Microsoft is in 766 Exchange Traded Funds including a Utilities ETF.
It’s in about a third of the nearly 1,800 domestic equity ETFs comprising a US-traded universe of 3,500 ETFs, adding in bond, commodity and international funds. Says the Investment Company Institute.
Is that a herd? Or a horde?
For perspective, 99.9% of US market capitalization is in the Russell 3000. Isolate to domestic equity ETFs and it’s 2-to-1, ETFs to stocks.
The MSFT executive team should know that 80 of its 766 ETFs – over 10% — are leveraged or hedged or long/short instruments designed to profit from or limit volatility.
That’s a key MSFT characteristic now — leveraged and hedged volatility. It makes sense against a backdrop of proliferating leveraged ETFs that aim to deliver 1-3 times the return, up or down, of a stock or basket.
They don’t own equity per se. Mostly they use total-return swaps, or baskets of options. Swaps are agreements for a specified period where one party pays a fee to receive the return on an asset without owning it.
What effect does the horde of ETFs and the pursuit of leveraged returns have on the way the stock market works? To arrive at an answer, first understand that ETFs don’t manage money for anybody.
Got that?
ETFs are not fiduciary instruments save for shareholders of the firms selling the ETFs. The assets they hold, they own.
Take the T-Rex 2x Long MSTR ETF overseen by Tuttle Capital. It’s got $2.5 billion of total return swaps on MSTR or some equivalent. It owes about $1.7 billion in offsetting obligations under the terms of its swaps. And it’s got $430 million of cash.
And it’s issued over 16 million shares of MSTU with a 1.1% management fee on assets.
Except it’s not managing anyone’s money. Investors own MSTU in a brokerage account. They’re not paying anyone for custodial services, account services, administration.
They’re basically paying a licensing fee.
And public companies, that means the ASSETS that ETF managers have received in exchange for ETF shares are theirs to do with as they please. Tuttle Capital is getting paid for $2.5 billion of assets – but it’s not managing that capital. It’s swapping it, and collecting fees.
NVDA is trading at $135, where it was two months ago in early October. NVDA is in 725 ETFs. What if those ETFs are trading NVDA out for AAPL (705 ETFs)? That’s a tax-free like-kind exchange permitting the ETF to bring back both with a step-up.
You and I can’t do that. ETFs can. I mean, I guess if we filed with the SEC and the IRS for approval to do a 1031 exchange of our stocks like that, maybe we could. Dunno.
And how are these hordes of ETFs priced? By relative value. Not sum of the parts or multiples of cash-flows.
I marvel at the guests on CNBC like Hightower’s Stephanie Link who appear to be encyclopedias on valuation metrics. The way she can rattle of how this stock “is 19 times earnings,” or “eight times next year’s cash flows!”
It’s impressive. But it’s not the way most of the money in the market behaves.
The market-makers (jargoned way to say they trade on a regular and continuous basis) and authorized participants for ETFs every day check the basket coming from the National Securities Clearing Corp, a unit of the Depositary Trust and Clearing Corp, for what things the ETF should track.
Among CVS’s 374 ETFs are a small-cap ETF and 49 all-cap ETFs. CVS has market cap of $70 billion! But it means a market-maker might justifiably trade the Russell 2000 versus CVS.
Does that seem right to you?
MSFT is in a Utilities ETF. Seriously.
It’s also in a Mid-cap blend ETF, a leveraged multi-asset ETF and 184 uncategorized ETFs serving a diversity of objectives. It’s in four alternative energy ETFs, four consumer discretionary ETFs, a health and biotech ETF, a commodities ETF, and 79 all-capitalization ETFs.
It could justifiably trade like any of those. Whom do you consider your peers? What if your biggest peer is the market? Or a leveraged inverse market trade?
This is why we at ModernIR say you have to know what the money is doing, and how the market works. That’s the starting point! If you want help, ask us.
None of this money I’m describing is motivated by PE multiples. ETFs are priced purely relative to other things. Look at the broad measures yesterday – way up, then down, then back to the middle, and all finishing about 25 basis points down.
That’s a product of ETFs. Not investor sentiment.
And the choices keep shrinking, so the money keeps classifying the same securities in different ways. Which is how Microsoft ends up in a Utilities ETF.
(Well. Somebody built into some model that Microsoft colocation facilities consume a lot of energy, so let’s say they’re INFLUENCED by the same forces affecting utilities.)
Public companies, you need to change how you report results to reflect the horde. And it can be a big help! Leverage your characteristics, not your earnings multiple. We can help. Traders, invest in Demand and Supply disparities. Don’t be overrun by the horde.
PS – For you investors, I’ve got an IBKR webinar Dec 16 on taking the stress out of trading. Register and join!
