Spin-offs frequently present investors with unique investment opportunities. However, to find the companies undergoing these transactions, investors need to continually stay well-informed on the corporate news flow and read dense SEC filings. In addition to finding companies executing spin-offs, investors must continually monitor the spin-off pipeline for key SEC filings and information related to the timing of proposed transactions. To do this along with thoroughly researching potential investment opportunities is time-consuming and difficult.
But given the attractive historical returns generated by spin-offs, the work is undoubtedly worth doing.
Yet, could it be possible to still generate attractive returns without having to do all the work? A handful of financial services companies have created products for investors to try to capitalize on spin-off returns through investing in ETFs that track an index of spin-offs.
In this article, we investigate these products to determine how they are structured and if it could ever make sense for investors.
S&P U.S. Spin-Off Index
The Index was launched in March of 2015 and is intended to measure the performance of companies within the S&P U.S. BMI, an index that includes all U.S. domiciled companies, that have been spun-off within the last four years. The index requires companies to have a market capitalization of at least $1 billion to be included in the index.
The S&P U.S. Spin-Off index weighs companies based on their market capitalization, subject to a 7.5% maximum, and are included in the index for a maximum of four years (48 months).
Additions to the index are made on a monthly basis and any eligible spin-offs that have happened at least seven business days prior to the rebalancing are included in the index. If a constituent has been in the index for 48 months, it is removed at the next monthly rebalancing.
As of the end of September 2018, the index had 47 constitutes and was relatively concentrated with the top ten positions comprising just over 53% of the index.
While the index appears interesting, there are many potential problems with it.
Since it is a market capitalization weighted index, it will substantially overweight large spin-offs relative to smaller ones. While this obviously isn’t a problem if those particular ones are the most compelling opportunities, it is a problem if they are not. This dynamic will lead to a “top heavy” index where the performance will be dominated by the largest market capitalization firms rather than the aggregate performance of spin-offs in general. This attribute can lead investors to believe they are broadly invested in spin-off opportunities when in fact they are only invested in the largest ones.
Also, a spin-off must have a market capitalization of at least a billion dollars in order to be included in the index. As a result, some of the most compelling opportunities could be withheld from the index simply due to their smaller market capitalization and nothing to do with the fundamentals.
Lastly, the index does not include any of the parent companies (RemainCo’s). In certain circumstances, the RemainCo could be a much more interesting opportunity than the spin-off. Unfortunately, the index does not capture these potentially compelling companies.
Overall, the returns of this index will be dominated by the largest spin-offs. Therefore, it won’t be representative of the combined returns of all spin-offs.
Horizon Kinetics Global Spin-Off Index
The Index tracks the performance of globally-listed spin-offs that are domiciled and trade in the U.S., Western Europe, and developed Asia.
There is not a lot of information about this index, but it appears to be different than the S&P Spin-Off Index in a few different ways.
- It invests in spin-offs around the globe rather than just in the United States.
- It doesn’t have market capitalization constraints. For instance, the smallest constituent has a $166 million market capitalization.
There used to be two spin-off ETFs: the VanEck Vectors Global Spin-Off ETF and the Invesco S&P Spin-Off ETF.
VanEck launched the fund in 2015. However, the ETF wasn’t able to attract enough assets (only had ~$5 million in AUM) so they liquidated the fund in July 2018. While the fund was operational, it tracked the Horizon Kinetics Global Spin-Off Index.
Now investors just have one spin-off ETF to choose from in the Invesco product.
Invesco S&P Spin-Off ETF (CSD)
The ETF tracks the S&P U.S. Spin-Off Index and invests at least 80% of its total assets in securities that comprise the index. Somewhat recently in May 2016, they actually changed their target index from the Beacon Spin-Off Index to the S&P U.S. Spin-Off Index. As a reminder, the S&P U.S. Spin-Off Index is comprised of companies that have been spun-off within the past four years and have market capitalizations greater than $1 billion.
As of the end of the second quarter 2018, the ETF is relatively concentrated with position sizes of 7% or greater in Fortive, PayPal, Synchrony Financial, and Hewlett Packard Enterprises. In total, the top 10 positions made up over 50% of the ETF. As described above, this dynamic is a result of the market capitalization weighting method used to construct the S&P U.S. Spin-Off Index.
The fund’s performance has been slightly better than the S&P 500 since inception in December of 2006 but has been significantly worse over the more recent 3- and 5-year periods. However, the fund has only been in existence for a couple of years under its current format with the change in the target index in 2016.
Since it has been tracking the new index, it appears that there have been some discrepancies as the underlying index was up over 15.1% over the past year, but the ETF was up only 14.4%. Also, the ETF is on the more expensive side with a total expense ratio of 0.62%.
When considering all the issues with the U.S. Spin-Off Index plus laying on fees and the potential performance inconsistencies, it doesn’t look like a great option for investors who just want broad exposure to corporate spin-offs.
While many mutual funds selectively purchase spin-offs, carve-outs, and split-offs, we could only find one that exclusively looks at these investment situations (as well as restructuring opportunities).
Kinetics Asset Management: Spin-Off and Corporate Restructuring Fund
The fund focuses on investing in both spin-offs and the parent companies as well as equity carve-outs and companies undergoing restructurings or shareholder activist campaigns. They also occasionally look to invest in companies that have the potential to execute a spin-off transaction or corporate restructuring.
They own companies across both the globe and market capitalization spectrum. Additionally, they can invest in other securities such as preferred stocks, securities convertible into common stock, warrants, rights, and depositary receipts.
The fund is concentrated with the top ten holdings accounting for nearly 72% of the fund as of 6/30/2018. This is driven by a very large allocation, just over 30% of the fund, to Texas Pacific Land Trust.
Historically, performance has not been good relative to the S&P 500. Annualized returns have trailed the index over the last 3-year, 5-year, 10-year, and since inception time periods. The S&P 500 index probably isn’t the best index for performance comparison purposes because the fund invests across the market cap spectrum and internationally. However, even when accounting for this, historical annualized performance does not look good.
The fund is relatively expensive with the lowest fee share class, the institutional shares, charging a net expense ratio of 1.25%. The most expensive share class, the Adv. C shares, will cost investors over 2%. The fee structure has further hurt returns.
While some financial services firms have introduced products that allow investors to participate in corporate spin-offs, there is not a simple way to create a rules-based-fund or ETF to easily replicate spin-off performance. The current options available to investors have idiosyncrasies that don’t allow investors to fully participate in some of the potentially most compelling opportunities.
As a result, investors will need to continue to do the work to evaluate each opportunity on its own merits rather than purchasing a broad ETF that attempts to track them. This is the only way to really determine if an individual spin-off will be a good long-term investment.
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