1. Details about the top four uranium ETFs

2. The supply and demand outlook for uranium

3. Valuation by ETF

4. Sub-sector exposure by ETF

5. Mkt cap weight by ETF

6. Country exposure and liquidity by ETF

7. Utility stock valuations

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Why Uranium

The current cyclical uranium bull market started all the way back in 2017, this was the year uranium inventories peaked and Japanese nuclear reactor restarts began accelerating after the 2011 Fukushima nuclear power station accident.

Commodities are characterized and defined by their cyclical nature, these markets are notoriously difficult for investors to consistently profit from.

Conversely, secular bull markets in commodities are what every commodity investor should be looking for - structural demand growth that overwhelms historical cyclical boom and bust cycles.

Nuclear power generation in America has been mired in a 40 year bear market, driven by public perception (Three Mile Island and Chernobyl) and project cost overruns and delays.

However 2024 will likely mark the year the secular uranium bull market was born.

Investor realization that massive amounts of new electricity will be needed to power an AI driven future, coupled with big tech companies announcing historic nuclear power investments has woken up governments and the public to the low carbon potential of nuclear energy once again.

The Investment Case for Uranium

The investment outlook for physical uranium and uranium miners looks bright, driven by a cyclical supply shortage and secular demand growth.

The secular demand growth story is powerful, but it will take time to play out, making the cyclical outlook far more important over the next 2-3 years.

In the here and now, as long as secondary uranium inventories are declining, prices should remain at levels that generate significant free cashflow for uranium producers.

Based on the most current supply and demand outlook according to IAEA and The World Nuclear Association, we have another 12-18 months of shortages and declining inventory before supply catches up to restocking demand from nuclear power plants.

Uranium Supply/Demand Outlook

Source: Bid/Ask Estimates, World Nuclear Association, IAEA

Viewing inventory levels on years of supply instead, the current shortage really comes into perspective.

Fabricated and enriched uranium inventory is dangerously low, less than 6 months left when we exclude the coming year’s requirements, according to the IAEA.

Utilities generally prefer to hold three years of inventory at a minimum.

Shortages in enriched uranium will feed through into mined uranium (U3O8) as conversion and enrichment ramps up to rebuild inventories, drawing down stockpiles of U3O8 at an accelerating pace.

Source: World Nuclear Association

The Uranium ETFs: And Then There Were Four

Achieving diversified, low-cost exposure to uranium may seem straightforward on the surface with only four liquid uranium ETFs currently on the market, however, there are many important differences between each ETF.

We break down these differences below, including an analysis of the implied valuation of each ETF, key information we haven’t seen anywhere else.

Size

The largest fund by far is the Global X Uranium ETF (URA) at $3.5 billion. The other three funds are two run by Sprott (URNM & URNJ) at $1.6 billion and $300 million respectively and one by Van Eck (NLR) at $262 million.

The two smaller funds have gained the most assets over past 12 months on a % basis, but on a dollar basis, URA has added $1 billion, vs $280 million for the other three combined.

Now lets see if larger size also equals better liquidity…

Liquidity

In the case of uranium funds, size equals volume. URA generates $83 million per day in trading volume with URNM at $25 million and both URNJ and NLR close to $6 million.

We want to stress that size and liquidity are far from the only factors you should consider when buying an ETF, but they are worth being aware of.

Sub-Sector Exposure

We wouldn’t fault you for assuming uranium ETFs exclusively own companies directly tied to uranium, but the reality is much different.

The largest ETF, URA, has 29% of the portfolio in companies that do not directly generate revenue from selling uranium. 25% is primarily in industrial companies involved in the construction of nuclear facilities with 4% oddly in companies mining lithium and battery metals.

NLR is even less concentrated with only 45% of the fund directly exposed to uranium sales. The fund owns 13% in heavy construction stocks and the remaining 42% in utilities like Constellation Energy (10% weight).

Visit our good friends over at the Idea Farm for more free, high value research.

Uranium Fundamentals Matter

Even though all of these ETFs are passive and don’t actively pick winners and losers in the uranium space, they follow custom indices with very different levels of exposure across sectors, countries, market caps and valuation.

These ETFs all ignore valuation and focus solely on size and liquidity. While there are good reasons for owning liquid, larger names, we believe it’s short sighted to completely ignore the price per pound you’re paying.

Using current stock market value and uranium resources by company, we calculated a weighted average EV/pound for each fund.

We weren’t surprised to see more large cap exposure equals a higher enterprise value per pound of resource.

If You Want to Own Large Caps You Have to Pay Up

The mix of stocks also had an impact, but in general uranium valuations increase with market cap.

A Word on Utility Valuations

Even though an ETF like NLR has a lower EV/Pound than URA on the uranium miner holdings, don’t forget it also has a big slug of the fund in utility companies, owners of the nuclear reactors.

And utility valuations certainly look stretched, driven by hype around electricity demand from AI workloads.

Looking at the forward P/E according to Bloomberg consensus estimates, the utilities in the NLR fund have all seen significant valuation multiple expansion this year and are trading at a premium relative to historical multiples.

With 42% of NLR assets in expensive utilities and valuations on the mining names also elevated, the other three ETF’s look superior from a valuation standpoint.

Market Cap Exposure

Differences among ETFs are also apparent when looking at exposure by market cap. It’s good to see URNJ is heavily weighted to small caps as the title implies, while URNM has chosen large weights for Cameco, Kazatomprom and physical uranium so the weight in mid and small cap miners is only ~50% vs 100% for URNJ.

URA’S higher weight in Cameco and large caps vs mid-cap explains the higher EV/Pound vs the Sprott products.

NLR is clearly highly geared to large cap industrials and utilities over uranium miners, making it a poor proxy for uranium exposure.

Country Exposure

Political risk is a serious consideration in Uranium with the increasing marginalization of Russia, a major player in uranium processing.

The US has already banned imports of Russian uranium, though is allowing nuclear fuel buyers to obtain waivers until the end of 2027.

While no ETF has direct exposure to Russia, there are lingering questions around how much influence if any Russia has on major producer Kazakstan.

For those who prefer to stay far away from Asia, URNJ has the lowest exposure to the region, with 95% of assets in the USA, Canada, Australia and UK.

The other three ETFs are 78% (URNM), 90% (URA) and 72% (NLR) exposed to those four western countries.

From a theme point of view, owning URNJ is the purest bet on uranium demand moving west. URA and NLR offer similar exposure but more diluted due to low direct ownership in uranium miners. URNM also is a bet on western demand growth, though the 16% weight in Kazatomprom is something to be aware of.

Same Sector, Big Differences

Regular readers of Bid/Ask will notice a trend in the research we’ve put out; funds in the same sector, targeting the same investment themes can have very different holdings, volatility and most importantly return.

The goal of our bi-weekly analysis is to help investment advisors and astute retail investors better target exposures they really want, while avoiding the hidden risks of poorly devised indices and strategies within passive and active ETFs.

Given the secular nature of this uranium bull market, we’ll be following the ETFs in the space closely and will provide periodic updates to our readers.

Coming up Next: 0 Day Options

If you aren’t already a subscriber, now may be a perfect time to become one. For our next next deep dive we are pivoting to an insane corner of the market, zero day option ETFs.

An area of the market that has been dominated by casino retail traders is seeing ETFs swoop in to capture alpha and harvest yield. We break down the strategies and assess their ability to generate attractive returns over time.

Though the focus of that episode was on technology, not AI in particular, over the course of our research we noticed something strange.

All but one of the funds had one thing in common. They didn’t own Meta, Alphabet or Tesla.

and this got us thinking…

Do technology ETF’s have an AI weighting problem?

When three out of the four biggest technology ETF’s, managing over $150 billion for investors, don’t hold owners of some of the largest AI trainer clusters in the world, we start asking questions.

Now in all fairness to these funds they’re simply following their mandate. To track companies classified by the index provider in the “information technology sector”.

According to MSCI, Alphabet and Meta are in communication services while Tesla is in consumer discretionary.

But stepping back beyond financial industry grouping conventions, what should really be considered technology?

According to the dictionary:

Technology is a manner of accomplishing a task especially using technical processes, methods, or knowledge

We would argue computer software and hardware fall firmly under this definition and all three companies have those in abundance.

• Meta recently purchased 350k Nvidia GPU’s all for AI workloads and is installing another cluster of 100k chips by November, making it a top 10 owner of AI hardware.

• Tesla owns 10k Nvidia GPUs and is tooling up another 50k more to train self driving AI. Considering Tesla’s FSD software adds $10,000 of revenue onto a $30,000 car, and much more if you consider the much higher software margin that goes with the FSD sale, its hard to argue AI isn’t critical to Tesla’s future growth.

• And last but not least, Alphabet. A pioneer in AI currently waiting for delivery of tens of billions of Nvidia’s cutting edge Blackwell GPU chips as we speak while also continuing to build its own in house AI silicon.

All three companies are obviously big players in AI and the success of AI products will drive a larger and larger portion of revenue growth in the future. Yet because of wonky classification scheme’s at most index providers, they are excluded from the largest technology funds available to investors.

Bottom Line: The MSCI GICS weighting scheme, used by most investors, is rarely flexible enough to recognize changing business models over time.

Improving Tech ETF’s with More AI?

In this episode we wanted to answer the question: “If Meta, Tesla and Alphabet were in the S&P 500 Technology Index before the launch of ChatGPT, would it have improved historical outcomes for investors in technology funds like XLK, FTEC and VGT?”

Before we get to the results, its critical to understand the regulatory constraints these funds all must follow.

The history of SEC diversification requirements

In 1940 congress passed the investment company act of 1940 to protect investors after the brutal 1929 stock market crash and great depression of the prior decade.

The most important section of the act requires almost all public companies (RICS), including ETFs, to meet two diversification requirements:

1. No position exceeds 25% of the portfolio

2. All positions greater than 5% can’t add up to more than 50% of the portfolio

No public ETF or fund can get around these rules if they want to market to the general public.

These diversification rules are wreaking havoc with many ETF’s. The market is growing more concentrated and these funds are being forced to sell down the MAG 7 stocks, some of the best performing lately.

Keep this rule in mind when picking ETF’s as it matters more than ever…

Results of The Bid/Ask Portfolio Backtest

Did adding Meta, Alphabet and Tesla to the S&P technology index provide a superior outcome for investors?

To test, we went back five years and created a customized S&P technology portfolio with Meta, Alphabet and Tesla added at their corresponding mkt cap weights at the time.

We then ran the portfolio forward letting market caps run unconstrained similar to the Index.

From a performance point of view, the Bid/Ask AI portfolio was an improvement over the index, beating it by 12% over 5 years.

A Look at Risk

We also looked at the beta of the Bid/Ask AI portfolio vs the ETFs to see if adding Meta, Alphabet and Tesla also lowered volatility.

The answer was yes.

The Bid/Ask portfolio had a relative beta of between 0.64-0.71 vs the tech ETF’s.

Adding large caps like Meta, Alphabet and even Tesla seemed to improve both absolute and risk adjusted returns of a technology portfolio.

One interesting observation was that the portfolio’s beta was relatively lower in the last 12 months than the previous 2 years. We know the volatility of the entire market has declined in 2024 compared to 2023, but the results tell us the Bid/Ask portfolio’s volatility declined more than the other ETFs on a relative basis.

Perhaps this was due to the significant decline in volatility for Meta which was ~7.5% of the portfolio to start 2024.

Could we be witnessing the early days of a regime shift where Meta, Alphabet and Tesla end up being a significant positive force in an investor’s AI focused tech portfolio?

If so, the $146 billion of assets sitting in tech ETF’s with zero exposure to these three stocks will fall farther and farther behind, hurting investor outcomes in the process.

Bid/Ask Portfolio Beating Tech ETFs Significantly Through September 17th (YTD)

There isn’t a technology fund on the market that tracks the S&P 500 information technology index AND owns AI champions Meta, Alphabet and Tesla.

However you can roughly recreate this exposure by putting 80% of capital in your preferred tech ETF and another ~20% in Meta, Alphabet and Tesla, weighted by market cap. As of September 18th, Alphabet, Meta and Tesla were 11.7%, 7.8% and 0.65% of the Bid/Ask AI Portfolio respectively.

To help you further differentiate between the technology funds available on the market, we’ve provided a detailed table of useful metrics.

Tech ETF Characteristic Table

Coming Up…

Bid/Ask is just getting warmed up. Next episode we are heading to a different sector of the economy, uranium.

Discussing the investment case, very timely with the three mile island announcement, and analyzing the supply and demand outlook as well as the ETF investment options available to investors.

Subscribe to Bid/Ask as we continue to shine a data driven analytical lens on the ETF industry.

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The efficient market hypothesis (EMH) is behind the meteoric rise in passive investing, now the dominant force in investment management.

EMH is the view that the market always knows best. If you can’t beat the market (ie. active investing) the most prudent thing to do is to join it.

Money in Passive Funds Now Equal Active Funds

The marketing of these passive ETFs has benefitted from the simplicity of the messaging, deliver market-based returns for a low fee - nothing less, nothing more.

However, investors owning passive technology ETF’s, a multi-billion dollar slice of the market, aren’t getting the ‘passive index returns’ advertised on the tin. $146B of technology ETFs are broken in the era of AI, underperforming the index they were supposed to track by as much as 20% since the beginning of 2023.

When Passive Returns Aren’t Up to Snuff

Since the AI boom began (January 2023), 3 of the 4 largest passive diversified technology ETFs ($146B in assets) have underperformed the main benchmark, the market cap weighted S&P 500 Information Technology Index.

These ETFs have underperformed over this period not just by a little, but by a whole lot.  

The Technology Select SPDR ETF, Vanguard Information Technology ETF and Fidelity MSCI Information Technology ETF have underperformed the index by 20%,18% and 17% respectively.

The iShares US Technology ETF is the lone fund to keep up with the index.

Relative Performance of the Largest Tech Funds vs S&P Technology Index (2023-August 2024)

The obvious question is why?

For an industry that should be plain vanilla (market cap weight the holdings), these levels of significant underperformance should warrant plenty of concern for the fund’s investors.

The answer: A perfect storm of mega-cap tech concentration colliding with regulatory rules; with each tech ETF navigating these forces differently, generating very mixed results.

Cheap Comes at a Cost

We peel back the opaque onion in this inaugural edition of Bid/Ask; arbitrary index rules and non-transparent decision making are creating land mines for investors to navigate.

Judging a fund by its fees alone won’t get it done, with the worst performing ETFs above also sporting the lowest fees. Do you really know what you own?

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Tech ETFs are Getting Tripped Up on Mega-Caps

Analyzing the performance attribution of the top three diversified technology ETFs (XLK, VTG & IYW) vs. the S&P Tech Index, the largest drag by far comes from not owning enough Nvidia.

• Technology Select SPDR ETF (XLK, $68B AUM): Underweight in Nvidia cost the fund 13%

• Vanguard Information Technology ETF (VTG, $73B AUM): Underweight in Nvidia cost the fund 9%, while their off-benchmark positions in Visa & Mastercard detracted a further 5%.

• iShares US Technology ETF (IYW, $18B AUM): Underweight in Nvidia cost the fund 6%, while their off-benchmark positions in Google and Meta added 4%.

The performance attribution clearly highlights something has gone off the rails in passive technology investing. Key questions investors should be asking:

• Why has the Nvidia performance drag varied so much for funds that are supposedly all tracking the same industry on a market cap weighted basis?

• Why are passive technology ETFs owning stocks that are outside the technology sector? Google & Meta are in the Communications Services sector, while Visa & Mastercard are in the financial sector.

These are big differences between passive sector funds that should effectively have very similar company names and weights.

Over the last 18 months assets flowed to these ETFs as investors have sought to gain thematic exposure to artificial intelligence (AI), however these significant difference in holdings has led to widely varying sub-sector exposures among mega cap tech stocks.

The weight differentials among ETFs in the semiconductors, software, communications equipment and internet media sub-sectors could certainly lead to continued big performance differences among these funds and relative to the market cap weighted index.

The Nvidia performance drag across all the passive ETFs is related to a historic SEC regulatory rule that limits the top 3 holdings in an ETF to a 50% weight in the overall fund. The mega cap era of technology has tripped this rule.

Bottom Line: The more concentrated the stock market becomes with the mag 7, the more these funds will underperform the index due to these SEC diversification rules.

Of all the funds subject to this rule, the iShares Technology Select SPDR ETF (XLK) is the fund raising the greatest number of red flags, earning it an entire section of this report.

XLK - When Index Rules Go Very Wrong

The iShares Technology Select Sector SPDR ETF (XLK) is a passive juggernaut. $70 billion dollars invested by retail investors and advisors who think they are closely tracking an index of technology stocks in the S&P 500.

But the index XLK tracks, the S&P Technology Select Sector Index, uses a capped weighting methodology, a decision that has critical implications for how the index and the fund behave.

In jargon free terms, the technology select index must keep the top 3 positions under 50% of the portfolio to be in line with SEC fund diversification rules.

You would think S&P would have the top 3 positions at similar weights over time, but instead they’ve made an arbitrary weighting rule that has driven significant underperformance and volatility recently.

Each quarter the S&P committee looks at the fund weights of any position above 4.8% in the index. The 2 stocks with the highest weights are typically left alone as long as they aren’t more than 24% of the index. However the stock with the 3rd highest uncapped weight is cut to 4.5% of XLK regardless of its weight in XLK prior to the rebalance.

Massive Underperformance Ensues

Unfortunately for XLK investors, the weighting scheme devised by the S&P committee has been a disaster for performance ever since the rise of AI.

Comparing XLK to other S&P technology ETF’s that don’t cap weights, or cap them more evenly across the top 3 positions, you can see the stark difference between Jan 2023 vs. early June 2024, just before XLK went through a dramatic rebalance explained more below.

While Nvidia was allowed to run in these other funds, XLK kept reducing the weight to 4.5% the whole way up, driving significant underperformance.

XLK suffered for it, underperforming an uncapped fund like the iShares US Tech ETF (IYW) by 20% over 18 months. And IYW has 214 positions vs XLK’s 67.

Buyers of XLK thought they were getting diversified technology exposure, but in reality, they were making a huge bet in favor of Apple and Microsoft over Nvidia.

10 Billion of Weighting Changes in a Single Day and More to Come?

Due to Nvidia’s big moves through early June Nvidia’s weighting in the uncapped index, which determines rebalances, was 2nd highest, above Apple, even though NVDA was still only 5.9% of the XLK ETF.

This caused XLK to cut Apple’s weight to 4.5% from 21% and raise Nvidia’s from 5.9% to 21%, a massive trade for XLK. This trade, executed in late June, moved $10 billion from Apple to Nvidia in a single day, 70% and 20% of Apple and Nvidia’s daily volume respectively.

This is a case of an index rule gone amuck, 15% swings in security weights in a single day rarely happen, even in active fund management.

With Nvidia down ~7% and Apple up ~7% since the June 21st rebalance, XLK investors are once again taking it on the chin.

XLK in White (June 21st to August 14th)

And a big rebalance like what we saw on June 21st could happen again soon, depending on how Apple, Microsoft and Nvidia perform.

If Apple rises enough over the next few months while Nvidia falls, it could trigger a cut to Nvidia back to 4.5% and billions in buying of Apple.

On top of the big weighting swings, because the S&P makes rebalance changes public before they happen, XLK shareholders are exploited by hedge funds who front run the rebalance. Nvidia outperformed Apple by 8% from June 11th-18th and then underperformed by 3% in the 2 days leading up to the rebalance.

So What is an XLK Shareholder to Do?

In the view of Bid/Ask, if an investor is seeking to own a passive technology fund (ie. market cap based returns) they certainly don’t want the baggage that comes with XLK’s capped weighting scheme.

Periodic 15% swings in the weights of ETF holdings is the literal anthesis of passive investing.

Transparency is a hallmark of passive index investing, however investors won’t find that with XLK. The ETF tracks an index run by a committee with no publicly available investment strategy.

If you think you’re getting disclosure from S&P on how they arrived at these major index rules and changes, you’ll be waiting a while.

Quoting S&P DJI’s own documents:

1. They do not comment on potential changes

2. S&P believes index changes are market moving therefore the index committee discussions remain confidential even after the change has been made.

3. S&P reserves the right to change the index rules at any time

Instead of owning XLK, funds like IYW, FTEC or VGT look like better alternatives… They’re more diversified across technology and apply the capping rule evenly across the top 3 positions. You won’t see the weights of Nvidia, Apple and Microsoft fluctuating 15% in a day like with XLK.

Critically, IYW is the only fund with exposure to the Internet & Media subsector, which includes Meta and Google, major players in the AI race. If you believe in the potential of AI.

Potential Alternatives to Owning XLK

6 Month Volatility by Fund (IYW=White, XLK=Orange, VGT=Green, QQQ=Pink)

IYW

Blackrock’s iShares US Technology ETF is especially unique among the group. It is well diversified but still more concentrated then Vanguard or Fidelity’s offerings with 140 positions.

Most importantly, IYW is the only large passive technology fund that owns Meta and Google which surprised us. These are two of the largest players in AI, a major technology innovation, yet they are unowned by most of the largest passive tech ETF’s on the market.

The fee is higher than other options but IYW has significantly outperformed the other funds since the market started to appreciate the potential of large language models in early 2023. We are talking 0.30% of extra annual fees against 20% of outperformance vs XLK.

VGT

The Vanguard Information Technology Index Fund is the cheapest, not a surprise with a Vanguard product, but is the most diluted with over 300 positions. Looking at performance over the last two years these extra positions have hurt not helped the fund, and have not lessened drawdowns vs the other funds (See comp table above).

VGT is also more weighted than peers to small cap tech. The median mkt cap is $10 billion vs $46 billion for XLT.

Bid/Ask: There’s Much More Sleuthing to be Done

If you think a $70bn “passive” ETF swinging 15% of assets in one day is wild… we’re just scratching the surface of sloppy index rules and outright mismanagement - the rabbit hole goes deep.

Subscribe to Bid/Ask as we continue to shine a data driven analytical lens on the ETF industry.

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