Modern portfolio theory suggests investing in a diverse basket of assets can reduce riskiness and enhance risk-adjusted returns. But in some cases, investors prefer to limit their sector exposure. For example, the failure of several small banks (and Credit Suisse) in early 2023 led some investors to shift banking exposure from smaller to larger entities.
In this article, we’ll look at the first of several upcoming active ETFs helping investors maintain precise sector exposure.
See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.
Invest in Large & Liquid Banks
The Roundhill BIG Bank ETF (BIGB) is the first of six active ETFs the issuer plans to launch using derivatives to create a portfolio mimicking the performance of a basket of a sector’s largest and most liquid stocks.
The initial BIGB ETF holds a portfolio representing the equal-weight performance of six of the largest U.S. banks, including Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo. In particular, it will hold 20% direct ownership of individual equities and 80% exposure using swap agreements.
The goal is to provide precise access to the most important banks without the dilutive exposure of many sector funds. At the same time, the fund mitigates single stock risks and eliminates the need for a manual rebalancing of a non-ETF stock portfolio. The result is a quick and easy tool to achieve precise exposure during any market cycle.
Additional Sectors Coming Soon
Roundhill plans to launch five other active ETFs providing similar concentrated exposure to significant sectors. Like banking sectors, these funds aim to provide access only to the largest and most liquid companies in these sectors, enabling investors to achieve a purer exposure without any dilutive exposure.
These funds include:
- Roundhill BIG Tech ETF (BIGT)
- Roundhill BIG Airlines ETF (BIGA)
- Roundhill BIG Defense ETF (BIGD)
- Roundhill BIG Oil ETF (BIGO)
- Roundhill Big Railroad ETF (BIGX)
The Roundhill BIG Bank ETF (BIGB) has an expense ratio of 0.29%, lower than the average 0.50% to 0.75% expense ratio for active ETFs. However, these expenses are significantly higher than many passively-managed ETFs. So, investors should balance their willingness to assume expenses with their desire for an auto-rebalanced portfolio.
Addressing Tax Challenges
The IRS and SEC require at least 50% of the value of a fund’s total assets to consist of cash, government securities, or other securities to qualify for the favorable tax treatment of a regulated investment company (RIC). However, these other securities must adhere to several diversification requirements to be eligible for the desired tax treatment.
In particular, a single issuer may not:
- Amount to more than 5% of the value of the fund’s total assets or represent more than 10% of the issuer’s outstanding voting securities
- Amount to more than 25% of the fund’s total assets invested in securities, any one issuer, or the securities of two or more issuers the fund controls in the same business
Roundhill uses swap agreements to meet these diversification requirements and qualify for favorable tax treatment. Using swap agreements and forward contracts, the fund anticipates gaining exposure to a concentrated portfolio of equities while complying with the IRS and SEC rules governing diversification.
The Bottom Line
Roundhill’s unique derivative-based strategy paves the way for highly-concentrated portfolios of sector leadership. Using these funds, investors can achieve precise exposure to sectors without the dilutive effect of smaller companies. And unlike building their own portfolios, these ETFs are automatically rebalanced and kept up to date.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
