How ETFs are Disrupting Small Cap US Stocks

One of our favorite parlor tricks at client events is to ask a simple question of the group: “What percentage of Apple’s stock is owned by exchange traded funds?” The answers usually come back in a range of 10 – 30%.

The answer is just 6.1%, which frankly surprised us even when we first started looking at the numbers a few years ago when the ratio was closer to 5.5%. Here are a few other super cap stocks and their level of ETF ownership:

• JPMorgan: 6.0%
• Facebook: 6.0%
• Google: 5.5% of GOOG and 5.9% of GOOGL
• Johnson & Johnson: 6.1%
• Exxon Mobil: 7.1%

In reality, US super-cap stocks mask the impact ETFs have in terms of shareholders, as the following data shows:

• While US listed ETFs own an average of 6.3% of the free float for the 10 largest companies by market in the S&P 500, they own 9.4% of the 10 smallest companies in the index. Two examples: ETFs own 10.1% of HR Block and 13.6% of SCANA. Bottom line: as you move down the cap table of even the S&P 500, ETF ownership almost doubles.

• The top 10 names by weighting in the Russell 2000 have an average of 10.2% of their shares locked up in US listed ETFs. Retailer Five Below, currently the top weighting in the Russell, is 11.9% owned by ETFs. Tech company Blackbaud (the third largest weighting in the index) has 11.9% of its shares held by ETFs. Health Tech company Medidata (#10 on the list) is 12.5% owned by ETFs.

• Using the Russell component list and going down to the 100th – 110th company by weighting the average ETF ownership of these names rises to 11.3%. Some standouts in this tranche: BancorpSouth Bank (13.9% ETF ownership), footwear maker Wolverine Worldwide (14.3%) and Selective Insurance Group (15.1%).

And now you can see why this analysis is in the “Disruption” section of today’s note; exchange traded funds have different effects on the very largest US companies (the top of the S&P 500) versus more typical public equities (the middle of the Russell). Three points we think are important:

#1. Contrary to popular belief, it is not the “FANG” names that benefit the most from the move to ETF based investing. In fact, the average ETF ownership of Facebook (6.0%), Amazon (6.1%), Netflix (6.5%) and Google (5.5% - 5.9%) is 6.1%. That’s actually slightly lower than the average of the top 10 names in the S&P 500 (6.3%).

#2. Rather, it is US small caps where ETF ownership is most dominant, but also the most unpredictable. From just 6-8% share ownership for the largest S&P 500 names, the Russell 2000 stocks have both higher average ownership and much wider spreads in terms of those stake holdings. In just our crude sample of the 100th – 110th names in the Russell, ETF ownership varied from 5.5% to 15.1%.

#3 What this means for small cap managers and those invested in the asset class:

• ETF fund flows into US small caps have been excellent this year, to the tune of $15 billion, with $1 billion in just the last week. These inflows have different effects on individual stocks (hence the variations in ownership), but the overall impact has been very positive on the group.

• Small cap stocks are generally illiquid, so any exodus from the group will have outsized effects on those names where ETF ownership is unusually high.

• Bottom line: US small caps have been THE winning trade in 2018, but much of the capital that has boosted the group comes from ETF money flows. Let’s be careful out there…

Note: All data here courtesy of www.xtf.com