Lyxor MSCI USA ETF Dist A/I USD (LSE:USAU) - ETF price


ETF Report

Lyxor MSCI USA UCITS ETF Dist (USD) USAU

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PortfolioConstruction

The MSCI USA Index is weighted by free-float-adjusted market capitalisation. The index contains 600-plus large- and mid-cap constituents and covers 85% of the free-float-adjusted market capitalisation in the US. The index is reviewed quarterly but can be adjusted at any time if a significant corporate action occurs. New size cutoffs are recalculated semiannually. To control portfolio turnover, buffers are used for existing constituents so that they are not immediately removed upon falling out of line with any of the index’s entrance criteria. The index is broadly diversified by industry. The most significant sector exposures are information technology (20%), financials, healthcare, and consumer discretionary (10%-15% each). There is limited portfolio concentration, with the top 10 positions accounting for about 15%-20% of the total. Top holdings include Apple, Microsoft, Amazon.com, and Facebook (2%-4% each).

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Fees

The Lyxor MSCI USA ETF has an ongoing charge of 0.25% (cut from 0.30% in 2015), which is in the middle of the range for ETFs tracking the MSCI USA Index. While the fund is cheap relative to active funds in the US large-cap category, MSCI USA-tracking funds are typically more expensive than funds tracking the S&P 500. The annual tracking difference (fund return less index return) during the three years ended February 2019 has been 0.36%, indicating that the ETF has outperformed its benchmark thanks to swap enhancements passed on by Societe Generale to the fund. Meanwhile, the annualised tracking error during the past three years has been very low, below 0.03%. Other costs carried by the unitholder include trading costs when buy and sell orders are placed for ETF shares, including bid-ask spreads and brokerage fees.

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FundConstruction

Lyxor MSCI USA ETF uses synthetic replication to capture the returns of the MSCI USA Net Return Index (which includes dividends reinvested net of tax). Instead of investing directly in the components of the index, the ETF enters into a swap agreement with counterparty and parent bank Societe Generale. In this transaction, the ETF uses investors' cash to buy a substitute basket of securities and exchanges their return for that of the MSCI USA Net Return Index (plus or minus a spread). Lyxor targets zero counterparty risk exposure. The swap is therefore reset whenever its value becomes positive. Swaps may sometimes have a negative value, which is equivalent to an overcollateralisation of the fund. The substitute basket, which can change daily, consists of stocks with a minimum average trading volume and market capitalisation, including stocks from indexes such as MSCI Developed World, MSCI Emerging Market World, MSCI Developed World Small Cap, Stoxx Europe 600, and FTSE 250. The fund's holdings are monitored daily and held in a segregated account at Lyxor's custodian, Societe Generale Security Services.

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Suitability

We are convinced that Lyxor MSCI USA ETF will outperform its Morningstar Category peers over the long term. However, there are cheaper alternatives with similar investment propositions that track US large-cap benchmarks. While the fund’s higher fee relative to other passive funds has not impaired the fund’s returns, it weighs on the fund’s outlook and limits our Morningstar Analyst Rating to Silver.  

With roughly 100 more constituents than the S&P 500, the MSCI USA Index provides equally broad and diversified exposure to US large-cap stocks. A solid body of evidence shows that it is difficult for active managers to consistently outperform U.S. large-cap benchmarks. As such, taking a passive approach for this exposure is sensible. 

Since its inception in 2006, the exchange-traded fund's risk-adjusted returns have ranked at the top of the first quartile relative to its category, which includes both active and passive funds over three-, five-, and 10-year periods.

In terms of tracking performance, similar to most funds tracking the MSCI USA Net Return Index, Lyxor MSCI USA ETF outperformed its benchmark. Such positive tracking difference is also attributable to enhancements achieved by swap counterparty Societe Generale. Meanwhile, tracking error has been very low.

At 0.25% (cut from 0.30% in 2015), this fund's cost lands in the middle of the range compared with other passive funds tracking the MSCI USA Index. While the fund's ongoing charge remains low compared with the category, MSCI USA-tracking funds are typically more expensive than funds tracking the S&P 500. 

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Fundamental View

Over its history, the MSCI USA, similarly to the renowned S&P 500, has proved a difficult hurdle for many US large-cap equity fund managers to clear. Many attribute active managers' collective struggles to beat index funds to the overall level of efficiency of the market for U.S. large-cap stocks. Efficiency in this case is meant to indicate the speed and precision with which market participants incorporate new information (economic news, earnings data, and so on) into stock prices (by selling on bad news, buying on good news). Furthermore, given advances in information technology and the growth in the portion of investable assets that is managed by an increasingly skilled set of professional investment managers, it can be argued that the market has become ever-more efficient over time. However, market efficiency alone does not explain the long-term success of broadly diversified market-capitalisation-weighted index funds.

The second leg of the investment thesis for index funds is their cost advantage. Index funds are inherently less expensive to manage than actively managed alternatives. Their sponsors don't have to pay teams of well-educated and highly credentialed portfolio managers and investment analysts to identify under- or overvalued stocks to be added to or sold from their portfolios. Also, market-cap-weighted index funds have lower turnover relative to actively managed funds. Turnover entails costs such as commissions, bid-ask spreads, and market-impact costs that add to the headwinds that active strategies face. Taken together, these costs are the largest and most persistent drag on the performance of actively managed strategies.

That said, market-capitalisation-weighted indexes like the MSCI USA have some noteworthy drawbacks. By owning "the market," investors are relying on other market participants to price stocks on their behalf. Over long stretches of time, market participants have done a decent job of valuing stocks, but these long horizons have also been marked by episodes of mania and panic. Market-cap indexes are prone to bubbles, as they naturally overweight stocks that have gone up in price and underweight those that have been beaten down. For instance, during the dot-com boom of the late 1990s, the MSCI USA Index was largely exposed to technology, media, and telecom stocks, which ultimately cratered. When the bubble finally burst, the flagship index fell by more than 40% and took four years to return to its precrash value. 

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Alternatives

Various ETF providers offer products that aim to track the MSCI USA Index, including (but not limited to) UBS, Xtrackers, and Amundi. Xtrackers MSCI USA Index UCITS ETF offers the lowest ongoing charge of 0.07%, but it does not distribute dividends. Income-seeking investors may consider the physically replicated UBS MSCI USA ETF at an ongoing charge of 0.14%.

As an alternative to the MSCI USA, there are other indexes with exposure to the US equity large-cap equity market, including the S&P 500, which has 100 fewer holdings but similar sector exposure. With an ongoing charge of 0.07%, the physically replicated Vanguard S&P 500 ETF is also a good option.

For alternatives to market-cap-weighted exposure to US equities, investors can turn to strategic-beta funds. However, it is important to understand that all these strategies can experience long periods of underperformance relative to the broad market. 

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