Discipline is the key to long-term investment success and while there’s a lot to be said for learning-by-doing, we at ETFG are big believers in not reinventing the wheel which is why we’re excited about the recently introduced Innovator IBD 50 Fund ETF (FFTY) built around the CAN-SLIM philosophy developed by investment great William O’Neil and popularized by his most famous publication, Investor’s Business Daily. FFTY’s focus on growth and momentum might not make it a slam-dunk for every investor portfolio, but investors looking to tap into the wisdom of a market guru and a focus on limiting losses will find a lot to like in this fund.
Investor familiarity might be one of the reasons why FFTY has met with such a positive reception as the fund pulled in over $27 million in assets since its launch on April 9th. Potential investors worried about buying a watered down version of William O’Neil’s famous investment philosophy can take heart that this fund is the real deal and strongly adheres to his famous discipline. The core of the strategy is finding stocks with strong quarterly and annual earnings growth as well as anticipated product developments and combining it with a strong technical outlook based on momentum.
Although no one would confuse CAN-SLIM with buying penny stocks; O’Neil favor’s stocks with a relatively limited float, institutional ownership (but not at extreme levels) and rising prices supported by strong volume. The official benchmark for the fund is the IBD 50 Index, a price-weighted index that is reconstituted every week after the close of business on Friday, however, the fund’s weighting system is actively managed and won’t match the published benchmark although it will hold the same fifty securities as the benchmark, tracking error should be expected.
With a focus on a strong track record of earnings growth, potential investors shouldn’t be expecting a lot of value oriented names in this portfolio because for FFTY it’s all growth, all the time. The CAN-SLIM philosophy and its focus on strong earnings growth and momentum doesn’t leave a lot of room for diversification, so buyers should note that the portfolio is heavily concentrated in a few sectors with technology stocks making up over 50% of the portfolio followed by healthcare stocks at close to 20% and consumer discretionary names making nearly 15%. And while O’Neil’s system eschewed low-priced stocks due to their lack of attractiveness to institutional owners, the focus on strong earnings growth has led to a large concentration of small-cap stocks in FFTY with nearly 42% of the fund in small-cap stocks and an average market capitalization around $5.4 billion compared to $5.6 billion for the fund’s most likely rival in this space, the iShares S&P 400 Midcap Growth fund (IJK.) The biggest difference between the two (besides number of holdings) is that FFTY has a nearly equal amount spread out between mid, large and giant cap names versus IJK’s overwhelming focus on just the mid-cap market.
But that heavy allocation to the small-cap space makes for one very wild ride at times and investors in FFTY should be braced for volatility. While the funds track record is still limited, FFTY is down 1.2% since inception on April 9th compared to a positive .54% for IJK but that overlooks the volatility investors experience along the way; during the two weeks from April 23rd to May 7th the fund dropped 5.45% compared to slightly more than 2% for IJK and 2.69% for one of the largest small-cap growth funds, the Vanguard Small-Cap Growth ETF (VBK.) Given that the benchmark can be reconstituted on a weekly basis, we haven’t been entirely successful in determining who the biggest culprits were but that might be another reason for investors to put this fund on their watch list.
Like many traders, O’Neil was a firm proponent of limiting losses, typically when positions suffered a 7% to 8% loss below the initial purchase price and trimming the losers while letting the winners run and the managers of FFTY seem to be embracing that philosophy. Unlike the IBD 50 Index, the managers have the discretion to weight positions (the largest is no more than 3.5% of the portfolio) based on the models conviction level and not on price and the most current holdings report found at the Innovator Funds website shows that less than 50% of the portfolio dates to positions acquired before the fund began trading while nearly 18% were added on 5/12. While the turnover might seem high, the fund charges a relatively high 80 bps management fee and the portfolio protection provided by reducing drag from losing positions might be well worth the fee.
As we said in the introduction, FFTY might not be a core holding essentially for every investor portfolio but for those investors looking for a growth manager who actually trades and manages their portfolio to a set of time-tested rules, this might be worth watching.
*Please note that ETFs are eligible for ETFG Red Diamond Risk Ratings following 3 months of trading and ETFG Green Diamond Reward Ratings following 12 months of trading.
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