Investment idea generation.

Blog

Our thoughts.

Playing The Spinoff Boom: ETF Edition

Sign up for the daily activist investing newsletter to stay in the know.

Forget Stodgy S&P 500 Index Funds, This New ETF is Poised to Crush Them by TMFDeeJ aka Jason Knapp 

There's two main types of investors in this world, active and passive.  Active investors mile myself seek out individual companies that they believe are going to outperform the overall market.  Passive investors usually stick their money in some sort of index fund, the most popular of which mirror the performance of the S&P 500 Index.  From time to time, I have had excess cash sitting around that I do not have a specific idea that I want to put it in.  When that happens, as long as I have ample cash in reserve, I take some of my money and place it in an index fund as well.  My fund of chose has never been an S&P 500 index fund, however.  I have been using an ETF called the Guggenheim Spin-Off ETF $CSD.

I first came across $CSD back in mid-2010.  As a special situation investor, the idea of an ETF that only invested in spinoffs intrigued me.  I have had money in the fund on and off since then, but I continue to own it in my on-line special situation investing portfolio to see how it performs.  Since I bought it there in June of 2015, $CSD has outperformed the S&P 500 by +55.42%, +151.65% to +96.23%.  That's some pretty impressive outperformance.

Having said that, a couple of things about the Guggenheim Spin-Off ETF have always bothered me.  I believe that there is an inherent flaw in the index that prevents it from performing even better than it does.  According to the description of $CSD on Guggenheim's website:

"The universe of companies eligible for inclusion in the Index includes companies that have been spun-off within the past 30 months (but not more recently than six months prior to the applicable rebalancing date), without limitations on market capitalization (including micro-cap securities), but which are primarily small- and mid-cap companies with capitalizations under $10 billion."

The ETF does not purchase shares of spun-off companies until at least six months after they have become independent public companies.  The theory behind this rule makes sense, but I believe that it is outdated.  Traditionally, the prices of shares of spun-off companies often drop in the first few weeks of their independence.  There are a number of reasons why this has happened in the past, often spinoffs are too small for shareholders of the parent to bother with so they sell them, index funds often dump their shares because the new companies should not be included in them, etc...  However, as someone who has been following special situations and spinoffs for a number of years, I now strongly believe that the days of indiscriminate selloffs of spun-off companies are usually long gone.  Time and time again I keep an eye on the shares of spinoffs, hoping to swoop in and pick up shares on the cheap after a selloff and time again I have been disappointed.  If anything, in today's market the shares of spun-off companies actually seem to perform fairly well.  So if $CSD is waiting six months to purchase a stake in spun-off companies, the ETF is likely missing out on some significant potential gains.

This week, I heard about a new spin-off ETF that is about to come to market that may fix the inherent flaws that $CSD has: Van Eck Global Launches Market Vectors® Global Spin-Off ETF $SPUN.

This new ETF, with the very appropriate ticker $SPUN, is designed to mirror the performance of the Horizon Kinetics Global Spin-Off Index. For those of you who are not familiar with Horizon Kinetics, the company is a well-respected investment boutique with a rich history of following special situations. The performance of the Horizon Kinetics Global Spin-Off Index since inception is impressive. 

Since inception, the fund has significantly outperformed both the S&P 500, MSCI World Index and $CSD, returning an annualized 25.0% over the past three years, 19.8% over the past 5 years and 15.5% since its creation in January 2004.

The new $SPUN ETF will add the shares of companies more quickly than $CSD.  According to a recent interview with Ryan Casey and Salvator Tiano from Horizon Kinetics (link):

"The holding period of our Index is five years, starting with the first quarter after a company is separated. We add them right away because we have found, based on our research, that the first year of life as an independent company has, on average, been the best year for a spun off company. We hold it for the following five years because we see a long-term fundamental improvement story that plays out over at least five years, and we also want exposures in years three, four, and five to get whatever premium may come from M&A activity."

It also appears as though $SPUN will have more international exposure than $CSD:

"On average over the past twelve years, international spin-offs in developed Europe and developed Asia have comprised approximately 30% to 40% of global spin-offs. Currently that number is lower, closer to 20%, mainly due to the elevated spin-off activity in the U.S. since late 2013 and 2014. Adding international spin-offs to a portfolio of U.S. spin-offs may provide valuable diversification. Some investors consider international diversification as the only real diversification, not just by sector or market cap, but rather by country as certain countries may experience bad economic environments, whereas others may be growing rapidly during the same time. In addition to that, the activity and the volume of spin-offs can differ from time to time and by country. Currently you may see lower spin-off activity in the international space while we see a record amount of spin-offs in the U.S. A few years from now, we may, for example, experience higher spin-off activity internationally, making up for lower spin-off activity domestically."

Investors who are looking for a passive way to outperform the markets can't go wrong with either, $SPUN or $CSD, but it certainly looks as though the new Horizon Kinetics ETF will perform better.  That's where I plan to put my extra cash in the future.

For more special situation investing ideas like this, make sure to click on the "Join Group" button at the top of my page.  Doing so enables you to opt to receive automatic e-mails whenever I write about an investment idea.  Even better, I'd love it if we can create a community of like-minded special situation investors who share ideas amongst each other.