Analysis

State Street lists three sector ETFs for the new economy. But will they work?

David Tuckwell

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State Street is partnering with research firm Kensho Technologies to list three new sector ETFs in the US. They are:

  • SPDR Kensho Intelligent Infrastructure ETF (XKII)

  • SPDR Kensho Smart Transportation ETF (XKST)

  • SPDR Kensho Future Security ETF (XKFS)

XKII tracks an index of US "Intelligent Infrastructure Companies". The fund focusses on companies in power grids, transportation infrastructure and water infrastructure.

To decide if a company is an "Intelligent Infrastructure Company" Kensho uses an interesting method which involves screening companies' regulatory filings for "specific terms and phrases." Companies deemed intelligent enough and infrastructure enough by this textual analysis are then divided into "core" and "non-core" depending on how much of their equipment, products and services are in infrastructure.

Companies either side of the core and non-core divide will be equally weighted within their half. XKII then tilts towards core companies, with an overweight factor of 20%.

To qualify for the index, companies must have a market capitalization of at least $100 million and a minimum three-month average daily traded value of at least $1 million. XKII then uses a sampling method to track its index, not full replication.

XKST and XKFS use the same index methodology.

XKST targets "smart transportation companies". The prospectus defines these companies as those trying to "improve the quality of transportation, or achieve other outcomes that monitor, manage or enhance transportation systems." Of particular interest to XKST are self-driving cars, drones, and "advanced transportation systems".

XKFS targets "future security companies". These are defined as companies that make "sophisticated weaponry, defensive systems and smart borders." XKFS is particularly interested in cybersecurity, border control, the militarisation of space, robotics, drones, wearables and virtual reality.

Analysis

State Street has been the dominant issuer of sector ETFs in the US and with these listings the company is signalling its intent to keep things that way. These listings come at a time when major index providers are shaking up their sector classifications to reflect industry consolidation (as in telecoms) as well as the emergence of what appear to be new sectors (in what sector does social media fit, anyone?)

The listings also arguably double up as thematic beta listings. Rather than targeting factors or fundamentals, thematic beta ETFs target changes in demographics, values, technology, etc. With smart beta in the US now overcrowded, thematic beta may be a new frontier for ETF issuers in the coming years.

Among the three listings, the infrastructure tracker is the least surprising. Infrastructure has come back in a big way this year, with ETF issuers globally rolling out funds targeting the sector. The source of the suddenly renewed interest seems clear: a rising tide of nationalist populism, and its demand to create more jobs. Thus infrastructure spending has been a feature of governments as disparate as Xi Jinping's China, Erdogan's Turkey, Orban's Hungary and Trump's America. Where money goes, ETFs follow. Thus issuers have brought their butterfly nets to capture renewed interest in the space.

ETFs that target self-driving cars have also been in vogue this year. However such products rub against the possibility that we're in a tech bubble as well as the well-reported failures of companies to create self-driving cars (they're often put off by leaves on the road). State Street is not the first to target improved transportation (Evolve in Canada comes to mind) and it's unlikely to be the last.

State Street's future security ETF is the most interesting of the three. An ETF that targets the militarisation of space and border control is fascinating indeed. While there is more than one cybersecurity ETF, there is no future security ETF - making XKFS something different. With concerns about refugees and immigration rising in North America and Europe, XKFS fits the zeitgeist. (One suspects this aspect is unlikely to feature in any marketing). It also fits with today's geopolitical realities, with escalating tensions around China and Russia driving spending and innovation in these areas. XKFS could be one to watch.

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