One of my favorite types of blog posts is looking under the hood at narrower ETFs to explore the theme and how the exposure fits into a portfolio. In years past I’ve explored ideas for publicly traded toll roads, airports, cement companies, publicly traded stock exchanges and the ETF industry. I also looked at fisheries and for a time there was such an ETF, but it had trouble gaining AUM traction, but I still think it is an interesting and important theme.

I’ve long had exposure for clients to the ETF industry through individual stocks, starting with Barclays (BCS) way back when it owned iShares, then I owned MSCI (MSCI) and for the last four and a half years clients have owned Blackrock (BLK). In the time I have owned it, it has mostly tracked the S&P 500 but has pulled away meaningfully in the last few weeks and it yields a handful of basis points more than the index.

Back in April, Toroso Investments launched the ETF Industry Exposure & Financial Services ETF (TEFT). The fund is very small, Yahoo Finance reports it at just $2.64 million so hopefully it can stay open enough to have a chance to gain some mass.

The holdings are a relatively broad mix of companies that play different roles in the ETF ecosystem. There are fund providers like WisdomTree (WETF), Blackrock, State Street (STT) and a few more smaller ones. The providers though, tend to be broader line companies other than WETF. TETF also owns exchanges where ETFs trade like CBOE Holdings (CBOE) and NASDAQ (NDAQ) and then companies from a few other spots in the food chain including a few large banks. I should mention that CBOE is also a long-term client holding.

I obviously believe in the exposure, I’ve had it for clients one way or another for the vast majority of the time since 2004. The following chart is what I would compare TETF to. XLF is of course the Financial Sector SPDR, KBE is the KBW Bank ETF and SPY obviously tracks the S&P 500.

When considering a narrow-based fund, the second thing I am interested in (the merits of the theme being the top priority) is trying to understand what the fund might bring to the portfolio. The chart as assembled provides a good look at how to answer this question. TETF is a of course a financial proxy. If you build your portfolio at the sector level (I do, and will explore that in a subsequent post) then I would want to know how it might compare to the sector broadly, XLF. Where banks are such a large part of the financial sector I want to see what it looks like against the banks, KBE. Part of the appeal to me is that I would rather be underweight banks and this niche is a way to possibly be underweight. Six months is not really a great sample size, but I believe is enough time to reveal whether it might be extremely volatile. Yes. you can get the stats for volatility but seeing it play out on a chart is helpful.

The theme itself, regardless of how good the fund is or isn’t, is an obvious one and the premise was the same in 2004 (oldest blog link I can find that mentions Barclays) as it is now, the assets are going to flow in (2017 is record for fund flows) and the space will continue to evolve to further democratize access to building sophisticated portfolios. The fact that the money was going to flow, and still will going forward, creates a tailwind. There’s no guarantee that such a tailwind will generate alpha, but it tends to be the sort of exposure I want to take on. Infrastructure is another example of this.

Buying smaller ETFs like TETF is difficult in case they close and a capital gain is foisted upon you. The problems of trading small ETFs are much less than what is perceived. I will write about trading in a future post but the short version is that other than extreme events like flash crashes, liquidity is almost always deeper than what you see.

To the extent this theme interests you, you can look at the SPDR S&P Capital Markets ETF (KCE) and the iShares US Broker Dealers & Securities Exchanges ETF (IAI). Both have been around for a while, IAI has dramatically outperformed KCE. IAI appears to be top heavy in brokerage firms while KCE is a little broader. TETF would appear to be the purer play on the ETF industry.