This past week, I had an interesting conversation with Phil Bak, CEO of Exponential ETFs, an upstart ETF provider who recently launched the Reverse Cap Weighted U.S. Large Cap ETF (RVRS). Phil took some flak on social media and even through direct e-mails in response to his new ETF. He describes that experience here. I have my own strong beliefs on the value of ETF innovation, but I decided to ask Phil for his perspective on the current ETF landscape dominated by a few companies offering mostly low cost, plain vanilla products. His response:
For a variety of reasons, not the least of which is simply the mention of beer(!), this is a perfect analogy for the ETF industry. Following prohibition and World War II, large scale breweries dominated the American beer scene, offering mostly bland American pale lagers. What they delivered extremely well, though, was consistency, overall quality (not necessarily taste), and an extremely attractive price point. With that in mind, by 1981, the five largest breweries controlled nearly 76% of the market:
While the largest players still dominate the beer market today, what has changed drastically since the early 1980s is the proliferation of craft and microbreweries:
Just like the beer industry nearly 50 years ago, the lion’s share of the ETF market is controlled by just a handful of players:
Each of these ETF issuers rightfully earned their position by delivering excellent consistency and quality, typically at a very low cost. Clearly, this has been a boon for investors. Everyone has cheap investment options now, just like everyone had good, cheap beer 50 years ago. Remember the classic Miller Lite “Tastes great, less filling” slogan? Low cost ETFs are a great way to build portfolios without filling-up on return-eating fees.
That said, investors view low cost, plain vanilla, market cap weighted ETFs about as exciting as Miller Lite. Bland, watered down, no character, inexpensive – but probably the best route to head if you’re in it for the long-term (or, continuing the beer analogy, a long day at the lake or night at the bar). More expensive niche ETFs are no way to build your financial future, just like if you overdo it on Sierra Nevada Celebration Ale and Sculpin IPA, you’ll have a higher bar tab and the next day might not be quite as productive as you would like. The idea here is low cost and no hangovers (financially or otherwise).
But it’s also difficult to imagine a world with no Pliny the Elder or Tank 7. Probably everyone knows about Pliny, but if you’re not familiar with Tank 7, it comes from Boulevard Brewing Co. here in Kansas City. Tank 7 comes correct with an ABV of 8.5%. Everyone in KC knows if you overindulge on Tank 7 or any of the Boulevard Smokestack Series, trouble awaits and you’ll likely be in for a rough next day. That said, the craftsmanship and taste of these beers is bar none. I encourage you to read the story of Boulevard’s founding. The gist is that the founder, John McDonald, took a trip to Europe in 1984 and was amazed by the variety and flavors of beer. That was in stark contrast to what he experienced in the U.S., which he described as “homogenous and unremarkable”. He endeavored to bring his European beer experience to KC. Tank 7, along with other Boulevard beers, has since won numerous medals around the world.
The point here is simple. I think Phil is spot on that we will see the pendulum swing towards more innovation in the ETF space. I think that’s a good thing. The market will speak on Exponential ETFs’ Reverse Cap Weighted ETF, just like it has on the thousands of craft breweries that have sprung up since the 1980s. As I’ve said in the past, money flows to where it is best treated. Not all new ETFs and ETF providers will make it, but investors will be rewarded with superior products from the ones who do. In the context of your investment portfolio – the right approach is still to hold your nose and rely on a steady diet of bland, inexpensive Bud Light. But there is nothing wrong with mixing in a Tank 7 or two – or perhaps put a better way, mixing in some Tank 7 is everything that is right.