To The Moon

Investment Thesis

This article continues my coverage of the SP Funds S&P 500 Sharia Industry Exclusions ETF (NYSEARCA:SPUS), a top-performing ESG fund that satisfies Islamic religious law investing requirements. In January, I rated SPUS a solid "hold" as I expressed my concerns about managers' unique debt screening process but was reassured by the overall portfolio's high quality. Nevertheless, SPUS has continued to perform well, delivering a 9.85% total return since my review and outperforming the tech-heavy Invesco QQQ ETF (QQQ) and its main competitor, the Wahed FTSE USA Shariah ETF (HLAL). As shown below, it's also kept pace with the SPDR S&P 500 ETF (SPY), the benchmark representing its selection universe.

One downside to SPUS is its 0.45% expense ratio, which I find excessive as a non-religious investor, given the number of similarly structured low-fee alternatives. However, I believe it's the best Islamic ESG ETF available because it has a competitive combination of growth and value while maintaining excellent quality. I look forward to discussing these fundamentals in more detail below and answering your questions in the comments section afterward.

SPUS Overview

Strategy Discussion

SPUS tracks the S&P 500 Shariah Industry Exclusions Index, a relatively new Index launched in October 2019. Two months later, on December 17, 2019, SPUS launched and has since amassed $575 million in assets under management. For an ETF with a relatively narrow target market, I consider this impressive. By comparison, HLAL has $452 million in AUM and was launched five months earlier, on July 15, 2019.

According to the Index Factsheet, S&P Dow Jones Indices collaborates with an independent consulting company specializing in global Islamic investment market solutions. The Index follows an industry exclusion method, which means it begins with the entire S&P 500 Index as its selection universe and then excludes companies that engage in specific business activities, including:

1. Advertising related to pork, alcohol, gambling, and tobacco.

2. Media & Entertainment relating to music, television shows, musical ratio shows, and cinema operators (news channels, newspapers, sports channels, children's channels, and educational channels are permitted activities).

3. Financial services (except Islamic banks, financial institutions, insurance companies, or others that pass Islamic and accounting-based screens.

4. Other activities such as pornography, recreational cannabis, and gold and silver trading as cash on a deferred basis.

These exclusions only apply if a company derives at least 5% of its income from these activities. In addition, the Index excludes companies with 36-month average debt-market value of equity ratios greater than 33%. Finally, the Index is float-adjusted market-cap-weighted and rebalances monthly.

Performance Analysis

Since January 2020, SPUS is up 99.37% compared to 86.30%, 118.62%, and 75.95% for HLAL, QQQ, and SPY, respectively. SPUS also had a reasonably high Sharpe Ratio, a standard measure of risk-adjusted returns.

Whether you consider these results impressive depends on how you categorize SPUS. According to a Returns-Based Style Analysis Report produced by Portfolio Visualizer, SPUS' returns mimicked a portfolio comprised of 81.95% large-cap growth stocks compared to 99.16% and 52.58% for QQQ and SPY, respectively. Therefore, while it's not as aggressive as QQQ, it's pretty close, and that will become more evident later as we go through its composition and fundamentals.

SPUS Analysis

Sector Exposures and Top Ten Holdings

The following table highlights sector exposure differences between SPUS, HLAL, QQQ, and SPY. SPUS is 43.70% Technology, which supports a large-cap growth classification. SPUS also has 12.74% allocated to Consumer Discretionary and 10.25% to Communication Services, 10.24% of which is Alphabet (GOOGL) and Meta Platforms (META).

HLAL is also highly concentrated in Technology but has slightly more exposure to Energy and Health Care, two sectors with relatively low valuation ratios. This helps explain the higher "Large Cap Value" allocation in the Returns-Based Style Analysis from earlier, and why SPY is perhaps HLAL's most suitable benchmark.

As of May 16, 2024, Microsoft (MSFT), Apple (AAPL), and Nvidia (NVDA) are SPUS' top three holdings, totaling 28.69% of the portfolio. Total Magnificent Seven exposure is 46.61% compared to 40.96% in QQQ, so SPUS is certainly a highly concentrated play.

SPUS Fundamental Analysis

The following table highlights selected fundamental metrics for SPUS's top 25 holdings, totaling 66.71% of the portfolio. This concentration level is slightly better than QQQ's, indicating that exposure for stocks 11-25 is relatively small. The takeaway is that SPUS shareholders should be comfortable with mega-cap growth stocks, as their exposure is only enhanced due to the religious and debt screens.

Here are three additional takeaways:

1. SPUS' constituents delivered a weighted average 7.80% earnings surprise last quarter, led by 11.40%, 25.61%, and 18.63% beats by Nvidia, Alphabet, and Amazon (AMZN). That's above the 5-7% long-term average for the S&P 500 Index and suggests that large-cap growth stocks are still in charge. I'm encouraged that most top holdings have relatively strong Seeking Alpha EPS Revision Grades, which I've normalized on a ten-point scale in the table above. However, it's also concerning how unbalanced the Grades are from top to bottom. The average score for the top ten holdings is 7.66/10, but 6.45/10 for the remaining 158 stocks. Put differently, there's tremendous pressure for only a handful of stocks to perform well, and if that stops, SPUS and many other large-cap growth ETFs could suffer tremendously.

2. As the earlier Returns-Based Style Analysis Report indicated, SPUS has a growth profile between SPY and QQQ. Specifically, its estimated one-year sales and earnings per share growth rates of 13.62% and 13.90% are below QQQ but above SPY. Similarly, SPUS trades at 30.52x forward earnings (simple weighted average method), 1.71 points less than QQQ but 3.45 points more than SPY. The pattern fits, but growth-at-a-reasonable-price investors might consider calculating a PEG ratio using these figures. By dividing the earnings growth rate into the forward P/E, we get the following:

• SPUS: 2.20
• HLAL: 2.93
• QQQ: 1.98
• SPY: 2.23

Since lower PEG ratios are more favorable, we can conclude that QQQ offers the best combination of growth and value, SPUS and SPY are similar, and HLAL is the least attractive. HLAL's result is surprising, but the fund has 27.60% allocated to Microsoft and Apple, and as shown above, their estimated earnings growth rates are relatively weak.

3. Despite these concerns, I reiterate from my prior review how confident I am that SPUS will succeed in the long run. It's a high-quality fund, and its 9.65/10 profit score ranks #18/57 in the large-cap growth category and #33/850 among all the U.S. Equity ETFs I track. Except for Advanced Micro Devices (AMD), all 25 top holdings have perfect 10/10 profit scores, corresponding to "A+" Seeking Alpha Profitability Grades.

Investment Recommendation

I am satisfied that SPUS' methodology results in high-quality selections, which is its best feature. However, I caution investors that despite its name, SPUS should not be compared to S&P 500 Index ETFs like SPY. My analysis revealed how SPUS is most similar to large-cap growth ETFs like QQQ, and by excluding several hundred S&P 500 stocks that generally have less risk and lower valuations, it relies heavily on a select group of mega-cap stocks. Unfortunately, few choices are available, and HLAL is not attractive now based on its poor combination of value and growth.

For non-religious readers, I can offer low-cost alternatives like SPYG, VUG, MGK, and IWY, all of which have PEG ratios and profit scores higher than SPUS. Otherwise, SPUS is a big fish in a small pond at this point, and assuming you have a high risk tolerance, it's your best option. Therefore, I have maintained my "hold" rating on SPUS, and I look forward to answering your questions in the comments section below. Thank you for reading.