Beyond Apple: Making a Better Technology ETF - Barron's

If you want to invest in the future, buy tech stocks. Or so the conventional wisdom goes. But if you invest in either of the two most popular tech exchange-traded funds—Technology Select Sector SPDR or Vanguard Information Technology—about a quarter of your portfolio goes to just two stocks— Apple AAPL 0.5270939127081057% Apple Inc. U.S.: Nasdaq ^USD156.39 0.82 0.5270939127081057% /Date(1501880400402-0500)/ Volume (Delayed 15m) : 20470960 AFTER HOURS ^USD156.65 0.26 0.1662510390689942% Volume (Delayed 15m) : 352442 P/E Ratio 17.77159090909091 Market Cap 807790008043.684 Dividend Yield 1.611356224822559% Rev. per Employee 1920430 More quote details and news » and Microsoft. MSFT 0.7345807345807346% Microsoft Corp. U.S.: Nasdaq ^USD72.68 0.53 0.7345807345807346% /Date(1501880400313-0500)/ Volume (Delayed 15m) : 22343260 AFTER HOURS ^USD72.68 % Volume (Delayed 15m) : 271123 P/E Ratio 26.918518518518518 Market Cap 559799106491.163 Dividend Yield 2.1463951568519537% Rev. per Employee 720927 More quote details and news » Worse, both ETFs have more than half their assets in 10 stocks.

Will Apple (ticker: AAPL) and Microsoft (MSFT) be tomorrow’s fastest-growing tech companies? That seems doubtful, given their already immense size and the age of their legacy product lines. The future will belong to newer innovations, and a new ETF aims to capture that.

The $1.2 billion iShares Exponential Technologies ETF XT 0.121765601217656% iShares Exponential Technologies ETF Bats BZX 32.89 0.04 0.121765601217656% /Date(1501877461757-0500)/ Volume : 1040 P/E Ratio N/A Market Cap N/A Dividend Yield 2.8877591973244146% Rev. per Employee N/A More quote details and news » (XT) has a much broader definition of technology. Key to that definition is the concept of “nonlinear” growth in the manufacture and usage of technology. Or as Morningstar, which designed the Morningstar Exponential Technologies Index the ETF tracks, put it in a white paper: “Exponential technologies [are] those advances expected to create significantly positive, nonlinear economic benefits for the companies that produce or use them.”

The exponential part turns the ordinary linear upward-sloping revenue growth of a company into nonlinear J-shaped growth. That growth is tied to the functioning of the technology itself. “If you’re familiar with Moore’s Law, computer performance has been doubling every 24 months,” says financial advisor Ric Edelman. “That’s an exponential growth rate.” Without Edelman there would be no ETF: It was his research on exponential tech and desire to invest in it that led him to approach BlackRock, which hired Morningstar and launched the iShares ETF in March 2015. (Edelman receives no compensation from the ETF.) He initially invested $628 million in the ETF and now has $902 million in it.

Morningstar identified nine themes for its index, including nanotechnology, bioinformatics, robotics, and 3-D printing. It then set its team of 100 analysts to work finding the 200 companies with the greatest exposure to these technologies. The index is equal-weighted so no one company like Apple can dominate.

The resulting ETF is so unusual that it doesn’t have a traditional category. (Morningstar lumps it with other “Miscellaneous Sector” misfits.) It has 31% of its assets in health-care stocks like Bristol-Myers Squibb BMY 0.8108108108108109% Bristol-Myers Squibb Co. U.S.: NYSE ^USD55.95 0.45 0.8108108108108109% /Date(1501880431148-0500)/ Volume (Delayed 15m) : 4080901 AFTER HOURS ^USD55.95 % Volume (Delayed 15m) : 80567 P/E Ratio 20.345454545454544 Market Cap 91753862371.7697 Dividend Yield 2.7882037533512065% Rev. per Employee 809520 More quote details and news » (BMY) and Intuitive Surgical ISRG -0.3307784533698724% Intuitive Surgical Inc. U.S.: Nasdaq ^USD931.07 -3.09 -0.3307784533698724% /Date(1501880400268-0500)/ Volume (Delayed 15m) : 323706 AFTER HOURS ^USD931.07 % Volume (Delayed 15m) : 1440 P/E Ratio 44.59147509578544 Market Cap 34590182751.3501 Dividend Yield N/A Rev. per Employee 764208 More quote details and news » (ISRG), which are key players in bioinformatics and robotics. Another 31% is in more traditional tech companies like Apple. There’s also 14% in industrial companies like General Electric GE 0.07763975155279502% General Electric Co. U.S.: NYSE ^USD25.78 0.02 0.07763975155279502% /Date(1501880410181-0500)/ Volume (Delayed 15m) : 21674059 AFTER HOURS ^USD25.78 % Volume (Delayed 15m) : 1638902 P/E Ratio 29.65945697192821 Market Cap 223201861276.971 Dividend Yield 3.7238169123351437% Rev. per Employee 400661 More quote details and news » (GE), which leads in nanotechnology, and 6% in innovative financial firms like PayPal Holdings PYPL 0.7531667237247518% PayPal Holdings Inc. U.S.: Nasdaq ^USD58.86 0.44 0.7531667237247518% /Date(1501880400416-0500)/ Volume (Delayed 15m) : 6065610 AFTER HOURS ^USD58.76 -0.1 -0.16989466530750935% Volume (Delayed 15m) : 125684 P/E Ratio 47.088 Market Cap 70773086544.4318 Dividend Yield N/A Rev. per Employee 642099 More quote details and news » (PYPL) and Intercontinental Exchange ICE -0.5065234075211051% Intercontinental Exchange Inc. U.S.: NYSE ^USD64.82 -0.33 -0.5065234075211051% /Date(1501880415768-0500)/ Volume (Delayed 15m) : 2513136 AFTER HOURS ^USD64.8717 0.0517 0.07975933353903117% Volume (Delayed 15m) : 250906 P/E Ratio 23.978100839714422 Market Cap 38146114846.041 Dividend Yield 1.234186979327368% Rev. per Employee 1041200 More quote details and news » (ICE).

Almost 40% of the ETF is in foreign stocks. “Many clients I work with are using this as a global equity fund,” says Daniel Prince, head of iShares Product Consulting. By that standard, it has performed well, delivering a cumulative 32% return since inception, versus the Vanguard Total World Stock VT 0.18713113574204693% Vanguard Total World Stock ETF U.S.: NYSE Arca 69.6 0.13 0.18713113574204693% /Date(1501889400001-0500)/ Volume (Delayed 15m) : 461523 AFTER HOURS 69.6 % Volume (Delayed 15m) : 7 P/E Ratio N/A Market Cap N/A Dividend Yield 2.67816091954023% Rev. per Employee N/A More quote details and news » ETF’s (VT) 18%.

Still, the iShares ETF has flaws. It employs analyst research to identify key players in new technologies, but Morningstar’s analyst team covers about 1,500 mainly large and midsize stocks worldwide—so many small tech companies are excluded. By contrast, Vanguard Total World Stock holds 7,849 stocks.

Edelman likes the ETF for his conservative client base, as small-cap tech can be higher risk. Yet he acknowledges some of the sector’s growth is missing: “We are seriously evaluating several other fund opportunities for that reason.” Although he wouldn’t go into detail, if Edelman has any say, exponential tech ETF 2.0 is on its way.

Email: editors@barrons.com

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