Industry Updates

First European Blockchain ETF launches

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Bitcoin made some people very rich in 2017 as its price rose 19 times over the year. But you could argue that Bitcoin was really just a small part of a bigger story.

For many observers, the really exciting development is the blockchain technology that facilitates Bitcoin. And a new ETF from First Trust is aiming to give investors exposure to this story.

What is Blockchain?

Blockchain is a digital ledger that provides a secure way of making and recording transactions and contracts. The technology allows a buyer and seller to interact directly without the need of a third-party to transfer goods or information. Any process that involves many parties and middlemen could potentially be made more efficient. Cheerleaders for blockchain say that Bitcoin and other cryptocurrencies are just an early application for the technology. There are lots of opportunities to come.

One example is the remittance industry - especially in the developing world. The World Bank estimates that remittances totalled $575 billion in 2016 and the average remittance price for these transactions was 7%. Blockchain may help in bringing those fees down. Blockchain may also play a role in the roll-out of the internet of things.

So there's a chance that blockchain may be the next big thing. I don't think it's a certainty, but there's a decent chance. Having reached that conclusion, the obvious follow-up question is: how do we invest in this?

How to invest

One option is to buy into cryptocurrencies such as Bitcoin. But these currencies have been extremely volatile so far, trying to ascribe a value is close to impossible. And anyway, blockchain is about more than currencies.

You might want to invest in a pure play blockchain business, but as far as I'm aware, no such business is listed on public markets. For retail investors, the only realistic option is to invest in businesses that have significant blockchain businesses or are likely to be big blockchain beneficiaries.

Over in the US, there are now four ETFs that invest in such businesses (see below)*, and now a UCITS version of one of those ETFs has been launched in Europe. It's called the First Trust Index Innovative Transaction & Process ETF (BLOK) and is listed in London.

Index construction

The ETF is tracking an index that is operated by Indxx, and the index comprises companies that are either 'Blockchain enablers' or 'Blockchain users.' 'Enablers' are companies such as Nvidia that manufacture chips that are used in the bitcoin mining process as well as many other applications. 'Users' are firms such as Walmart and Barclays that are already taking a lead in incorporating blockchain technology in their operations. (A retail application for blockchain would be to get customers to pay for goods using a blockchain-based loyalty card. That could cut credit card companies out of the transaction and save cash for the retailer and consumer.)

The maximum number of companies in the index is 100, with up to 50 users and up to 50 enablers. Stocks must have a minimum market cap of $250 million. Each stock in the enabler group is equal weighted, and that's also the case for the user group.

So if only ten 'enablers' qualified for inclusion, each enabler stock would comprise 5% of the fund at the rebalancing point. Similarly, if there were only twenty 'users' then each user stock would comprise 2.5% of the fund. After the most recent rebalance, 20 enablers were included in the index along with 62 users. Once the rebalancing has been completed, weightings change as share prices move around.

Interestingly the index construction process isn't completely passive. There is a subjective element as index compilers, for example, review comments made in a company's annual report to see if the business qualifies as an enabler or user. First Trust says that Microsoft is included in the index on the basis of comments made the firm's CEO, Satya Nadella.

Top 5 countries in ETF

Country% of fundUnited States41.2%China7.3%Germany7.0%Taiwan6.7%Japan4.1%

Top 5 sectors in ETF

Sector% of fundInformation Technology67.3%Financials25.0%Industrials3.2%Materials1.6%Consumer Discretionary1.3%

Top ten stocks in ETF

Stock% of fundASUSTek2.8%Intel2.7%Gemalto2.7%IBM2.7%Microsoft2.6%Nordic Semiconductor2.6%Software AG2.6%Taiwan Semiconductor2.6%Cognizant2.6%

It's an interesting range of companies and clearly these are all businesses that aren't just focused on blockchain. So if blockchain proves to be a big fat flop, you aren't going to lose all your money.

Internet index

First Trust cites the success of the Dow Jones Internet Index to try and drum up demand. Between 1997 and 2018, the Dow Jones Internet Index has delivered an annual return of 12.9% beating a pure technology index. That success is probably down to the fact that firms such as Amazon and Netflix have been categorised as consumer firms rather than tech ones.

So, clearly First Trust is trying to plant the idea that the blockchain index will beat a more traditional technology index. And that may prove to be the case. Or not. Either way, you're investing in a range of attractive businesses that aren't ridiculously expensive overall. The average price/earnings ratio for companies in the index is currently 19. The Total Expense Ratio for the ETF is 0.65% which is higher than many ETFs, but you are investing in a fairly specialist fund.

It's certainly one to keep an eye on.

  • Four US Blockchain ETFs

BLOK Amplify Transformational Data Sharing ETF

BLCN Reality Shares Nasdaq Next Generation Economy ETF

LEGR First Trust Index Innovative Transaction & Process ETF

KOIN Innovation Shares Next Generation Protocol ETF

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