If there was one shiny object for investors over the past few years, it would have to be the metaverse.
What else could prompt the company formerly called Facebook to restructure and rebrand to Meta Platforms (META) and even strike a deal with an exchange-traded fund issuer to switch a fund ticker so it could complete the marketing blitz by trading as META? This rebrand occurred in June 2022, and by December of last year, META had realized a $700 billion decline in its market capitalization and, in February, announced it had burned through close to $14 billion in 2022 in its Reality Labs business. Since the October lows, the company has seen a double, even with the full-year earnings disclosure.
As the line goes, "I told you that story so I could tell you this one."
Sensing a shift in the tides for the metaverse and sidestepping an awful lot of carnage, iShares decided that the metaverse is now a place worthy of investors' love with the Valentine's day launch of the iShares Future Metaverse Tech and Communications ETF (IVRS) . The fund sports a 47-basis point expense ratio, so a shareholder with $1,000 invested over a calendar year would pay $4.70 over that period. The fund tracks the Morningstar Global Metaverse & Virtual Interaction Select Index. Let's see Morningstar goes about picking names for this index and ultimately, the fund.
Security Selection Process
As mentioned, IVRS is a passive fund that tracks a Morningstar index. The index methodology lays out what type of exposures Morningstar analysts are looking for, and are as follows:
Metaverse Platforms: Companies providing collaboration tools (commercial), and applications connecting consumers (retail)
Enhanced Social Media: Companies providing tools that allow users to create and consume content in a 3D environment
Immersive Gaming: Companies involved in software development and publishing, providing development tools, and video game hardware
3D Rendering and Simulation Software: Companies providing Computer Aided Design (CAD) tools for both consumer (entertainment) and corporate (training, education) oriented activities
Wearable Technology and Augmented and Virtual Reality: Companies providing Virtual Reality headsets, Augmented Reality devices (Apple iPhones and only iPhones mentioned specifically here)
Digital Assets and Payments: Companies providing digital payment platforms, blockchain technology as well as Cryptocurrencies themselves, including no-fungible tokens (NFTs)
Now that we know what they are looking for, what are the exposure criteria that will allow a company to make it into the index?
Morningstar uses a 0 to 4 grading scale where less than 10% revenue exposure gets a company a "0", 10% to 25% earns a "1", 25% tp 50% a "2". For revenue exposures greater than 50%, if the company is part of the metaverse supply chain, they receive a "3" and if they are a final goods or services producer, a rating of "4". Once these discrete scores for each exposure are determined, it gets interesting.
Tier 1 names are those that score at least "3" in any sub-theme and have a non-overlapping aggregate revenue exposure of at least 25%. Tier 2A names score "2" in any sub-theme but interestingly can accept a score of "0" when it comes to Metaverse Platforms. Tier 2B names are those "which are not in Tier 2A".
From these various categories, 50 names are selected with no set allocation between the tiers meaning if there are 50 qualifying names in Tier 1 then those will be the final constituents. Setting weights for the final index is fairly complicated once you get beyond the initial float-adjusted market capitalization allocation. Page 10 of the methodology has a full-page flow chart outlining the capping mechanism that follows.
Wrap It Up
If you're like me, you were reading through the security selection criteria, especially the 25% and 50% revenue exposure criteria, and thinking "what is this going to look like, QQQ (QQQ) ?" and you would have not been too far off that mark.
There are names that I like for this space, like Roblox (RBLX) , Autodesk (ADSK) , Unity Software (U) , PTC Inc. (PTC) , and ANSYS (ANSS) . Video game developers Take -Two Interactive Software (TTWO) , Electronic Arts (EA) , Activision Blizzard (ATVI) , and Ubisoft Entertainment (UBSFY) also make sense. Where I start to get lost is in names like Zoom Communications (ZM) , Sony (SONY) , Microsoft (MSFT) , Samsung (SSNLF) , Alphabet (GOOG) , (GOOGL) , Intel (INTC) , and Nvidia (NVDA) .
As I've said before, these head-scratchers are most likely good investments, but if you are looking to get targeted exposure to the metaverse, they just don't provide it. They may be meaningful to the metaverse but their exposure to the metaverse just isn't what's driving their top or bottom line. Will this portfolio do well over time? Probably. Will the catalyst for those returns be a resurgence of the development of the metaverse? It will play into it but from my perspective won't be the key driver.
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