Generally speaking, I tend to stay away from the ETF space as an investor. There are thousands of ETF products, which makes it difficult to choose the one that best fits my investing goals, and the product itself is not without its drawbacks. Personally, I will either choose a tracker fund or individual stocks.
However, the one ETF that recently caught my eye is the Dhandho Junoon ETF, which is interesting because it is managed by the same firm that is owned by well-known and respected value investor Mohnish Pabrai (Trades, Portfolio).
An ETF worth a second look
Rather than focus on individual value stocks, the Junoon ETF selects its components from three categories – "Share Buybacks," "Spinoffs" and "Select Value Manager Holdings." Companies falling into the “share buybacks” bucket actually constitute most of the ETF's holdings. The fund is targeting around 75% of assets under management to be devoted to this asset bucket. The last 25% of assets is divided between"Spinoffs" and "Select Value Manager Holdings." To qualify for the Select Value Manager Holdings category, issuers must have been held by one of 22 selected value hedge funds during the previous quarter as reported on their Form 13F filings.
It is clear that this ETF is constructed in a quantitative way. The share buyback stocks have to be cash-rich businesses that consistently repurchase a significant amount of outstanding stock. And it is this category that interests me.
Share buybacks tend to split opinions among the investment community. Some investors believe buybacks are a waste of time and money, only serving to enrich the managements of the companies that commission such returns of capital while investors believe buybacks to be great ways to return cash to investors. To qualify for the Dhando buyback bucket, issuers must have repurchased between 1% and 26% of their shares outstanding during the trailing 12-month period.
This might be a sensible strategy to follow. In the U.S. the Standard & Poor's 500 Buyback Index has easily outperformed its nonbuyback counterpart during the past two decades. Indeed, between December 1993 and December of last year, the S&P 500 Buyback Index returned to 13.9% per annum on average compared to a return of just 9.05% for the S&P 500 total return index.
There are some key differences here, for example, the buyback index is a portfolio of roughly 100 companies all equally weighted whereas the S&P 500 is market cap weighted so top holdings have a much greater impact on the overall portfolio but overall buybacks seem to be outperforming around the world. The MSCI Europe Buyback Yield Index has more than doubled the average annual return of the MSCI Europe Index since 1999, a return of 8.09% compared to 3.67%.
Just like its U.S. counterpart, the European index is a more focused portfolio with only 70 holdings compared to the market average of 446. Moreover, the European buyback portfolio is weighted with a combination of market capitalization and “buyback yield score.”
The right course of action?
Based on past performance of buyback stocks around the world, it seems that the Dhando buyback bucket has the right goals. Unlike the majority of other ETFs as well the Dhando product runs an extremely concentrated portfolio.
At the time of writing around 30% of the portfolio is placed in just two stocks, AutoZone Inc. (AZO, Financial) (16.3%) and The Travelers Companies Inc. (TRV, Financial) (14.7%). While this concentration will almost certainly increase volatility, it may also accelerate returns. Highly concentrated portfolios have been shown to produce the best returns in the long term if the stocks selected prove to be winners. This may or may not be the case with AutoZone and Travelers, but it is a fascinating portfolio construction technique nonetheless.
Companies that purchase a significant amount of their own outstanding shares have been shown to outperform in the long term. The Dhando fund is attempting to recreate this anomaly and achieve outsized returns thanks to its highly concentrated portfolio.
Disclosure: The author does not own any share mentioned.
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