Q2’s Best and Worst ETF Investment Themes

What do you think is the best performing US listed ETF so far in Q2 2018? The answer is the ProShares UltraShort MSCI Brazil Fund (BZQ), up 63% in the quarter. Makes sense: a levered (2x) negative play on equities in an emerging market should be doing well just now. Just don’t look at the long-term track record on BZQ; it is down 90% from the start of 2016. Remember, it is a levered product and resets daily…

Since there are now over 2,100 exchanged traded funds available to US investors with every imaginable index-able strategy, scanning their performance is a good way to assess the current market mood. Being short Brazilian equities with daily leverage this quarter hasn’t just been a “Good idea”. It has been the single BEST theme around.

Take away all those ETFs that use leverage (which distorts compounded returns), and here are the quarter-to-date winners:

Up +20% for Q2 2018-to-date:

  • 3 ETFs that focus on the US Energy Sector: PXE (+24.7%), FTXN (+24.2%), and PSCE (+22.2%). Worth noting – the last one, the Invesco S&P Small Cap Energy ETF, is simply the Energy component in the S&P 600 Small Cap Index.
  • 1 ETF that goes short US stock volatility: XIVH (+21.1%).

There are also 18 ETFs up between 15-20% for Q2 2018-to-date, where the following themes are working:

  • MLP Exposure: BMLP (+17.7%), IMLP (+15.9%), AMZA (15.6%), YMLI (+15.5%). All have clearly benefited from higher energy prices.
  • Select commodity plays: Uranium (Global X Uranium ETF, symbol URA, +18.2% QTD), Cotton (iPath Bloomberg Cotton Subindex, symbol BALB, +16.1% QTD), and Nickel (iPath Bloomberg Nickel Subindex, BJJN, +15.4% QTD). We advise caution on these – whenever we do these best/worst lists, there is always a commodity play in the mix. They rarely appear the next time we look at top performers.
  • Select tech stock plays: Internet stocks, even weighted to accentuate exposure to small caps (SPDR S&P Internet ETF, XWEB, +16.5% QTD)
  • And 2 actively managed ETFs in the Tech/Health Care sectors: ARKK (Ark Innovation ETF, +17.0% QTD) and ARKG (Ark Genomic Revolution, +15.4% QTD).

As for the big losers so far in Q2 2018, no prizes for the worst performing idea: yes, it is a levered long Brazil equity fund (BRZU, -59.2% Q2-to-date).Removing ETFs with leverage from consideration, here are the investment themes at the bottom of the performance pile for the second quarter and some data to frame the numbers.

  • There are 17 unlevered ETFs that are down 15% or more this quarter.
  • The largest cluster track US equity volatility, which has been on the decline since the February melt-up: VXXB (-33.8% QTD), VIXY (-31.35), VIIX (-31.25), VXX (-31.1%), VMAX (-20.5%), VIIZ (-18.8%), VIXM (-18.6%), VXZ (-18.5%)
  • The other group is tied to emerging market equities: Franklin FTSE Brazil (FLBR, -25.0% QTD), iShares MSCI Turkey (TUR, -24.4%), iShares Brazil (EWZ, -23.9%) and small cap Brazil (EWZS, -21.9%), and 2 Latin American equity funds (ILF, down 18.2%, and FLN, down 17.1%).

What we make of all this, in 3 points:

  • The MLP space is back from its long hiatus. Rising energy prices allows these offerings to provide income that is uncorrelated to fundamentals in the fixed income market. ETF money flows for the products we highlighted earlier are understandably strong, and given the market’s sentiment that interest rates will trend higher in 2018, we can see why.
  • Aside from emerging markets, which you know have had a horrible quarter, the other bad trade in Q2 has been “Long volatility”. In fact, you’d be marginally better off owning Brazilian stocks than most of the VIX trackers we cited above.
  • The energy sector – especially small caps – is the real story of the second quarter (even more than Tech). Given the performance chasing that tends to go on into the end of calendar quarters, we aren’t likely at the final chapter of that narrative.