as to why Canadian companies are also excluded (maybe because of BMOs Investment Banking business?). One thing I find interesting about the approach here is that the index doesn't just focus on commercial airlines but also includes companies involved in aircraft and parts manufacturing (limited to the five largest by market capitalization) and companies providing air freight and logistics. These criteria produce a portfolio that has a large number of airlines including Delta (DAL) (9.54%), American Airlines (AAL) (9.09%), and United Airlines (UAL) (8.55%), as well as FedEx (FDX) (9.24%) and United Parcel Service (UPS) (8.70%), and names like General Electric (GE) (8.92%) and Honeywell International (HON) (8.77%) not to mention Raytheon (RTX) (8.55%), General Dynamics (GD) (6.48%) and Boeing (BA) (8.31%).
The portfolio provides broad-based exposure to all things airlines, but it got me thinking that perhaps, given the 3-times levered nature of the product, the underlying portfolio might be too diversified to produce the kind of volatility that will attract hard-core traders? Thinking more about it one thing that ties many of these names together is the cost of fuel so if traders are really looking for juice, wouldn't going for a three-times levered oil product help them cut to the chase? I'm not saying this product doesn't have a place for some traders but if you're looking for high-vol moves, there might be more attractive products out there.
The security selection criteria for CARU and CARD spelled out in the index methodology guide takes a similar widespread approach to the auto industry although the market capitalization requirements are higher ($1 billion vs $500 million) as is the liquidity threshold ($25 million average daily value of shares traded as compared to $10 million for airlines). Qualifying segments include "Automobile Manufacturing", "Automobile Parts and Retail", "New Car Dealers", and "Used Car Dealers." Top names include Ford (F) (11.81%), Tesla (TSLA) (11.69%), and Rivian Automotive (RIVN) (11.69%). Resellers Carvana (CVNA) (5.82%), CarMax (KMX) (3.91%), and AutoNation (AN) (2.72%) are also included, as are DIY auto repair companies AutoZone (AZO) (6.95%) and Advance Auto Parts (AAP) (5.00%). I guess I have the same volatility-themed thought here as well. If this was a buy-and-hold investment product, I'd say it does a great job capturing large, liquid names in this space. As a 3x levered trading vehicle, I'm not so sure, especially when you can trade products like Direxion's daily levered Tesla (TSLA) products (TSLL) , (TSLS) and get your dopamine hits and profits, hopefully, from Tesla's high volatility day to day moves.
Wrap It Up
My take on these products as you can tell from my comments is that they would be better suited as one-times long or one-times inverse buy-and-hold products, or both, than 3-times daily reset trading vehicles. Aside from the risks inherent in putting money into a daily reset 3-times leveraged product, don't forget that these ETNs are 20-year unsubordinated debt issuances from BMO. As such, they can be called away at the discretion of BMO if they feel the products represent too much risk on the bank's balance sheet. Another aspect of ETNs is that the issuer often acts as the lead market maker for any secondary trading of the notes which in itself isn't a huge flag but having a sole source of liquidity in a product can be problematic if and when things start to get hairy in the markets or for the bank as described in a piece I wrote about ETNs.
As with other products, I'm not trying to dissuade you from using these vehicles, but as I've said before, the more you know. You know?