Meet the Innovation Shares NextGen Protocol ETF (NYSEMKT: KOIN), a new exchange-traded fund that bills itself as the first ETF to use artificial intelligence to pick stocks that should benefit from the adoption of blockchain technology.
The new ETF follows in the footsteps of Amplify Transformational Data Sharing ETF (NYSEMKT:BLOK) and Reality Shares NASDAQ NextGen Economy (NASDAQ:BLCN), two blockchain ETFs that have already amassed $185 million and $101 million in assets, respectively.
Here's what you should know about Innovation Shares' new blockchain ETF before entrusting it with your hard-earned money.
How the Innovation Shares NextGen Protocol ETF picks stocks
An ETF is only as good as the index it seeks to track. This particular ETF relies on the Innovation Labs Blockchain Innovators Index, which uses a "natural language processing" algorithm to decide which stocks have exposure to blockchain, ultimately breaking them down into four groups:
- Cryptocurrency payees: Companies that accept cryptocurrencies as payment for products or services and are developing blockchain payment solutions.
- Mining enablers: Companies that make hardware used to create new blockchains or mine cryptocurrencies as a main business line.
- Solutions providers: Companies that assist others in the creation and use of blockchain applications.
- Blockchain users: Companies that primarily use blockchain technologies to create internal efficiencies, optimize processes, enhance customer experience, and/or increase data security or integrity.
It also has a few other rules (stocks must trade on major exchanges and have a minimum market cap of $100 million for inclusion), but such rules are boilerplate. They're common among ETFs that want to avoid the risk of plowing money into stocks that simply aren't liquid enough to buy and sell without moving the market.
The index was obviously designed to give a lot of room for inclusion, since there are very few true blockchain stocks on the market today. The fund admits this in a regulatory filing, stating in no uncertain terms that "there are few public companies for which Blockchain technology represents an attributable and significant revenue stream," hence why it has to cast a wide net to find worthy stocks. (In case you were wondering, that text is in bold in its regulatory filings, too.)
What this blockchain ETF actually owns
To be absolutely clear, this fund does not and will not own cryptocurrencies directly or indirectly (you can rule out bitcoin futures and the sort-of bitcoin ETF), nor will it invest in initial coin offerings (ICOs). This is a pretty ordinary stock ETF that tries to invest in public companies that will theoretically benefit from block chain technology -- nothing more.
The "natural language processing algorithm" this ETF ultimately relies on was set loose to find good blockchain stocks, but it appears it just copied off a tech ETF's homework. It shares 31% of its portfolio with the market's largest tech ETF.
As of Jan. 30, 2018, the Innovation Shares NextGen Protocol ETF's largest holdings were as follows:
|Top 10 Holdings||Portfolio Weighting|
|Total in the top 10||57%|
Realistically, it's hard to believe that Amazon.com or Microsoft have any real, needle-moving exposure to blockchain, but Visa and Mastercard really stick out to me as bad blockchain stocks. I'd argue the payment networks are stocks you'd buy if you wanted to short blockchain, not stocks to buy if you believe blockchain is here to stay as a method of making payments.
The fund holds only 34 different investments, so like most theme or sector ETFs, it's pretty concentrated in its largest positions. Note that information technology companies make up approximately 70% of the portfolio, broadly defined, while consumer discretionary (10%) and financials (7%) make up the majority of the remainder, according to ETF Research Center.
Interestingly, this fund doesn't have much in common with existing blockchain ETFs. It has only 37% portfolio overlap with the actively managed Amplify Transformational Data Sharing ETF and 31% overlap with the passive Reality Shares NASDAQ NextGen Economy ETF, according to ETF Research Center. For comparison, the two largest tech ETFs have 86% overlap, since everyone largely agrees on what is or isn't a tech stock. No one seems to agree on what is or isn't a blockchain stock.
What it costs
The Innovation Shares NextGen Protocol ETF borrowed a trick out of the playbook of the Amplify Transformational Data Sharing ETF by temporarily waiving fees to reduce the reported cost of holding the fund.
The fund carries a gross annual expense ratio of 0.95%, but it temporarily waived 0.30 percentage points of the fee. Thus, the fund currently carries a net annual expense ratio of 0.65%, which is the lowest of any blockchain ETF, but not by much. From the least expensive blockchain ETF to the most expensive, the difference is just 0.05% of assets annually. Stock picking, not fees, will drive differences in performance.
Frankly, I'm not a big fan of ETFs that use temporary fee waivers, since the waiver can be reversed at a later time, resulting in higher costs for investors who may not be paying attention to what the fund actually costs. The fee is only contractually set at 0.65% until March 31, 2019, when the fund manager could decide to roll back the fee waiver. At the full price of 0.95% per year, this passive ETF would carry a fee higher than the average fee paid on actively managed mutual funds!
It's possible that the manager will keep the fee waiver in perpetuity, since ETF fees have almost universally moved in one direction -- down. That said, anyone who invests in this ETF should know that the fee could rise significantly if the waiver is reversed in 2019 or thereafter.
Is this blockchain ETF fit for your portfolio?
I'm not sold on the idea of paying 0.65% in annual fees for an ETF that is mostly made up of large-cap tech stocks. Looking through its portfolio, I had to go all the way down to its smallest holding, Overstock.com at a minuscule 0.05% weighting, to find a company that I believe has real, meaningful exposure to blockchain.
Though blockchain ETFs are far from perfect, Innovation Shares' ETF has the least exposure to blockchain stocks, in my view. And while I'd pass on all blockchain ETFs, I tend to think this one is especially dubious based on its portfolio of companies that are unlikely to see any tangible impact of blockchain on their bottom lines.