Kevin O’Leary Created O’Shares Investments to Limit Volatility

Kevin O’Leary created O’Shares Investments to launch exchange-traded funds that would model his personal investment priorities of producing income, preserving wealth and delivering capital appreciation.

O’Leary, a billionaire who serves as a wealthy panelist on ABC’s “Shark Tank” television program in which entrepreneurs seek funding to grow their start-up businesses, shared his personal investing strategies with me recently when I interviewed him in the Shark Bar at the Palms Casino Resort in Las Vegas. He recalled learning about the value of reducing volatility from a female money manager who analyzed balance sheets to find the stocks that offered the best opportunities to receive income and produce capital appreciation for the least risk.

Paul Dykewicz interviews “Mr. Wonderful” Kevin O’Leary at the Palms Casino Resort in Las Vegas; Photo credit: John Phillips

Since the first of the four O’Shares exchange-traded funds (ETFs) only launched in July 2015, none of them have a long track record that can be used to measure their performance against other ETFs. However, O’Leary said that among the roughly 1,700 ETFs that exist, none adhered to his three core investment principles of income, wealth preservation and capital appreciation, so he decided to launch his own.

Kevin O’Leary Created O’Shares Investments to Provide Income

O’Leary worked with global index partner FTSE Russell, which created innovative rules-based indices for the United States, Europe and Asia to focus on his three core objectives. His inaugural ETF, O’Shares FTSE U.S. Quality Dividend ETF (OUSA), is now listed on the New York Stock Exchange and was envisioned by O’Leary to address his long-term investment objectives of owning a diversified portfolio of quality U.S. stocks that pay dividends and have low volatility.

The low volatility focus is aimed at the preservation of capital to guard against the kinds of market pullbacks that have occurred occasionally since late 2018. In recent months, OUSA has withstood the worst of the fallout from rising trade tensions between the United States and China. In the latest example between July 26 and Aug. 5, OUSA avoided 21 percent of the 5.95 percent fallout absorbed by the S&P 500. Another example occurred between April 30 and June 3, when OUSA sidestepped 35 percent of the 6.61 percent drop endured by the S&P 500.

The key to protect against market pullbacks is to limit balance sheet risk, O’Leary said.

Even though O’Leary told me he does not regard himself as a “value investor,” he said he learned through experience that investing in market downturns requires a focus on companies that offer balance sheet quality.

“It is the only thing that matters,” O’Leary said.

Kevin O’Leary on the floor of the New York Stock Exchange

Kevin O’Leary Created O’Shares Investments to Preserve Wealth

Years of experience in hiring managers to manage his personal wealth on the equity side taught O’Leary about the wisdom of analyzing balance sheets in choosing investments. Many years ago, O’Leary said he became impressed by a female balance sheet analyst who was agnostic about market capitalization and sectors but developed four rules for investing in stocks.

“Each quarter, she would analyze four metrics on a S&P 500 company’s balance sheet,” O’Leary recalled

The first rule is to consider return on assets, which is “an old school” metric which generally takes two quarters to manifest itself either up or down, O’Leary said. It sometimes takes just one quarter if “inventory is piling up,” he told me.

The second rule it to look at free cash flow, while staying agnostic to the cash on hand, O’Leary said. The third rule is to assess leverage to determine whether it is going up or down every 90 days. The fourth rule is to check for volatility against the overall index.

She didn’t care about market cap and instead focused on volatility, O’Leary recalled. With the S&P 500 stocks that she used as her universe of choices for investing with her four rules, the larger the market capitalization, the lower the volatility, he added.

Basically, O’Leary said what he learned from her was that he received the S&P’s returns with 26 percent more yield, 20 percent less volatility and only incurred 62 percent of the downside on the index’s drawdowns.

Kevin O’Leary Created O’Shares Investments with FTSE Russell

“I took her rules and I went to FTSE Russell back in 2015 and I said, ‘Look, I want you to develop an index for me and I’ll buy it from you. I’ll pay you to make it. I want to own it. Here are my rules. Go build.’”

O’Leary said his proposal was rejected with a reply that “we don’t build indexes for a guy. We build indexes that are unique, and we license them back to geographies and currencies,” O’Leary recalled.

When O’Leary said he showed the FSTE Russell officials his rules, they responded, “We have nothing like this. We’ll spend millions developing it. We have 150 researchers and we’ll develop it and we’ll see if we like it or not.” About a year and a half later, they said, “We like it.”

O’Leary said he was offered the opportunity to license use of the index for American stocks in U.S. dollars, but the developer would own it. Even though O’Leary complained that he had given FTSE Russell the rules to use for the index, he was told the index would need to be maintained every quarter with 150 researchers working on it.

The stocks the index includes are only those with the high-quality balance sheets identified by the four rules, O’Leary said. Those holdings also offer “way more yield” than the S&P 500 and “way less” volatility, he added.

“Mr. Wonderful” getting ready to ring the bell at the beginning of the trading session.

Unique ETFs Came from Kevin O’Leary’s Creation of O’Shares

O’Shares FTSE U.S. Quality Dividend ETF (OUSA), which began in July 2015, seeks to track the performance, before fees and expenses, of its target index, the FTSE USA Qual/Vol/Yield Factor 5% Capped Index. The target index is designed to measure the return of the publicly listed large-capitalization and mid-capitalization dividend-paying stocks in the United States. Stocks in this fund need to meet certain market capitalization requirements.

OUSA has $516.5 billion in total net assets, a 30-day Securities and Exchange Commission (SEC) yield of 2.56 percent and an expense ratio of 0.48 percent. The fund’s biggest holdings, as of Aug. 12, were Procter & Gamble (NYSE:PG), 4.99 percent; Exxon Mobile Corporation (NYSE:XOM), 4.75 percent; and Johnson & Johnson (NYSE:JNJ), 4.70 percent. The ETF’s three biggest sector holdings are consumer goods, 15.77 percent; health care, 13.65 percent; and consumer services, 13.59 percent. The ETF’s total return, based on its net asset value (NAV) on Aug. 12, reached 13.79 percent year to date, 9.28 percent in the past year and 9.06 percent in the past three years, according to Morningstar, which rated the fund three stars. In comparison, the S&P rose 16.73 percent year to date, 3.7 percent for the last year and 10.24 percent during the past three years.

Chart courtesy of StockCharts.com

O’Shares FTSE Russell Small Cap Quality Dividend ETF (OUSM) is an ETF that seeks to track the performance, before fees and expenses, of the FTSE USA Small Cap, ex Real Estate 2Qual/Vol/Yield 3% Capped Factor Index. OUSM consists of more than 200 small-cap stocks selected for quality, strong balance sheets and profitability, as well as limited volatility.

Founded on December 30, 2016, OUSM has $95.7 billion in total net assets, a 30-day SEC yield of 2.25 percent and an expense ratio of 0.48 percent. Its top holdings, as of Aug. 12, were information technology companies Leidos Holdings Inc. (NYSE:LDOS), 3.91 percent; Teradyne Inc. (NASDAQ:TER), 2.73 percent; and Cypress Semiconductor Corp. (NASDAQ:CY), 2.39 percent. The largest sectors held by the fund, as of July 31, were information technology, 22.54 percent; industrials, 20.14 percent; and financials, 18.78 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 13.74 percent year to date, but dipped 2.99 percent in the past year, according to Morningstar.

Chart courtesy of StockCharts.com

O’Shares FTSE Europe Quality Dividend ETF (OEUR) is intended to track the performance, before fees and expenses, of the FTSE Developed Europe Qual/VOL/Yield 5% Capped Factor Index that measures the returns of public large-capitalization and mid-capitalization dividend-paying issuers in Europe that meet key market-capitalization, liquidity, quality, low volatility and dividend-yield thresholds. The strategy is designed to limit exposure to high-dividend equities that have incurred large price drops.

Launched on August 19, 2015, OEUR has $24.4 billion in total net assets, a 30-day SEC yield of 3.11 percent and an expense ratio of 0.48 percent. Its top holdings, as of Aug. 12, were consumer goods company Nestle S.A (OTC:NSRGY), 5.53 percent; pharmaceutical company Novartis (NYSE:NVS), 5.07 percent; and pharmaceutical maker Roche Holding AG (OTC:RHHBY), 5.00 percent. The fund’s three largest sectors, as of July 31, were health care, 20.60 percent; consumer goods, 13.96 percent; and energy, 13.33 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 9.57 percent year to date, 0.24 percent in the past year and 2.71 percent for the past three years, according to Morningstar.

Chart courtesy of StockCharts.com

O’Shares Global Internet Giants ETF (OGIG) is designed to mirror the performance, before fees and expenses, of the rules-based O’Shares Global Internet Giants Index featuring some of the largest global companies that gain most of their revenue from the internet and e-commerce sectors. The holdings are chosen to identify quality stocks with growth potential. The ETF’s biggest holdings, as of Aug. 12, were Alphabet Inc., the parent company of Google, (NASDAQ:GOOG); 6.63 percent; Tencent Holdings Ltd. (OTC:TCEHY), 6.15 percent; and Alibaba Group Holding Ltd. (NYSE:BABA), 6.03 percent. The three biggest sector holdings of OGIG, as of July 31, were information technology, 36.93 percent; communications services, 35.33 percent; and consumer discretionary, 27.71 percent. The ETF’s total return, based on its NAV on Aug. 12, reached 25.69 percent year to date but dipped 0.20 percent in the past year, according to Morningstar.

Chart courtesy of StockCharts.com

Diversification Comes from Kevin O’Leary’s Creation of O’Shares Investments

New York-based money manager Hilary Kramer, who heads the Value Authority, GameChangers, Turbo Trader, High Octane Trader and Inner Circle advisory services, said one of the “best things” about the ETF format is the built-in diversification.

“While an expert stock picker can often capture bigger returns, there’s always the chance that a concentrated portfolio of one or two stocks will hit a speed bump while a wider universe keeps plodding along,” Kramer said. “You pick the experience you’d prefer, whether that’s a roller coaster that ends with either bonanza or bust or a slower glide more likely to lead somewhere in between. If you can’t achieve diversification on your own, this is the quick way to get it.”

In addition, many ETFs also “open up access” to stocks that are challenging for U.S. investors to buy separately, Kramer said. Within O’Shares ETFs, one example is the European Large Cap Quality Dividend Fund (OEUR), which includes companies such Nestlé and Roche, she added.

It is hard to get access to companies like these without a foreign brokerage account, Kramer said. The fund obtains exposure to them with a single trade, she added.

Global Internet Giants has several Chinese dot-com companies that U.S. investors otherwise would have trouble trading, Kramer said.

Certain Retirees May Like Kevin O’Leary’s O’Shares ETFs

Bob Carlson, who leads the Retirement Watch advisory service, said the O’Shares ETFs use investment strategies based on well-established research about which stock characteristics result in index-beating returns. Unfortunately, over the last few years, real results haven’t matched the long-term research.

“It will be years before we know if that’s a short-term change or a permanent change in the markets,” Carlson said. “Regardless, investing based on the factors should result in lower risk and volatility, and the O’Shares ETFs have delivered that in their short lives.”

Since the O’Shares ETFs are relatively new, they aren’t widely held and the value of the shares can fluctuate from net asset value, Carlson said. When OUSA was new in 2015, the shares fluctuated from a premium of 0.41 percent to a discount of 0.32 percent, he added. In 2018, the shares ranged from a 0.27 percent discount to a 0.19 pecent premium. OEUR has an even wider range of discounts and premiums to NAV.

Investors who sell shares during a period when other investors are heading to the exits are likely to be trading their shares at a discount to NAV, Carlson said. A mature ETF usually has a much lower variation between share price and net asset value.

In addition, the ETFs have net expenses that are higher than the category average, according to Morningstar.

Mark Skousen, who heads investment advisory services Forecasts & Strategies, Five Star Trader, Skousen High-Income Alert, TNT Trader and Fast Money Alert, said, “You do pay a price for efforts to reduce volatility — higher annual fees.”

O’Leary expressed optimism that investors would look for ETFs such as those at O’Shares to limit volatility in hopes of preserving capital when the markets drop. For investors who like O’Leary’s strategy and don’t mind paying higher-than-average expenses to follow his four rules for investing, his funds offer something that the other approximately 1,700 ETFs in existence currently cannot match.

Publisher’s Note: Special thanks goes to Mark Skousen for inviting Kevin O’Leary of “Shark Tank” to speak at this year’s FreedomFest in Las Vegas. StockInvestor.com and Eagle Financial Publications were premier partners at July’s FreedomFest event. Mark founded FreedomFest in 2007 to bring together the best and the brightest thought influencers from around the world to talk, strategize, socialize and celebrate liberty. With this year’s impressive attendance of 1,920 people, the three-day festival continues to live up to its billing as “the world’s largest gathering of free minds.” You can learn more about FreedomFest by clicking here to reach the official website.

Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business Daily, USA Today, the Journal of Commerce, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz.