A peek at the restaurant menu

August 30, 2017 01:13 PM

Since the  presidential election in November 2016, restaurant stocks have risen 25% and they are up 20% so far this year, according to the Restaurant Index published by the National Restaurant News. While equity markets did well as a whole during that period, with the S&P 500 rising 14%, the restaurant sector clearly outperformed the broader market.

Considering their low correlation and superior performance (higher profit margins and return on equity) to the sputtering tech sector that have been pushing this market to new highs, and the more than 70 publicly traded names, it seems like there’s something on the menu for everyone. That is unless investors are scanning their screens for a list of good funds to choose from, then they might find their appetites unsatisfied. 

Even with record inflows into exchange-traded funds (ETF) and dozens of publicly traded names to choose from, there’s only one ETF devoted to the restaurant industry, the aptly tickered USCF Restaurant Leaders Fund (MENU). Not that there haven’t been other attempts in the past, although they had the same lifespan as a “gastropub” focusing on sprouts. MENU began trading in November 2016, and was the second restaurant fund with BITE, also known as the ETF Managers Group Restaurant ETF, opening in late 2015 only to close about a month after MENU was launched. Neither fund has gained much traction; BITE only accumulated roughly $2.5 million in assets before closing while MENU currently has less than $2 million despite performing in-line with the broader market in 2017. 

So, why can’t the fund get anyone past the front door? Largely because it’s difficult to build ETF for concentrated industries and publicly traded restaurant stocks can be divided into McDonald's (MCD), Starbucks (SBUX) and everyone else. McDonald's and Starbucks make up more than 60% of the industry’s market cap and like them, the other stocks with a market cap of more than $1 billion tend to have everything investors love; like lower volatility, dividends and consistent earnings. Unfortunately, there aren’t enough names with that large of a market cap and when two of them are bigger than the rest of the sector combined, funds are forced to add smaller companies to the mix, along with the challenges they can bring like higher volatility, wider spreads and more uncertainty over earnings.

USCF, known for its commodity funds, hopes to succeed where others failed by giving MENU a smart beta orientation. MENU uses an equally weighting scheme, just as BITE did, but they take a very different approach to sizing up the industry before they even begin to sort names. First, they divide the restaurant universe into full-service and quick-service names with an intended 30/70 allocation between the two, which is a major difference from the current situation in American restaurants where quick-service names have 80% of the sales. Then they run their universe through a proprietary screening process to help identify potential outperformers and equally weighting the survivors based on that intended 30/70 split. The net result is an allocation where mega-cap names have a smaller role in the fund in favor of smaller outfits. So Chipotle (CMG) has only a slightly larger allocation than El Pollo Loco (LOCO) despite being more than 20x its size, which gives MENU a small growth leaning. 

But for those investors concerned over how quickly things can change in the restaurant industry, MENU is also reconstituted on a quarterly basis rather than annually or semi-annually, making it more responsive to changing fortunes. The Cheesecake Factory (CAKE) and Buffalo Wild Wings (BWLD) were both down double digits in June, weighing down MENU’s returns, but the funds quarterly “refresh” gives it the chance to reboot, and with an expense ratio of 0.65%, it is in-line with other sector funds (see “rebalance now,” above). 

Maybe investors should skip the old “dine and dash” and stick around to see what MENU has to offer. 

About the Author

Matt Litchfield is content editor for ETF Global (ETFG.com) and is responsible for all posts and new product updates on ETFG.com. @ETF_Global