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Investment Thesis
The Invesco Dynamic Retail ETF (ticker: NYSE:PMR) is an actively managed strategy that invests in companies principally engaged in operating general merchandise stores. Examples of these brick-and-mortar storefronts include department stores, warehouse clubs, home improvement stores, and discount stores. Per its most recent fact sheet, PMR’s management team “thoroughly evaluates companies based on a variety of investment merit criteria, including: price momentum, earnings momentum, quality, management action, and value.” Though most investors would understandably hesitate in investing in retail stocks right now, PMR’s approach is unique.
The most intriguing aspect to PMR’s strategy is its resistance to Amazon (i.e. online retailers), based on its top 10 holdings which comprise ~50% of total holdings. Therefore, investing in companies that have brick-and-mortar operations and a business model that resists online competition is a solid approach to investing in the retail sector. In addition, Amazon is often a large holding in most passive indices, including the S&P 500 index (~3%), the S&P 500 Consumer Discretionary sector (~24%), and the S&P Retail Select index (~1.5%). Therefore, investing in PMR provides access to the retail / consumer discretionary sectors while also providing diversification away from Amazon (assuming investors have Amazon stock individually or passively through funds).
Furthermore, PMR is a relatively defensive approach to retail versus similar strategies. Auto parts retailers, discount stores, and consumer staples companies comprise a material portion of overall holdings. The defensive nature to PMR’s strategy is in stark contrast to its passive peers, where highly cyclical stocks comprise a majority of the S&P Consumer Discretionary and Retail indices. For the purpose of this thesis, the SPDR S&P Retail ETF (NYSE:XRT) will be used as a reasonable benchmark and reference point for PMR’s strategy.
Fund Overview – as of 3/29/19
[source: PMR website]
Key Stats
Top 10 Holdings
In analyzing PMR’s top 10 holdings, it is abundantly clear that it is a highly concentrated strategy which will likely be more volatile than its passive peers. Again, these ten holdings highlight PMR’s strategy to build a portfolio resistant to Amazon. Lululemon (LULU) and Abercrombie & Fitch (ANF) are brands, not retailers, but provide consumers with a storefront presence. Ross Stores (ROST) and Dollar General (DG) can be a bit susceptible to online retailers, though its “treasure hunt” business model and highly discounted products differentiates itself a bit. AutoZone (AZO) and O’Reilly Automotive (ORLY) provide products and services that will be very difficult to replicate solely online. Even though Walmart (WMT), Home Depot (HD) and Kroger (KR) are direct competitors with Amazon, solvency concerns are currently limited relative to other retail stocks (i.e. department stores, specialty retailers, etc). Finally, Etsy (ETSY) has a unique business model that does not compete directly with Amazon.
Even though the brick-and-mortar retail sector is extremely susceptible to online competition, PMR has built a strategy that provides limited exposure to such competitors (at least, relative to its passive peers).
Portfolio Composition
PMR’s portfolio has an 80% allocation to the consumer discretionary sector and a 20% allocation to the consumer staples sector. As previously mentioned, its consumer discretionary exposure is relatively defensive. For example, AutoZone, O’Reilly Automotive, and Dollar General sum to ~15% of the overall portfolio, yet are categorized as consumer discretionary. An argument could be made that these businesses are non-cyclical (or at least significantly less cyclical than the average consumer discretionary company). In addition, stocks such as Ross Stores and Etsy – which combined contribute to an additional 8% of the portfolio – are likely less cyclical than other department stores / retailers.
PMR is 100% allocated to U.S. stocks and its market cap exposure is diverse:
[source: PMR fact sheet; as of 12/31/18]
Performance
In the chart above, PMR’s performance is compared to XRT, a proxy for the S&P Retail sector and an appropriate benchmark for PMR’s strategy. Over the intermediate term, PMR provided investors with excess returns over the benchmark, though its long-term returns materially underperformed. The long-term underperformance of PMR (relative to XRT) primarily corresponds to the market rebound after the financial crisis. In 2009, XRT’s total return was ~78% vs ~30% for PMR – and in 2010, XRT’s total return was ~37% vs. ~24% for PMR. Cumulatively in those two years, an investment in XRT returned ~145% while an investment in PMR returned ~60%.
For reference, the performance tab on PMR’s website highlights the S&P Composite 1500 Retailing Index as its primary benchmark.
Risks
Liquidity
A significant risk associated with an investment in PMR is the lack of trading liquidity. The 90-day average volume for the ETF is about 2,000 shares – which translates to about $75,000 per day of total transaction value. In addition, its Bid-Ask spread is typically wide, and PMR’s price can differ materially from its NAV / Indicative Intraday Value (IIV). Therefore, it is highly recommended that investors be very careful when building or liquidating positions in PMR, and use limit orders accordingly. Please refer to your respective broker/dealer for further information.
Concentration
As previously mentioned, PMR is a highly concentrated portfolio. At any given time, it will invest in about 30 different stocks versus 95 holdings within the passive S&P Retail Index. As most investors know, concentrated strategies provide greater potential for alpha but encompass greater volatility along the way.
AUM
PMR’s net asset base is quite low: ~$7.5mm. The primary concern associated with low asset bases in ETFs is the typically high expense ratio, due to the fixed costs associated with managing ETF portfolios. PMR’s expense ratio (0.63%) seems reasonable relative to its passive ETF peers and actively managed fund peers. But PMR is more susceptible to increasing fees than funds with larger asset bases, which is still a risk for investors, nonetheless. There is also a possibility that PMR might dissolve since its asset base is quite low; however, this should not have a material impact on the performance of the fund.
“Amazon Risk”
Though PMR seems to be the best approach to the brick-and-mortar retail sector, in terms of its resistance to Amazon, it is not completely in the clear. There are several holdings that currently and directly compete with Amazon (and other online retailers). In addition, it can be assumed that Amazon (or other online retailers) will eventually compete directly with other holdings in the future. Therefore, PMR (and its retail investment peers) are indefinitely susceptible to the secular movement towards online shopping.
Conclusion
The primary purpose of this investment thesis is to highlight an intriguing, actively managed ETF strategy for those investors that are searching for exposure to the retail sector. The decision regarding whether the retail sector looks like an attractive opportunity should be considered prior to investing in PMR. However, if investors conclude so, then PMR’s approach to the sector seems relatively enticing. In addition, for those investors that have exposure to Amazon individually or though other passive investments, PMR provides diversification benefits to the retail sector.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information presented is based upon sources and data believed to be accurate and reliable.
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