Cash in on the Spinoff Craze With This ETF

Cash has been piling up on corporate balance sheets since before the financial crisis and S&P 500 companies now hold combined liquid assets of nearly $1 trillion. So in a sluggish economy like this one, it would be reasonable to expect cash-laden companies to allocate huge sums to acquisitions as a relatively easy way to “buy” growth.

That certainly has been happening, but many firms are taking the opposite path to growth — spinoffs.#-ad_banner-#

The point, for those less familiar with spinoffs, is to streamline a company by carving out struggling or less profitable segments and forming them into totally independent entities. On Oct. 4, 2011, for example, Fortune Brands Inc. completed the spinoff of its home security products business as Fortune Brands Home & Security Inc. (NYSE: FBHS). The remaining business was appropriately renamed Beam Inc. (NYSE: BEAM), since it’s now a pure-play spirits maker best known for its Jim Beam bourbon.

Sometime in 2013, the well-known businessman Rupert Murdoch plans to break his newspaper, media and entertainment conglomerate News Corp. (Nasdaq: NWSA) into two companies by making the underperforming newspaper unit into a separate entity. Also next year, pharmaceutical giant Pfizer Inc. (NYSE: PFE) will be carving out its struggling animal health unit. The shares will become available in an initial public offering with an estimated total value of about $100 million.

The reason I’m telling you all this: Spinoffs can present opportunities to invest in potentially profitable but out -of -favor businesses that can quickly skyrocket before the rest of the market realizes their worth. Once fully independent, a spinoff no longer has the protection or resources of the parent firm and must thrive or perish. Those that thrive can make shareholders a lot of money. During the 13 months since Fortune Brands Home & Security was spun off, for example, shares have jumped 136%.

But the thing is, spinoffs can also be highly risky, because they generally have no history of independent operation. Even though they used to perform well enough to survive as part of a larger firm, they may prove incapable of surviving, let alone thriving, on their own.

So if you’re looking for a way to profit from the spinoff trend, but don’t want to be vulnerable to the risk involved,  then consider using an exchange-traded fund (ETF) called Guggenheim Spin-Off (NYSE: CSD). This ETF eliminates the guesswork and provides diversification by holding a basket of spinoffs.

The fund mimics the Beacon Spin-Off Index of stocks that have market capitalizations of less than $10 billion and were spun off within the past 30 months. The company that created the index, Beacon Indexes LLC, defines a spinoff as any company resulting from: 1) the distribution of stock of a subsidiary to parent company shareholders or 2) partial initial public offerings in which a parent company sells a percentage of the equity of a subsidiary to the public.

Like the index, Guggenheim Spin-Off’s holdings currently include 24 small and mid-cap stocks that meet this definition. Among them are Fortune Brands Home & Security and the Cablevision Systems Corp. (NYSE: CVC) spinoff Madison Square Garden Co. (Nasdaq: MSG), which now owns New York City’s Madison Square Garden arena, basketball and hockey teams, regional sports channels and Radio City Music Hall. Another well-known fund holding is TripAdvisor Inc. (Nasdaq: TRIP), a provider of travel reviews that used to be part of online travel giant Expedia Inc. (Nasdaq: EXPE). The fund’s 0.65% expense ratio is reasonable.

Guggenheim Spin-Off’s Top 10 Holdings

Guggenheim Spin-Off has been generating market-beating returns recently, posting a three-year annualized rate of return of 17.4%, compared with 11.6% for the S&P 500. The fund was slightly less volatile than the S&P 500 (typically by about 7%) during the same time.

Risks to Consider: While the most recent crop of spinoffs has propelled Guggenheim Spin-Off Index far ahead of the market during the past three years, there’s no guarantee the future will see a repeat performance. Spinoffs can be highly speculative. 

Action to Take –> There are two main ways to use Guggenheim Spin-Off: To gain the broadest possible exposure to the spinoff arena or as a source of investment ideas if you prefer to invest in individual stocks. The latter strategy is obviously much more speculative, since individual stocks are typically riskier than more diversified funds.

If you invest in the ETF, then be prepared for the possibility of more volatility than it has shown during the past few years. New additions to the fund’s benchmark may display far more price variation than existing components and could ratchet up risk, especially when less volatile components are no longer eligible to be in the index and are eliminated.