ETFs have totally altered my investment strategy. Where there used to be mutual funds, with their mail-in investments and redemptions and high expense ratios, now there are ETFs that are much cheaper and can be traded in seconds via my brokerage account.
There used to be little hope of mirroring an index or finding a basket of interesting stocks that could fill out your portfolio. Now, ETFs come in all shapes and sizes, allowing investors to build out a truly diversified portfolio not only according to sector or asset allocation, but also diversified within that sector or asset allocation.
That brings me to the concept that ETFs, like stocks, can be undervalued. Some ETFs trade at a discount to their net asset value, meaning the price of the ETF is actually below that of the value of all the securities it holds.
This situation may exist for many reasons, but the most likely culprit is usually investor sentiment. For whatever reason, a given sector or asset class represented by an ETF is out of favor. Here are three ETFs trading at a discount to their NAV worthy of consideration.
The first choice is First Trust RBA American Industrial Renaissance ETF (NASDAQ:AIRR) The ETF has 41 holdings and an annualized yield of 0.66%. It’s an interesting little basket of stocks in industrial and manufacturing sectors, along with community banking. The notion is that trends that drove US companies overseas have reversed in certain cases, and that is creating an new “industrial renaissance.”
These are mostly small- and mid-cap companies, and I think it’s a very intriguing way to play some fundamental economic elements in the American economy. In many ways, it’s an actively managed index since the stocks that are chosen by way of a proprietary methodology.
I suspect it trades at a 5.2% NAV discount for two reasons. First of all, it was only launched ten months ago and I don’t think the ETF is widely known, tamping down demand. Second, I think there remains a lot of skepticism about American manufacturing truly being able to compete.
First Trust NASDAQ ABA Community Bank Index Fund (NASDAQ:QABA) holds 143 stocks, yields 1.24%, and trades at a 5.9% discount to NAV. Like the one mentioned above, this is a relatively new ETF, which is one reason for the discount.
The ETF invests, as its name implies, community and small banks in the US. I think there’s an inherent bias against small banks ever since the financial crisis. “Small” seems to equate with “unstable,” which is a pretty broad generalization, and another reason for the discount.
I think investors are probably a lot more comfortable, ironically, buying the big financials and big banks, even though those were the ones that were more likely to fail.
The ETF is heavy on California regionals, with a median market value of $663 million. Still the ETF was up over 30% last year, and that was better than many big financial ETFs. So the discount here makes this seem like quite a value.
The third choice is very highly targeted, and I suspect is overly concentrated, which is why it trades at a discount. First Trust ISE Cloud Computing ETF (NASDAQ:SKYY) is an ETF with 39 holdings, trading at a 3.74% NAV discount.
Cloud computing is all the rage now, although this ETF has been around for three and a half years. In this case, I think you are looking at a pure-play that has a lot of investors spooked because it isn’t diversified enough. Its return since inception is about 10% annualized compared to more than 15% for the S&P 500. People perceive tech stocks as being riskier, and I think they are skittish about being so concentrated.
Nevertheless, there may be some upside here as I think tech is poised to do well in 2015 as energy stumbles and investors look for alternatives.
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