ProShares’ New ETFs Offer No Real Reason to Buy

With nearly 1,800 exchange-traded funds currently on the market, you can’t fault fund sponsors for trying something different. However, you can fault them for creating something that most of us will never need.

ProShares' New ETFs Offer No Real Reason to Buy


In this case, we are talking about a new suite of ETFs from ProShares.

The firm — most known for its leverage, inverse and alternative ETFs — continues with its expansion into those alternatives with a four-ETF launch. The new smart-beat ETFs represent an interesting take on the bread-and-butter S&P 500 index by eliminating certain sectors.

While ProShares’ intentions may be good with the four new ETFs, the launches are actually head-scratching in a number of ways. And for most investors — retail or institutional — the four new ETFs may not been needed at all.

ETFs Without “Problem” Sectors

There are plenty of smart-beta strategies out there, some complex and some simple. ProShares went with one of the simplest — by unassumingly eliminating whole sectors.

The new ETFs — the ProShares S&P 500 Ex-Energy ETF (SPXE), S&P 500 Ex-Financials ETF (SPXN), S&P 500 Ex-Health Care ETF (SPXV) and S&P 500 Ex-Technology ETF (SPXT) — each provide exposure to the S&P 500 minus a particular sector. SPXE kicks out the 42 energy stocks and still provides exposure to the remaining firms in the S&P 500, the SPXT removes technology etc.

The four ex-sector ETFs’ underlying indexes follow the same rules as the S&P 500 in terms of market-cap weighting and stock selection. The difference is that the excluded sector’s portion is redistributed among remaining S&P 500 companies on a pro rata basis. For example, energy stocks make up just over 7% of the S&P 500, so that extra amount is just tacked onto the rest of the stocks in the index for the SPXE.

All four of the new ex-sector ETFs charge 0.27%, or $27 per $10,000 invested, in annual expenses.

New ETFs Intended to Give Flexibility

The idea behind the launch, according to ProShares, is that investors now have the opportunity to exclude sectors which they expect to underperform — either via overvaluation fears or thematic views.

The poster child for this view has been the energy sector. As oil and natural gas prices have fallen, stocks within the energy sector have tanked. The Energy Select Sector SPDR ETF (XLE) — which owns the 42 energy stocks within the S&P 500 — has fallen about 17% over the last year while, as a whole, the S&P 500 has only fallen about 5%. However, the S&P 500 is actually up 5.79% after you kick out energy stocks over the last year.

ProShares also suggests that investors who are already overweight a certain sector via active management or other ETFs or mutual funds could use the new suite of ex-sector ETFs to balance things out.

The Problem With ProShares’ New ETFs

All of this sounds really great, at least in theory. However, there are some problems and limitations with ProShares’ new ETFs.

For starters, you’re not really indexing. ProShares CEO Michael Sapir said at the time of the ETFs’ launch that, “If you want to use the S&P 500 as the core of your portfolio, you’re sort of required to take everything that comes with it.”

What Mr. Sapir is missing is that’s actually the point of using a broad index fund like the S&P 500.

You’re making a very active-management-style decision when you exclude certain sectors from a parent index. The beauty of indexing is that you take the good with the bad, because next year, odds are that the “bad” will be the “good” and vice versa. Sure, energy has been down in the dumps lately, but just a year ago, it was one of the main drivers of the S&P 500’s returns.

By choosing SPXE, you’re making the active decision that energy is going to underperform. And if you’re going to go that route and make that shorter term call, you might as well use ProShares’ own Short Oil & Gas ETF (DDG) and really profit from that call.

Secondly, you better be right by using SPXE. You need to actively call the right underperforming sector at the right time. And let’s not forget what happens if oil spikes or some biotech hits it big — then suddenly your actively chosen ex-sector bet doesn’t look so good.

On the flipside, if you’re overweight a sector, chances are you’re doing that on purpose. If you’re overweight healthcare via a vehicle like the Healthcare Select Sector SPDR Fund (XLV), you’re not going to pair the SPXV with it — because you then own just the market, rather than owning more of a sector.

Finally, there are better alternatives to eliminating whole sectors from the S&P 500. Namely, equal-weighting them. This removes many of the sector biases inherent in the index and you don’t have to be right about which sector is going to underperform. The proof of equal weighting comes from the Guggenheim S&P 500 Equal Weight ETF‘s (RSP) long-term returns — which have managed to add about 2% a year onto the bread-n-butter indexes with no sector guessing required.

Bottom Line

ProShares’ new ex-sector ETFS are interesting, but aren’t really as useful as they may seem. The suite really isn’t “indexing and there’s a lot more guesswork and active management than at first glance.

It might be best to ignore them and move on.

As of this writing, Aaron Levitt was long RSP.

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