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What's in Store for Buyback ETFs Ahead?

Stocks with an increased buyback are usually investors’ favorites. With a low interest environment commanding most developed economies including the U.S., buybacks should surge and the related ETFs should beat out the broader market benchmark. But this did not happen in reality. In the last one year (as of May 3, 2016), buyback ETFs underperformed the S&P 500 based ETF SPY.

During this frame, SPY lost 0.08% while buyback-oriented ETFs lost in the range of 6% to 7%.  Let’s find out why?

Buybacks lower the outstanding share count and thus increase earnings per share. Having said this, if companies are buying back their own shares at steep prices and accessing the debt market to finance that buyback, the move is less likely to be helpful, as indicted by Market Watch

After all, S&P 500 (ex-financials) companies’ cash position remained decent, but probably not great. Cash and short-term investments balance of those companies was $1.44 trillion at the end of Q4 (ended in January 2016), down 0.5% year over year. On a quarter-over-quarter basis, the figure was flat, as per Factset. Of the nine sectors, seven recorded a year-over-year decline in their cash balances (Utilities sector was flat year over year) (read: 4 Sector ETFs at a Bargain).
 
Moreover, the market was guilty of overvaluation concerns, forcing companies to repurchase their shares at higher prices than what they are actually worth. Probably this is why a waning momentum was seen in the buyback activity.
 
Dollar-value share repurchases were $568.9 billion on a trailing 12-month basis (TTM), representing a 0.5% decline year over year and flat with Q3 (August–October), as per Factset. In Q4 (November-January), dollar-value share repurchases were $136.6 billion, up 5.2% year over year but down 13.5% from Q3.
 
The splurge on buyback has been the main driver of the market rally lately. If this activity cools down ahead, the broader market will likely feel the pain. Moreover, the Fed entered the policy tightening era in December 2015. Though the central bank is presently staying dovish on global growth issues, sooner or later the market will see further hikes in rates. And then, financing buybacks through debt would not be an easy task (read: ETFs that Won & Lost Post Fed Meet).
 
So, investors should now be cautious while playing buyback ETFs. There are a couple of ETFs that focus on this niche strategy. PowerShares Buyback Achievers Portfolio (PKW) is the most popular fund in the space managing an asset base of $1.64 billion and trading in good volumes of 210,000 shares a day.

PKW tracks the NASDAQ US BuyBack Achievers Index, which comprises companies that have repurchased 5% or more of their common stock in the trailing 12 months. The fund holds a basket of 232 stocks and charges 64 basis points as fees (see Total Market (U.S.) ETFs here).
 
Another buyback ETF SPDR S&P 500 Buyback ETF (SPYB) tracks the performance of the top 102 stocks with the highest buyback ratio in the S&P 500 over the last 12 months. The fund charges 35 bps in fees. The fund has about $9.4 million in assets.
 
In Conclusion
 
Having said this, we would like to note that both the ETFs outperformed SPY in the last three months (as of May 3, 2016). So, it can be said that the languishing trend has recovered to some extent. Also, both SPYB and PKW have a decent relative strength index, below 50. This indicates these funds are yet to reach the overbought levels. The products can thus be played for a few more days, though with a strong stomach for risks.

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SPDR-S&P500 BB (SPYB): ETF Research Reports
 
PWRSH-BYBK ACHV (PKW): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
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