New-to-Market: VETS

Thursday, June 28, 2018 - New-to-Market: This blog series highlights ETFs that have recently gone public and reflect those strategies currently most in demand by investors. While ETFs are not eligible for ETFG Risk Ratings until traded for 3 months and ETFG Reward Ratings for 12 months, our goal is to highlight the most cutting-edge investment strategies that have recently embraced the ETF structure – we hope you enjoy this special series of posts!

When it comes to ETF trends, the only thing that may be hotter than Strategic Beta is Impact Investing, an umbrella term for a wide range of investment practices focused on investing in companies that share their investors’ principles. Call it a natural extension of the “voting with your dollars” concept. Seemingly opposed to the more mathematically driven world of strategic beta, the two share one key similarity; a deluge of new products allowing investors to put their capital to work supporting nearly any cause you can imagine. That included everything from alternative fuels to gender equality and even biblical values but until 2018 one cause beyond reach was supporting the men and women of our armed forces after they put their life in uniform behind them.

Enter Pacer ETFs who has partnered with VETS Indexes to create an innovative product and the subject of our latest “New-to-Market” post, the Pacer Military Times Best Employers ETF (VETS). This ETF allows the public to easily invest in those companies that believe hiring veterans and good business go hand-in-hand. Launched on April 10^th, the fund is among the first of its kind focused on investing in companies that both make veterans a priority as well as reap the benefits of this unique group of employees.

So how does VETS work? Like all ESG funds, the first step is to build an "investable" universe. Instead of employing a black box or private consultant, the initial screening process is done via the annual Military Times Best for VETS Employers List, perhaps the country’s most comprehensive and well-respected evaluation of companies devoted to hiring and developing veterans. Published annually by the Military Times, the survey is an exhaustive list of 90 questions and hundreds of sub-questions focused on issues such as veteran recruitment policies, company culture and support of employees who continue to serve as reservists. The responses are scored and the top 60% is included in the Employers List, currently a record 82 companies spread across a variety of industries with ample statistics available on the Military Times website to support their inclusion.

While 82 holdings would be a deeper roster than most ESG funds offer, the Employers list is just the first step in the process. VETS  then screens for both liquidity and consistency selecting only those companies with a market cap of $200 million or greater and at least three consecutive years on the Best for VETS Employers List. Those criteria quickly cut down the current allocation to a more manageable 36 names (see full list here: Index Components) that are then equally weighted, although we should note that there is no limit on how many names can be included in the fund or on sector weights, meaning the fund could grow and take on more benchmark-like characteristics or substantial factor exposure depending on how the Employers list changes over time.

Reconstituted annually in September, the current make-up of the portfolio is hardly what first comes to mind when most people think about what companies would make veteran recruitment and support a priority. Potential investors thinking this is another aerospace and defense fund are in for a surprise with only a handful of defense names in the portfolio and with Lockheed Martin (LMT) the most-well known although it’s hard to find a public company who doesn’t count the government as a crucial client. Consider the case of VETS' strongest performer, Amazon (AMZN), whose foray into secured cloud hosting for the CIA and DoD has helped push the company into profitability and put Washington D.C. on the short-list for its next corporate headquarters.

Instead of defense stocks, the current holdings report not surprisingly reads as a “Who’s Who” of the large-end of Corporate America with most of the portfolio consisting of Large Cap and Mega Cap names who can devote extensive resources to veterans' initiatives. What is surprising is the industry make-up. The largest single sector weighting going to financial stocks including megabanks like Citigroup (CITI) and J.P. Morgan (JPM) along with well-known insurance names like Progressive. Industrial names like General Motors (GM) and Union Pacific (UNP) are a close second thanks to their constant need for mechanically skilled and motivated workers.

How does that portfolio work as a whole? VETS has a short track record with the fund up 1.62% from inception on April 10^th through June 26^th but studying the portfolio attributes might help address one of the oldest concerns about sustainable investing. One widely repeated argument against sustainable investment practices has been the idea that they will typically take on unintended factor exposures, exposing investors to unknown and potentially uncompensated risk. While the future allocations can and will change depending on who makes the cut on the Employer’s Survey, the current allocation is underweight in technology and overweight in Utilities relative to the Russell 1000. That might give VETS a more value-oriented tilt, although it retains an overall “Large Blend” feel to the portfolio that can best be understood by studying some of the most common price multiples. VETS has lower price-to-earnings, book and cash flow multiples and offers a slightly higher dividend yield than the iShares Russell 1000 ETF (IWB), offering a more attractive way to gain large core exposure than a pure index replicator while avoiding a more energy and healthcare-oriented pure value.

Ultimately, impact investors are less concerned about whether one investment style or another will outperform from one year to the next but rather whether the companies in which they invest, engage in practices that keep them awake at night. For those investors who believe both that supporting our troops and hiring veterans can be good business, VETS may be the right choice.

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