Optimism

Me: What should I write about?

V: How to get through difficult times with a smile on your face. People need optimism.

Me: … I’ll write about the Fed crushing the spirits of small businesses while funneling cash to large banks.

She is right though, as usual. So I’m going to try.

It’s a challenge. Sitting at my computer day after whatever day of the week it supposedly is, watching the news come in. The Fed has sprung into action, immediately propping up illiquid markets. My local dry cleaner put a handmade sign in the window with a personal cell phone number to arrange a pickup of any needed clothes items inside; might never re-open. Banks collected billions in loan processing fees from the small business lending program. An email comes in: “my husband is too embarrassed to ask, but can you help him find a new job?”. The NASDAQ is trading at all time highs. Suicides too.

Its enough to make you think thoughts you’ve never thought. And this time around you have to process those thoughts without the chance to bounce it off of friends, to see life, to hug. This time around I am not feeling optimistic at all.

Naval Ravikant once said that life is a single player game. And at the end of the day we lay down in bed with our own thoughts to work through. If we want to have a chance at this thing, if we want to get a peaceful night’s sleep and wake up ready to fight again, then we all need to find peace within our own minds. And to do that we have to hold on to whatever optimism we can find.

I went from being a depressed teenager to a confident adult when I trained myself to control my mindset. It’s a hard thing to articulate. People who have gone through similar transitions understand it immediately. People who haven’t, well, I can feel you rolling your eyes. But no skeptic can tell me that I didn’t win the war inside my own mind. Hardest thing I’ve ever done, hardest thing I’ve ever tried to talk about, and the hardest thing to hold myself to. If I can will a healthy mind upon myself then what excuse do I have to be wallowing in depression while my family is healthy and their bellies are full?

God grant me the serenity to accept the things I cannot change; the courage to change the things I can; and wisdom to know the difference. -Serenity Prayer

This little prayer has comforted people with Styrofoam cups of coffee and uncomfortable folding chairs since 1935. And for good reason. The words are simple but the concept is complex, eternal and truthful.

Accepting that which I cannot change runs counter to everything that makes an entrepreneur successful. I’ve spent four years not accepting those things. I can fight back against the largest company in my industry, and win. I can rage sense back into the markets. I can show them all that inflated prices are the problem, not the solution. But I didn’t, I can’t, and I won’t. Losing battles, all three of them.

And I can take those losses and still come back again tomorrow. We all can. The curve has peaked, most likely. Humans have been around for more than a couple years, and yes, viruses have done damage once a century or so, but not once has the virus won. So peek around the corner and we can all see baseball’s opening day. An avalanche of delayed birthday parties and weddings, and yes, funerals too. Because those hugs are also overdue.

And just as we have endured watching the world press pause we will soon watch the world press play. And we’ve all got some catching up to do. We’ve all got some extra living to live.

Let’s just make sure we hold on to the courage to change those things we can. Because soon enough we’ll have the opportunity, if not the obligation, to do so. And that’s all the optimism we need.

Beyond the Trough

Detroit is a tough town. The weather is tough, the people are tough, the sky is grey for eight months out of each year. I didn’t grow up in Detroit so there are things I notice as an outsider. Like the fact that everyone starts work early in Detroit. They start the day early, they quit the day late, and in between they work hard.

The morning in Detroit has a certain toughness. Tough people with thick old gloves and boots carrying thermoses and lunch pails to their jobs. White-collar workers walking with a touch of shame; blue collar workers with a touch of pride. That, more than anything, is a Detroit thing.

Charles Ragauss grew up in Grand Rapids, and furthest from Michigan he ever got was a brief stint in Columbus, Ohio. When our office was based in Ann Arbor it never felt right to Charles, who moved to downtown Detroit even though it meant a long commute. Charles feels more at home in Detroit among people who work each day until they can’t anymore, and then drink a Manhattan when they get home, thinking about how to do it all over again the next day.

Josh Blechman grew up just outside of Detroit. It is ironic, because Josh is now managing our NYC presence, the only member of Exponential who is no longer based in Detroit. Josh carries a West Bloomfield pleasantness on the outside which masks his Detroit toughness below. Josh doesn’t carry a worn old lunch pail to work but he does carry the work ethic that accompanies it.

Eric Kelly grew up a few miles outside Detroit. He comes to office early every single day, ready to grind and ready to work. He never complains, he never has an off day, he never brings up the fact that he has taken on three times the amount of work as he signed up for.

Christina Stage too, is from the Detroit suburbs. Christina has so many jobs I couldn’t even keep track if I tried. Christina manages human resources, billing, marketing and special projects for Exponential – and does the same for our sister companies The ACSI and Detroit Vineyards. There is no amount of work that is too much for Christina to handle.

Qiao Duan, however, did not grow up in Detroit. Qiao grew up in Xinjiang, a province on the Western edge of China. A province that is decades behind the Chinese metropolises in terms of development. It is a cold province, it is under conflict, and it is tough. After Qiao got recruited to come to America to enroll in the University of Michigan’s Quantitative Finance and Risk Management graduate program, her fellow students all sought jobs in NYC and Chicago. But for Qiao, Detroit felt closer to home.

This is the team I get to work with at Exponential ETFs. My team is Detroit Tough.

Here is a graphic that Paul Graham put out, a graphic that illustrates the life of a startup:

Trough of Sorrow. If anything, that is understated. It is hard to describe that transition from initial enthusiasm to the Trough of Sorrow. When you start, sure, you plan for contingencies, you model out the “bear case” you think you’ll be prepared when it gets hard. But really, that is the head talking, not the heart. Startups are launched with the eyes on the upside. Startups are launched with founders imagining the glory, the wealth, the fun and the freedom. But it is hard. Harder than founders expect, and many aren’t as prepared as they thought. And sure enough, just about every startup lands in the Trough of Sorrow.

Competing in a saturated market is not for the timid. Sleep becomes a luxury, something you hope will come a few nights each week. And the obstacles take a psychological and physical toll.

It took a toll for me. It took a toll when the Cincinnati gatekeeper condescendingly chastised me for telling him the benefits of a fund I had launched just the week prior. Even systematic strategies need a three year track record for him to have the ability to evaluate them, he smugly instructed, and how dare I waste his time with a brand new fund.

It took a toll when a promising new hire practiced for days in preparation of a client meeting with a Chicago-based financial advisor. The advisor never showed up. Three weeks later that new hire left the industry.

It took a toll when an ETF strategist told me that they love one of our funds but that they “don’t invest with startups” even as they describe themselves on their own website as… a startup.

And of course, it takes a toll when you watch as the entire risk management and portfolio optimization process is dumbed down to four  words that you are told over and over and over again: What. Are. Your. Assets.

It wears you down. You get tired. You have self-doubt.

But a tough team bounces back. A Detroit team bounces back. Day after day my team fought behind me and we tested, we pivoted, we adjusted, and we iterated. This is what four years of iterating looks like:

We knew the outcome but we didn’t know the path. Here is another graphic I think about often:

And sure enough, slowly, we started to see progress. One day our friends at Sage Hill allocated to one ETF, and then my friend in Charlotte allocated to our other ETF. We formed a partnership with my old friend Larry Medin who was launching a firm called Brandometry. And then we formed a partnership with some of the top industry leaders at Toroso Investments.

Before we knew it we had another partnership, this one with Amplify ETFs, perhaps the most promising emerging company in the ETF industry. And then we formed a partnership with Tidal ETF Services. We formed partnerships with some of the best investors in the country from Argi Financial Group to Acquirers Funds. And then a partnership with SoFi. And then we closed out the year with two more partnerships, SP Funds and ARIS.

And suddenly we are putting out a press release and running a victory lap because we hit $500 million in AUM. But those are the companies that did the hard work, and those are the companies that we owe any success to. Those are the companies whose success we are as committed to as we are our own. Those are the companies who have a Detroit Tough team behind them.

Here is a quote from James Clear’s phenomenal book Atomic Habits: “When nothing seems to help, I go and look at a stonecutter hammering away at his rock, perhaps a hundred times without as much as a crack showing in it. Yet at the hundred and first blow it will split in two, and I know it was not that last blow that did it—but all that had gone before.”

You spend day after day hammering at the rock, and in the Trough of Sorrow you don’t see any progress. I have spent much of the past two years working to create the best podcast I could. Every week I would work on something else – my speech impediment, speaking slowly, prep work, promoting the podcast, audio quality… something different every single week. And for so long it seemed like I was getting nowhere. Until suddenly I look back and can see some results!

The rest of our business has gone the same way. Charles, Josh, Qiao, Eric, Christina grinding and fighting day after day after day through the Trough of Sorrow. And then we look back one day and see that maybe, just maybe, we have crawled out of the trough.

There are bigger firms out there, and there are more profitable firms out there, but we have built ourselves a base. We have reached the upswing in the curve, outside of the trough. And the future is bright. We are talking to some of the smartest venture capitalists in the country about working together. We are building tech-enabled products that can change the industry, that we can create from scratch and bring to our clients to help them manage their expenses and help them compete and grow.

I am thinking about our bright future and writing this note in our Detroit office. The sky is grey and will be until June. July if it’s one of those years. I can see someone walking down the block with a thermos, a lunch pail and a tough look on their face. He is walking to a construction site across the street – used to be a vacant lot there but now they are building a skyscraper. Yah, we fit right in here.

This post first appeared on exponentialetfs.com.

Cap Weight Concentration: Same as it Ever Was, Until Now

The most valuable skill an investor can acquire is the ability to distinguish theory from law. Examples of theory include forecasts, the relationship between gold and inflation, or anything ever written by an economist.

Examples of law include principles of diversification, statistical arbitrage, and mostly, the fact that anything good that ever gets posted online is done on those nights you’ve promised your girlfriend a nice dinner out and your full attention.

Michael Batnick, Director of Research at Ritholtz Wealth Management, posted a fantastic chart online a few days ago, and my phone lit up like a Disney fireworks show.

Phil: “Sorry, we’ve got to get home earlier than expected”

V: “Ok, sure, it must be something important”

Phil: “I have to tweet and blog about company weights within the S&P 500”

V: “…”

This article was published by Yahoo! Finance, please click this link to read the article.

ETFs are the Rule

If you look up the word exemptive in the Oxford Dictionary, you won’t find any results. The word “exemptive”, it turns out, is actually not a word at all.

ETFs have been primarily governed by the Investment Company Act of 1940, which is essentially a rule designed for mutual funds. The “40 act rule”, as the name implies, was written up almost 80 years ago in a generation that could never imagine the efficiencies and varieties of low cost investment options that would become available to investors today. To launch an ETF, an issuer has always had to go to the SEC to get a specific approval known as “exemptive relief” to exempt themselves from the aspects of that same “40 act” which make the fund look… well, not like an ETF. In other words, an ETF issuer gets an approval to launch a mutual fund that isn’t, governed by an ancient mutual fund rule, but exempt from the mutual fund aspects of that rule.

Get it? Don’t stress it if you don’t – the industry is on the verge of getting an exemption from the exemptive relief requirement.

Governing by the exception is an inefficient way to oversee any industry, let alone one that has become the “Silicon Valley of Finance” (hat tip to the incomparable Eric Balchunas for that one). When you govern by exemption, exceptions abound. For example, a couple of fund companies received exemptions to list leverage and inverse funds before the SEC had a change of heart and refused to issue any further leverage ETF exemptions, level playing field be damned. Those early exemptive relief orders are grandfathered in, so the rule has created an oligarchy in an otherwise fiercely competitive market. Similarly, some fund companies can use custom creation and redemption baskets, while others can not. Some fund companies can offer transparent actively managed ETFs, while others also can, basically, but they just haven’t formally asked yet. The system is as inefficient as it is confusing.

But the real story here, governing by exceptions may work for an oddity of an investment vehicle, or a structure on the fringes. The ETF may have started off that way, but it has matured to the point where it is now the preferred investment vehicle of the modern investor. In fact, a recent Schwab survey declared that “Exchange Traded Funds (ETFs) are the investment vehicle of choice for 91% of Millennial investors”.

The SEC announced that they will hold a hearing on the matter on June 28. A new ETF rule could mean that the vehicle is finally being governed by its own rule, the same rules for all, and not by exception.

Since 2009, the mutual fund structure has seen net outflows of $24,439,000,000, while the ETF structure has seen net inflows of 2,102,305,000,000. You read that correctly – net outflows for mutual funds coinciding with TWO TRILLION in net inflows into ETFs.

ETFs are no longer the exception. They are the rule. And it is time for them to be governed that way.

This post first appeared on exponentialetfs.com.

Simple Investing Strategies Stand the Test of Time

Always be sure to do your homework on companies, ETFs and various investing strategies.

Don’t chase the fads.

The most shocking thing about the collapse of Theranos is that people are shocked. Well, I suppose that isn’t fair. The story is shocking, without a doubt. As detailed in John Carreyrou’s new book, “Bad Blood: Secrets and Lies in a Silicon Valley Startup,” Elizabeth Holmes lied constantly about every aspect of her business, its products and anything else – reaching a valuation upwards of $9 billion before reality came crashing down around her.

But the primary deception around the efficacy of Theranos’ supposed breakthrough compact blood-testing technologies really shouldn’t be that shocking at all. Because what has become very clear about the star-studded list of venture capitalist backers, board members, fawning journalists and investors is that none of them understood the technology or bothered to evaluate it for themselves.

This isn’t the first time we have seen brilliant investors left naked and exposed over a shameful lack of due diligence. The documentary film “The China Hustle” has exposed accounting irregularities and what appears to be rampant fraud amid the Chinese reverse-merger boon. Again, investors were exposed after assuming due diligence had been conducted by institutions that, as it turned out, had done no such thing.

This article was published by The Street, please click this link to read the article.

It’s Tough Out There

I should have known because we stopped sending press releases.

This was back, I don’t know, 2012 or so. I was working at the New York Stock Exchange and my clients were ETF issuers. My job was to move the ball forward on market structure initiatives, help issuers get product filings through the SEC 19b4 process, and to generally keep clients happy. The easiest way to keep clients happy was to leverage the NYSE brand to help them promote their funds. And the easiest way to do that was to send out our own press release when they launched a new fund to help get them some media exposure from the trading floor. Or to at least look like we were trying.

We were launching over 200 products a year, and one day our internal communications manager insisted that we stop sending ETF launch press releases. It was hard to disagree when she explained that her media contacts were threatening to exile our email account to the spam box and that an ETF launch was no longer news. Her media contacts were pleading with her to stop sending the press releases, so we obliged. And whatever obvious signal that was to me that the ETF market was becoming saturated clearly went over my head.

As ETF assets continue to explode, the individual new ETF success rate continues to decline. Getting an ETF off the ground requires a two-pronged attack where intra-day liquidity is built in one market and buy and hold assets are built in another. Meanwhile, wirehouse gatekeepers are preening the trees just as RIAs are instituting asset minimums to manage the bombardment of issuer pushes. I’m not going to lie, it’s tough out there.

The Kaufman Foundation (I know, I know) ran a study in 2009 that found that 47 of the Fortune 100 companies were founded during a recession. It is a fascinating study, because it shows that companies that have an easy road during their early years become complacent while companies that have it hard learn to fight, learn to be efficient, and learn to focus on what matters.

We launched Exponential ETFs in 2016, squarely in a bull market for equities, and an extreme bull market for ETF products specifically. So I like the fact that it is tough out there, that we are being challenged and earning our battle scars. We are surviving, we are learning, we are adapting… and soon enough we will be thriving. And if I take my own biases out of it, it SHOULD be tough out there. We are creating investment products for financial professionals who in turn are providing fiduciary services on behalf of real people who have scraped and clawed to save and invest that money. They ate dinner at home instead of going out, they passed on the luxury options on their new cars, they vacationed in Phoenix instead of Maui. They worked hard, year after year, and they saved. So in walks the fund industry telling their advisors that there is a new and exciting way to invest – be skeptical! Be thorough! Be cautious!

Tadas Viskanta writes a fantastic blog called Abnormal Returns. He recently put up a post asking some of the best minds in the industry “What ETF, if it were launched tomorrow, would you invest in with little (or no) hesitation?”

The responses were dispiriting, to say the least. Here is a sampling:

• Robin Powell: “It would be refreshing to have a day without another ETF launch!
• Charles Sizemore: “We arguably have a bubble in ETFs, indexing in general, and even in smart beta.”
• Tom Brakke: “There are too many already.”
• Cullen Roche: “The ETF market is becoming saturated.”

Like I said, it’s tough out there. I had lunch with one of the bloggers from that post about a month ago, someone who I am a big fan of and who I consider to have the perfect balance of free and creative thinking mixed with critical quantitative analysis, and there was one offhand comment during the lunch that just stuck with me and I haven’t been able to shake it off.

I was explaining our new fund launch and our company plans and he said “well, if it works out, you’ll be on a yacht somewhere”. The comment caught me off guard and I just shrugged and agreed in the moment. But it stuck with me because it is such a different point of view than the one I have.

Ending up on a yacht somewhere would be lovely. But that has never been the motivation behind anything I have done or any product we would ever launch. So it stuck with me and I have been at a loss for how to respond. We are in an industry where some charge a 20% performance fee for fund management – with lockup periods and opaque investment methodologies. Exponential ETFs charges 29 basis points for one of our ETFs and 65 basis points for another (which utilizes proprietary data that carries tremendous fixed costs). Our ETFs are fully transparent and designed to withstand the toughest institutional scrutiny on the planet. If we were in it for the money-grab we would be the most incompetent hucksters on the planet.

Let me take several steps back. I grew up a smart ass kid with severe ADD and a disdain for authority, in an environment where there was an emphasis on book learning in schools run mostly by rigid, humorless Rabbis. These two things do not mix. But after serving in the army and learning how to push myself, I went about giving myself an on-the-job education. I started my career as a stock trader, and then on an FX desk working the graveyard shift, and then a product developer. I was blessed with those opportunities and I threw myself into it with everything I had. Even more so, my good fortune landed me in the ETF industry right at the beginning. ETFs are in my blood; I love this stuff*.

*Yes, I love ETFs, and my favorite ETF was always the simple elegance of RSP. Until I level-upped it, which is exactly what we did.

Exponential ETFs was born at the collision of two different paths. Here is one path: a mundane shopping experience led me to the big idea that direct customer experiences in any industry will eventually show up in a company’s bottom line, and I went about looking for data to test that thesis.

Kevin Quigg had overseen one of the most successful expansions of a fund business ever, and was ready to get back to the point where the job was fun and free from bureaucracy. Charles Ragauss was the hardest working portfolio manager in the ETF industry and had just seen his newborn ETFs sold to a firm on the East Coast. Josh Blechman went from being a hedge fund trader to mastering an entirely new skill set. What Qiao Duan had to go through to be a part of this is a blog post I’ll save for a future date.

Meanwhile, the other path, Dr. Claes Fornell had a problem. He went from being one of the premier academics in the country (the author of three of the 20 most cited marketing science papers published in academic marketing journals… and five of the top 50) to being one of the premier entrepreneurs in the country (founding ForeSee Results, CFI Group, The ACSI & Detroit Vineyards). But, his two hedge funds which utilized his customer satisfaction data had three sovereign funds as investors, and those investors were starting to grumble about the fund structure – everything I mentioned: the lockups, the performance fees, the opaqueness.

And then out of the blue some kid cold-called him with a big idea.

Take a look around the ETF industry, because it’s not just us. Something special is happening. Eric Ervin found a way to isolate and optimize dividend investing. Gregg King found a brilliant way to embed a gold investment into an equity position. Jamie Wise built a proprietary data scraping tool that is generations ahead of those used by 2/20 hedge funds. Christian Magoon launched a retail ETF that demolishes any other in the category. Mike Venuto did the same in the financial sector. And these funds are available in the most efficient wrapper, at the most efficient prices. I could go on, and I know I am leaving many out, but it is the same story over and over.

None of these people are selling ETFs because well paid consultants advised them that flows are moving into the vehicle. These are fund strategies built by passionate people who believe in them. Every one of those entrepreneurs has had to fight and sacrifice and grovel for funding, beg for allocations, miss their kids’ soccer practice and lose sleep to create these funds. After all, it’s tough out there.

So where two products diverge in the wilderness, if you insist that only the most well-travelled are worthy of consideration, my ask is that you at least open your mind to the possibility that a better solution could one day be out there. Stay cautious and skeptical, by all means, but also stay open minded to the possibility that someone could build something better for your clients and better for your portfolios, and it just might be sitting out there on the road less travelled.

This post first appeared on exponentialetfs.com.

The Big Systemic Market Structure ETF Risk That No One Is Talking About

It’s not every day asset management firms advocate for the right to pay new service fees. Yet that is exactly what we are doing.

Recently, FINRA put out a request for the ETF industry to comment on lifting Rule 5250 — a rule put in place long before ETFs were recognized as the vehicle of choice for the modern investor, a rule that prevents ETF issuers from properly incentivizing market makers.

As it stands today, ETF market makers are compensated through a “maker-taker” model, paid for providing liquidity and paying in for taking away liquidity. Those rebates are enhanced when taking on market maker obligations, which include continuous quoting of a two-sided market within a predefined spread range and a minimum acceptable amount of depth on the bid and ask.

While any market maker can trade ETFs opportunistically, only the lead market maker enjoys the enhanced rebates that the “LMM” programs offer. However, as market fragmentation continues, the primary listing venues where trading is eligible for the enhanced rebates only see fractional volumes.

This article was published by ThinkAdvisor, please click this link to read the article.

There’s a New ETF Game in Town

The exchange-traded-fund industry is being shaped by a new paradigm — not active vs. passive.

It was the image of dart-throwing monkeys that got me. I would like to think it was the analytics, the white papers or even the raw performance data of active managers over the years. But if I’m being honest, it was that image of active managers as dart-throwing monkeys that really hooked me.

I was in my early 20s and reading Burton Malkiel’s “Random Walk Down Wall Street” for the first time. The way Malkiel wrote about it, there was just something rebellious and cool about the index side of the index vs. active debate — so I became an index guy.

This article was published by ThinkAdvisor, please click this link to read the article.