Episode #258: Best Idea Show – Wes Gray, Alpha Architect, “An ETF Centralizes Everything Into One Product”

Episode #258: Best Idea Show – Wes Gray, Alpha Architect, “An ETF Centralizes Everything Into One Product”

 

 

 

 

Guests: After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in the suburbs of Philadelphia with his wife and three children. 

Date Recorded: 9/10/2020

Run-Time: 1:27:26

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Summary: In today’s episode we welcome our guest, Alpha Architect’s founder and CEO, Wes Gray. We’re covering Wes’s best idea: Launching an ETF. We cover the ups and downs of the asset management business, and the different permutations his business went through before eventually landing on the ETF structure as the best way forward.

From transparency to tax efficiency to ease of access for investors, we chat about why someone should consider launching an ETF. We spend a lot of time walking through the process of getting a fund up-and-running, which is not for the faint of heart, and even walk through some case studies of some folks that have launched ETFs with Alpha Architect’s white label business.

Please enjoy this special “Best Ideas” episode with Alpha Architect’s Wes Gray.

Links from the Episode:

 

Transcript of Episode 258:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft in investing, and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions, and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Hello, friends. Today, we have another instalment of our “Best Ideas” series. We have one of our show’s inaugural guests in the house today. He’s a former Marine captain, now CEO and co-founder of Alpha Architect. In today’s episode, we’re covering his best idea, how to launch an ETF. This is a question that I get, if not every day, certainly, every week. We go deep and cover the ups and downs of the asset-management business and the different permutations his business went through, before eventually landing on the ETF structure as the best path forward.

From transparency to tax efficiency to ease of access for investors, we chat about why someone should consider launching an ETF. We spent a lot of time walking through the process, from all the nuts and bolts of getting a fund up and running, which is not for the faint of heart. We even walked through some case studies of some folks that have launched ETFs successfully with the Alpha Architect’s white-label business. Please enjoy this special “Best Ideas” episode with Alpha Architect’s Wes Gray. Wes Gray, welcome to the show.

Wes: Hey, Meb. Happy to be here again.

Meb: Wes, where’s Grizz [SP]? I’m looking at your home office which, by the way, is…was the same office pre-coronavirus. I don’t see Grizz in the background. What happened to him?

Wes: Well, so to be COVID-friendly, I moved into the kitchen where Grizz is, and put my office in here. And then, you can’t see it, but he is in the middle room here for everyone to see, and he hangs out with the training and execution team. I figure they’re nearer to killing bear markets than me.

Meb: For the podcast listeners who aren’t watching this on Zoom, Grizz is a giant grizzly bear that Wes has in his office. My background is in the Flat Tops Wilderness, where Wes, I mean… Come on, your brother, I’m trying to give a little shout out to the Flat Tops Wilderness guides. You have a local… You’ve probably been to this lake, at some point.

Wes: Yeah, yeah. If anyone out there listening is into elk hunting or going on crazy adventures, happy to offer up the family discount. Just have to reach out Meb or reach out to myself, and happy to put you in touch.

Meb: We’ll have to do a Meb-West-shareholder wilderness excursion. We’ll put that on the schedule. It’s pretty easy to social-distance out in the middle of nowhere. We did a three-day horse-pack trip there and didn’t see anybody, so, wonderful. All right, Wes. We haven’t had you on as a guest since you were one of the inaugural episodes in, I think, the first week of the show back in 2016. And the topic was…and this is in 2016, “Even God Would Get Fired As An Active Manager.” And walk forward four years, and probably, God would have been fired. What’s your general takeaway on how the world’s played out in the last four years?

Wes: Yeah. So I mean, unfortunately, if God had anything to do with value investing, at this point, he probably was fired. Maybe if God was lucky and did some more momentum stuff or mega-cap stuff, maybe he’d still be hanging in there. He or she’d been on “What Do You Think About These Things.” But yeah, definitely. Unfortunately, a good conversation, but the truth is ringing a little bit too true at the moment for all of us out there who are kind on the value side of things.

Meb: Listeners, go back and check out that old episode. We’ll put a link in the show notes. It’s really insightful on not just the difficulties and challenges of being an investor that moves away from market cap, but also expectations on return, and most importantly, draw-downs. The thesis was, really, even if you had perfect foresight, you would have gotten your face punched in enough that you probably would have quit, anyway. At least, that was my takeaway.

Wes: Yeah, no, that is the takeaway. Even if you’re a long-term investor… And that study was looking out five years. Even if you know the winners and you do that strategy, because those markets are so noisy and crazy in the short run, you could be the smartest person out there and still look like an idiot. And I put a more than one-percent chance, that could be what happens for the next five years. Well, right now, if you sorted the stocks on the future five-year winners, assuming you could, I would not be surprised if five years from now, people find out that that portfolio is a bunch of these crazy, underappreciated, deep-value stocks that had been left for dead. And it probably won’t be Tesla.

Meb: That’s the beauty of y’all’s line-up. I know we’re not going to talk too much about y’all’s funds, but listeners, you can check out…we’re shareholders, by the way, full disclosure, Wes’ suite of ETFs. They have pretty concentrated strategies that will give you pretty extreme exposure to both value on one side of the coin, and momentum. I think momentum strategies are up 20%-plus this year, or something pretty crazy, but that’s the way the world’s going. All right, now, the topic of what we’re talking about. This is a…one of the inaugural shows in our new concept called “What’s Your Best Idea Right Now?” We’ve done a few already, we had on Jeremy Schwartz talking value in Japanese stocks. So, Wes, what is your best idea right now?

Wes: So my best idea’s not really related to a necessary…a specific strategy, per se. but my best idea is launching an ETF. And we can talk about why, but yeah, that’s the bottom line. Launch an ETF and put whatever investment strategy you have in the best wrapper out there for the future.

Meb: So I get this question, if not every day, certainly every week, where someone will email me and say, “Hey, Meb. I’ve got this great idea. I’m ready to launch an ETF, how do I go about it?” And we have an old post that’s probably six, seven years old now, about how to start an ETF, and the new [inaudible 00:06:42] definitive guide, which we’ll put in the show-note links. But figured I can now point them to this podcast, because this will be a master class, and everything that goes into starting a fund: the drawbacks, the benefits, the pot of gold at the end of the rainbow. I think it’d be instructive or helpful to hear a little bit about how you guys decided to start launching ETFs from the early days, what was the on-ramp. And then, we’ll get really deep into the specifics on how all the sausage gets made.

Wes: Sure. So going back…way back, I’d been trying to figure out how to win in this investment-management business for a long time. Not as long as you have, Meb. And we’ve kind of grown up in this thing together, at some level. But this business we have now is basically the fourth attempt at trying to win in the asset-management business. And before that, obviously, those were bad attempts, and they were all related to the traditional way of looking at it, like, “Hey, let’s do asset management. Let’s start up a hedge fund and do a black box, charge high fees, and try to beat the market.” You know, different permutations of that, one of which I started in September of 2008, which, obviously, terrible timing.

But essentially, after getting a lot of scars on my back and taking a deep breath and assessing, “Well, what do people actually want,” do they really want to buy totally opaque, really expensive things that rely on me to beat the market? Probably not. The world is moving the Vanguard route, where people like transparency, they hate fees, they hate taxes, and they want to understand what they’re buying and why. And unfortunately… But I think, fortunately, as an asset manager, no one wants to do that, because now, you have to be transparent, you’ve got to keep your fees low, you’ve got to tell people what you’re doing.

That’s great for the client, not necessarily great for the asset manager. But we just made a hard decision, probably around in 2012/13, that that’s where the world was going, and that’s where we wanted to be. And that, obviously, naturally led us to the ETF structure and away from hedge-fund structures and SMA structures and all the other options out there.

Meb: So you guys have…let’s see, five funds of your own, and a handful of other white-labels, which we’ll get to. But talk to me about, just generally, what’s the business concept opportunity, and why starting in ETF in the first place. Here we are in 2020, there’s thousands of funds, you mentioned Vanguard is this goliath sitting at pretty darned near zero percent for half of them. Why should someone start an ETF in the first place?

Wes: All of this outlined the high-level costs and benefits, and then we can pull on each of those. And I talk about, like…at least what we’re offering, how that might help you make that decision. But essentially, when you look at, well, first off, what is the downside of launching an ETF, or frankly, a mutual fund or any of these registered-fund vehicles, the most obvious one is the high fixed cost. And we’ll explain how we’re trying to fix that problem, but that’s a problem that will, frankly, never go away. The other one is, with ETFs, transparency is a key component of operating them smoothly. And obviously, there are solutions out there that try to get around the whole transparency element.

I’m pretty sceptical that those are actually any good. But who knows, maybe that problem will be fixed. And then, the other really big challenge with ETFs, before people get too excited, is, it’s really hard to know exactly who owns your ETF. So to the extent that you have people selling your product on your behalf, you want an ability to identify what they sold, so you can pay them fairly. There’s technologies that are making that easier, but it’s not as easy as it is in, say, a mutual fund structure. So potentially high fixed costs, a lack…or high transparency and distribution. Transparency issues are the main cost, so that’s the sucky part. But why would you do it? What are the benefits?

Well, the number one benefit that I just said is a negative is transparency. And that’s just because we believe that clients and investors nowadays actually find transparency to be a good thing. So yeah, you’ve got to spill your secret sauce. But I think it’s important that people know what they’re buying and why, so I see the transparency of ETFs as, actually, a huge benefit. The other really big one for us, specifically just because we traffic in people that hate taxes more than they like making money half the time, is tax efficiency. So I know, Meb, you’ve talked a million times about it. But essentially, ETFs are kind of like 1031 for stocks. So if you know about 1031 in real estate, where you kind of roll your bases…

Meb: Good, I’m going to steal that. I’m going to use that in the future.

Wes: Yeah, yeah, yeah. It’s the easiest way for me to explain it. Because a lot of people know about 1031 in real estate, I just say, “Hey, it’s basically the same idea in stocks.” You can keep punting the bases out, and you don’t have to distribute out the capital gains, which is obviously a huge benefit for anyone who’s doing strategies that turn over, essentially. And then, the two other big benefits is, one, the market access. So if anyone’s ever filled out, like, a 50-page subscription document for a hedge fund, as you know, it’s a total pain in the ass. Whereas, if you want to be a proud owner or seller of an ETF, all you do is type in a ticker, and you own it. There is no SMA, there is no LP docs. It’s done. So it’s very easy to access the product.

And then, the final thing that we always tell folks about the benefit of the ETF is, if you are an asset manager and you’re running 1,000 SMAs and all these different lines, operationally, that can be a huge pain. Whereas an ETF just centralizes everything into one product, where you can manage the taxes, the trading, the whole bowl of wax, in one vehicle, as opposed to trying to tax, harvest, and manage every single account out there. So that’s kind of, like, the high-level costs and benefits of just the ETF at a high level.

Meb: So we’ll dig into each of those. I’ll just make a couple quick comments, from our experience. The transparency, it’s funny, it’s been sort of a media darling for the past decade, about launching these non-transparent ETFs. But to me, it’s always been a feature of the transparency being a positive, and why in the world anyone on the consumer side would ever want non-transparent. They wouldn’t. It’s just the high-fee fund providers that want, in my opinion, an excuse to charge more. So you’ve seen it, and I don’t think it’ll be a big development. That’s my two cents. And second, from our own personal experience, we have over 50,000 clients now, and having a separate account business, like almost every advisor does in the country, managing the complexity of that.

And it’s easier when you have iRebal and TD or Schwab’s, or any of the various software programs. But it’s still, in my opinion, a hundred times harder than running an ETF. So there’s plenty of… And we’ll get more into this, but there’s plenty of advisors out there that I don’t think you’ve ever considered the route of wrapping it into a fund, versus doing it through the traditional separate accounts. But we’ll dig more into that. Okay, let’s talk about the process. So when I got started… I mentioned that we predate you guys. In the early days of ETFs, in the early 2000s, even in the 90s, you had to do a whole bunch of legal wrangling to get the exemption and permission to launch funds. And the SEC had sort of a patchwork set-up where different people got different permissions at different times, and it was just sort of a mess.

It cost us probably $200,000 in 14 months, we have friends that had to pay $1 million in legal and set-up fees. And now, it’s essentially zero, or close to it. So that’s the good news for the providers, the world has changed. But the SEC finally, with the new ETF rule, has sort of levelled the playing field for everyone, which is a great thing, but also been a huge boon to the tax remit, which I think will eventually kneecap all the mutual funds and accelerate the changes. So talk to us about the process of launching a fund, all that goes into it: how to plan it, all the pre-launch, the actual launch, all that good stuff. Walk us through.

Wes: As you mentioned, it is like a super… There’s a lot of moving pieces, but… So what I’ll do here is just the real high-level, because at a high level, it’s frankly not that hard. And everything I’m going to mention is just ballparks, right? If you’re going to do a triple-levered, long-short, draw-down, zero-fund that talks to RenTec every day, none of this is going to apply. This is more for, generally, down the pipe, been-done-before ETFs, right? And so, essentially, what you look at is, it’s kind of like a four-phase approach to launch an ETF. The first one is just planning. And when you do an ETF, one of the downsides we mention up front is, there is a big fixed cost. It’s not like firing up an SMA, where you don’t really need a lot of infrastructure up front.

So you’re going to have to invest a lot of time and money, you want to do a lot of planning. In those phases, you want to understand, first off, how are we going to pay the bills? And that either works through raising VC capital, being willing to float that out of your own personal capital, or maybe even talking to your own clients that are in SMAs, and pitching them on the idea of, “Hey, maybe we should launch an ETF. It’s more tax-efficient, and I’ll even give you a part of the business.” Whatever it is, you’ve somehow got to be able to finance this sucker. And that’s just the operating capital to run it. And then, the second big part of the planning phase is really understanding, like, “What is my baseline distribution plan,” or, “How am I going to raise money?”

Maybe not, “How am I going to raise $1 billion,” because who knows how people do that. At least, you’ve got to have a plan of, “How do I get to $5 million,” “How do I get to $25 million,” “How do I get to $50 million?” Just focus on what’s in front of your face. And so, in that planning phase, you’re really just figuring out, like, “Hey, how am I getting the money to fund this,” “Who’s going to be my initial buyers,” and, “Does this product actually make sense in the marketplace, given what’s already out there?”

And we always tell people that that could be 10 years, or that could be zero months, or zero time, depending on how much we’ve been thinking about this…you know, daydreaming about it all day. So any questions or thoughts you’ve got on just the baseline planning phase, in your experience, Meb?

Meb: Yeah. I mean, I’ll make a couple of just, quick comments. The first one is, 99% of the time when people contact us, it’s, “I have this great idea for an ETF.” And they see the pot of gold at the end of the rainbow, and then we walk through the actual, “Hey, how do you plan on getting to $100 million? Do you have any assets?” “No.” “Do you have any marketing plan?” “No.” “Are you willing to subsidize this for three years?” “No.” So what people really see is, “Hey, it’s like a free lottery ticket,” or something, but they have to walk through the actual reality of competing with Vanguard. And I’ll say this real quick, and then you can continue.

We repeat often, where there’s four criteria for us to launch a fund, personally. One, it either doesn’t exist, meaning you’re doing a totally new category, or we think we can do it much better or much cheaper. And cheaper is rare these days, but it still happens, particularly relative to the mutual-fund and hedge-fund space. Two, it has to be something that has some sort of academic or practitioner research…and you guys do a great job with this, supporting the concept or the fund strategy. Three, something I would put my own money into, so much of the big providers… And one of your co-workers, Ryan, talks about this, where a lot of the assumption of the smaller providers, like [inaudible 00:19:28] and Cambria, is, people always say, “Wow, it seems risky. You guys are small.” But in reality, the big shops close dozens of funds every year.

So they have more of the spaghetti mentality, where I think shops like ours, it’s much more of a, “Hey, will I put my own money into this,” versus, “What can we sell?” And I think that’s a very different mentality. And lastly is, does anyone actually want it? And so, you touched on this. There’s a couple of ways to actually check that box versus, do you have a big, fat seed? Is someone willing to seed it? So the good examples of, like, Fisher starting a couple of these funds with Barclay’s, where they were seeding with hundreds of millions of dollars.

Two would be, are you willing to incubate it and let it marinate for three years, in hopes that the world just thinks you’re brilliant and the performance is in line? And lastly would be, do you have some sort of cannibalization, which I think is an area that more people should consider, or… And then, fourth would be, do you have a very clear marketing plan of how to get this to, at a minimum, $20 million, but really, $50 million to $100 million? Otherwise, they sort of get lost in the wash. All right, that was my very long short input on that.

Wes: No, no. And this is, honestly, the most important phase. Because to your point, now that we’re in the business of helping other people do it, you get every story on the planet. And I think what you mentioned there is great wisdom. This thing better be something Vanguard or iShares really can’t do efficiently. And you’d better be willing to fund and back this thing with your own capital for a long period of time, or at least in our situation, we don’t want to do business with you.

And to your point, on our own funds, we’re never liquidating our funds, because they’re built for our own money. And a lot of people that we work with and a lot of people you work with, the whole point of the ETF wrapper is the tax deferral. And if we’re iShares, burning up 20% of our funds every year, well, you don’t get the tax deferral, then. So you really need to look at the ETF sponsor and provider, and make sure that they’ve got the…one, the culture and the capital and the capability to be around for a long time. And we always tell people that they’ve got to look… You know, the front of the book isn’t everything, you’ve got to read the book a little bit.

A shop like ours, where our infrastructure costs a lot less than even Vanguard, so we may be able to sustain a fund, or our partners may be able to sustain a fund that may be $25 million to $50 million for a long time. Whereas PowerShares or iShares, like, a $100-million fund that’s not really doing anything, they’ll be more than happy to blow that up and move on to the next piece of this spaghetti you throw against the wall.

Meb: Yeah, I remember being on one of the panels with one of the big shops in the early days, and someone asked that question, “What’s the minimum break-even for an ETF?” And I was like, “Twenty million,” and Vanguard was, like…it was in the hundreds of millions. Part of that is because they’re at two basis points. But also, it was because they have armies of salespeople and fixed costs. All right, so just walk me through the actual… You know, you guys are kind of the perfect team to talk about this, because you have a military efficiency about it.

So let’s say, an RIA is listening to this and he says, “Meb, Wes, you guys are right. I’m tired of dealing with these separate accounts. I’m going to take and wrap $100 million of my separate accounts…” $500 million, whatever it is, “and just launch an ETF, and just manage that instead of dealing with all these separate accounts, tax efficiencies,” yada, all the other good stuff. Walk us through how the phases go. Like, let’s say they call you today, or email you after this and say, “All right, let’s do this. Let’s light this candle.” What then? How long does it take, what are the costs? Let’s go.

Wes: Sure, yeah. So let’s say you’re doing the “bring your own asset” approach, which I think was coined by Eric Balchunas, which would be the case of an advisor who’s already got a bunch of underlying investors, where they go in there and they say, “Hey, team. We want to launch… We’re doing the strategy right now, it’s kind of tactical, it’s engaging a lot of tax-inefficient trades. We want to do the same thing, but do it in an ETF wrapper, where now, we can gain all this tax efficiency, operational efficiency,” blah blah blah. And the clients get it, they’re like, “Awesome.” And they’d probably have to negotiate to make sure they’re not getting double-feed, and it’s in their best interest, and what have you.

But we were able to very easily convince our SMA client base that the ETF was just a better idea, so they were more than willing to be the initial funding for it. And most RIAs, I think if they sit down with their clients and explain the benefits, their clients were like, “Well, yeah. Of course, we’re going to do that.” So you’re going to do it, you’ve got some funding. The fastest you could possibly do this…if you are ready to rock, day one, and you’re pretty squared away, is, you’d call us today, “Hey, I want to launch an ETF. What’s the soonest I could do it?” I’d say, realistically, probably four months. Maybe you could squeeze it down a little bit more than that, but that’s as fast as you’re going to do it. And it could extend out to years, dependent on how slow you are, right? So it’s just a ballpark concept.

And then… So what’s in that, let’s say, the four-month plan, where you’re just whooping it on? Well, the first part is in the pre-launch, right? So the pre-launch phase is where it’s mainly a big, heavy lift on the legal documentation. You have to file a registration statement, where the key document there is your prospectus, right? So you’ve got to pay the lawyers all this money to draft up, like, what is this strategy, what are all the various risks, how does it work, etc., etc.? That’s kind of the cornerstone element you’ve got to do in the pre-launch phase. And in this stage, obviously, you’re interacting with the lawyers, and they’re interacting with the SEC. Because you need to get this registration statement approved, so we can actually launch this fund.

This whole phase, it ranges. But you can usually bang it out all-in for probably, like, $50,000, let’s say. Sometimes, it could be cheaper, sometimes more expensive. But just the initial structuring phase, the one-off cost, is around $50,000. And I don’t know, does that seem in the ballpark with what you’ve seen, Meb?

Meb: Yeah. I mean, look, I think it could be cheaper or it could more expensive. It just depends on what is involved in the strategy. If you’re like, “Hey, I’m going to do U.S. equities, 20 stocks, I rebalance it once a year, or something,” that’s probably a lot easier to get out than something that’s new frontier or trailblazing with totally new ideas. And by the way, I’m going to say this real quick, as you go through this. A lot of people come to this and say, “I’m debating doing this on my own versus white-labelling.” And let me emphasize as you listen to Wes, what a gigantic nightmare doing this on your own is, if you haven’t done it 2, 3, 5, 10 times already. Because I think that for the two of us that have done it enough, it’s sort of old hat.

But I remember the first time doing this and being like, “Oh, dear God. This is the most… This is like dealing with an enormous oil tanker with 17 different international agencies being involved, and having really no clue what to expect, or what’s going on.” And then, you spend 70% of your day, like I do, signing forms, dealing with compliance, chatting with lawyers, dealing with the SEC, all the gist nonsense of managing the business of running a fund versus actually just running a fund. And for a lot of people commenting this, they’re doing this because of the simplicity. And so, partnering with a firm, to me, is such a no-brainer. Anyway, continue on. I think $50,000 may be high, but it totally depends on the strategy. We’ve certainly spent more than that.

Wes: A hundred percent. And so, there’s two things to add on, on that. Number one is… And you know me, Meb, cheap-ass of the world. We actually initially tried to do all this ourselves, being totally idiotic. We didn’t even hire a lawyer. We’re like, “All these guys do is cut and paste the document that we can get off to SEC. Let’s just grab that, put in our data, and send it to them.” And we did that, because we’re idiots. And then, we got a call, literally, from one of the SEC lawyers. And the gal said, “Are you guys trying to submit this without a lawyer?” And we were like, “Yeah.” And she was like, “Well, you can do that, technically. But nobody does that, and here’s the 50 reasons why.”

So long story short, just don’t be an idiot and do what we tried to do, where we tried to cut out the lawyer. It’s just not going to work. And then, the other thing to emphasize here is that the whole ethos of our white-label concept is, we are trying to make it affordable and efficient for entrepreneurs to get into the ETF business, because we want to promote entrepreneurship in ETFs. And so, our whole goal is, how do we economize and make access to this traditionally super-high barrier to entry market more affordable? So all the costs I’m throwing out here are… You can obviously cut them off.

I’m just giving you the ballpark with a little bit of padding, just so people have some expectation management that, “Oh, well, Wes said it was…you could do it for $30,000. And if…” You know? So I’m being… What do they call it? I’m sandbagging a little bit here, throughout. And so, just as people listen to this, yeah, you can always get a little bit more razor’s edge.

Meb: But the funny thing to me is…I often tell, people, too, is that the up-front initial cost is not the main cost. The main cost is, you launch a fund and it sits there at a donut, assets are zero. This is the big…you know, what you’re on the hook for, if you…

Wes: Exactly. And another thing I should bring up here, because it’s a good time, just because it’s a misconception that we always get, is, a lot of people reach out and they’re like, “Oh, I heard the SEC passed this new rule where it’s free to launch an ETF now.” And what they’re not understanding is that you no longer have to pay for the exemptive relief, which Meb, you mentioned initially, that cost you guys a couple hundred grand. It cost us, probably, like, $20,000 or $30,000. That part’s free, as long as you’re doing something that’s in the ballpark of normal.

But you still have to pay for all the registration statement, the ongoing…you know, etc., etc., the stuff we’re going to outline here. So the SEC ruled to not make it free to launch an ETF. They made it “free” to not have to deal with the cost of exemptive relief.

Meb: There’s also a big efficiency benefit of partnering with someone like you guys, which is, every time you send an email or call your lawyers, you’ve got to remember, that’s minimum, $500, $1,000 an hour. And those bills… Like, if you just don’t know what you’re doing and you’ve never done this before, those bills rack up really, really fast, because you’re going to spend a lot of time getting up to speed. But working with someone who’s done it a million times, you’ve obviously minimized those sorts of costs, too.

Wes: Yeah, 100%. And just to reiterate on that point, is, that’s why I said $50,000, because that assumes you like to talk a lot. But our CCO, Pat, he’s super-efficient. You know, like, former captain of the Marine Corps. He’s pretty much a lawyer at this point. So if you just trust us and allow us to do it efficiently, you don’t have to pay the lawyer a gazillion dollars an hour. Obviously, if the cost can be coming down and maybe I could get it for $30,000, it feels like leading-edge. But the main point is, this is a cost…just the cost of doing business. And it’s this next stuff that you really need to be thinking about, not saving the $10,000 on the launch, because frankly, it’s not going to matter in the grand scheme of whether you’re successful or not in an ETF business.

So that’s initial, just to get the thing rocking, the initial slug of legal compliance and work with us to figure out how you want to structure it. And there’s… Just to quickly touch on that, there’s really two ways that we can work with someone. Either they’re an index provider, where you just basically send us a spreadsheet, and we pretty much do everything else, and your job is to promote and talk about and educate people on your index. And then, the other version of that is, if you don’t want to have an index-based fund and you want to be active, what people can do is, they partner with us as a non-discretionary sub advisor, so we can legally be able to pay you through a contract relationship.

But in the end, you’re not really doing anything, right? You’re a sub advisor and you’re non-discretionary. So really, your job is, again, to just send us the spreadsheet to tell us what to buy and sell. So those were the two different options of how you can be structured in our set-up. So you get all this stuff going. And while this is happening, again, this is really what gets the ball rolling, and this is, like, a three to four-month process. But now, you can start working on a bunch of other things, as far as your marketing plan, getting your initial materials together, your website together, etc., etc. But let’s say we get through this, and now, we’re at launch phase. So we are now about to actually spin this thing up and have, essentially, an IPO in the marketplace.

The key things you’ve got to do here is, there’s a coordination effort where you have a fund, you’ve paid the bills to the SEC and to the lawyers. But now, we need to get an initial seed commitment from one of the authorized participants or broker-dealers out there, because they’re the ones that have to basically fund up this ETF, initially. And that’s usually, like, $2.5 million that they post. And so, you need to… We, on your behalf, need to convince someone that is going to post up $2.5 million that these people are credible, and that they’re going to be able to raise at least $2.5 million…preferably, like, $5 million, day one, to get them out of the seed. Because brokers don’t want to be in the business of owning your ETF. They want to be in the business of market-making and doing trades and executions.

Meb: And the general mood on that…maybe it’s just my own personal experience, it used to be a lot easier than it is today. I remember we had, like, a $15-million seed in our first fund. And now, it’s like scratching and clawing to get anyone to do it.

Wes: It’s very difficult. And that’s why, more and more, it’s actually very important that you work with a counterparty, either a while-labeller, or you’re coming in the business with tons of credibility. Because even us, we have to do tons of reputation management. We’ve never launched a fund that didn’t get out of seed, day one, essentially. So we’re batting 100 for 100…or, sorry, 100%. We haven’t launched 100 funds. Whereas iShares, because they’ve got bajillions of dollars, market-makers are willing to let them roll, even if it crashes and burns, just because they have so much more flow.

But it’s important for boutiques like us, that when we go to market, and we put an ask on a market-maker and we say, “Hey, man,” handshake, “we’re going to get you out of seed,” that needs to be a money-good handshake.

Meb: To be clear, there’s lots and lots of funds that never… I mean, not never, but go a very long time without any kind of seed.

Wes: Yeah, there is good reason why market-makers don’t like this, is because they’ve been burnt so many times. So this, to your point, is becoming… A much more challenging component of launching an ETF is, we need to be able to convince the marketplace and our counterparties that these people are legit. And that obviously helps by working with someone else who’s already built brand and trust reputation. So you or I can easily launch an ETF, where Joe Schmuckatelli, a random RIA guy says, “Hey…” or girl, “Let’s launch an ETF,” they may not be engaged as much. But that’s a big component of the initial aspect, is just…is working in the capital market side, and getting someone to commit to the seed capital and to be your lead market-maker.

Usually, that involves a dog-and-pony show, where you pitch us, “Okay, we’re in. This seems viable.” And then, we have to turn around a pitch you, and hopefully, close the deal the deal. That is a super time-consuming element. And then, the other time-consuming element here before launch is, you’ve got to get the website rocking, you’ve got to get your fact sheets rocking, all your marketing material. And the reason that can be a bit of a pain is, it’s not if you’re an RIA, where you just…you manage your own marketing material. Anytime you’re in the security business…and an ETF is technically a security, all the market materials need to be approved by FINRA.

And that’s just a lot more convoluted process that could take, potentially, weeks. We want to be working through this. As the SEC is reviewing your materials, we’ve got to start prepping the fact sheets and prepping the websites, and all these sorts of things. So there’s a lot of backfill and little minutiae jobs that we need to get done before this ticker actually goes live, day one. So you’ve got anything to add on just the general launch phase, right before you’re about to click the “Go” button, Meb?

Meb: No. I mean, I think… Thoughtfully thinking through a number of things, namely, like, you either have the seed, you have a very clear plan, you’ve got a fund ticker, perhaps memorable, that can help, I think you’ve been pretty accurate so far, on all that you’re mentioning. What’s next, launch day?

Wes: Yeah, so… And I’ll add a little bit of colour on seed capital, like, the initial money, who’s going to be the first $5 million in this fund. Just some random ideas out there that I’ve seen that have been pretty successful, is for…if people are listening or thinking about this. The best idea I’ve seen, to date, is where an ETF sponsor or future sponsor goes to an operating capital base…like, they go raise a little angel, a little VC. And they say, “Listen, if you put $100,000 in my operating company, you have to commit $400,000 in AUM capital to the fund,” with the idea being…is, you’re now solving two things at once. You’re solving the operating-capital problem and initial-capital problem in AUM.

And the argument is, like, “Well, if you’re a VC and you’re willing to give me money for the operating capital, you should probably believe in the product. So put skin in the game.” And that’s been a very successful way I’ve seen a lot of folks who are out in the markets for this, raising the operating capital and AUM seed, initially. That’s a good technique, for sure.

Meb: And the AUM seed…or the path, is so important, listeners, for a couple reasons. It’s not just the profitability of the fund. So we say, “Yeah, you need to get to $20 million, $30 million, just so you’re profitable and you’re not writing big checks,” which we’ll get to in a minute. But it’s also perception from investors. I think when investors see a fund that’s at $5 million that trades 200 shares a day, for better or for worse, they think that it… And it probably has a big bid-ask spread. Typically, bid-ask will condense as the fund gets larger. So for the individual investor who’s buying 100 or 1,000 shares or 10, that can be frightening. And then, also, there’s a little bit of that social element, where people like to get the warm and fuzzies from other investors blessing something.

So if they look at something that’s sitting there, and it’s been out for 1, 3, 6, 12 months, 2 years, and it’s at $5 million, they’re saying, “Well, am I just the crazy one buying this, and no one else is buying it? What am I missing?” And on top of that, there’s a lot of these platforms, and the typical wire houses are being the big ones. But also, all the various brokerages, they all their different rules. Some, it’s AUM, some, it’s volume, some, it’s all sorts of other stuff. But you’ll also be blocked on a lot of those. AUM cures a lot of those headaches.

And so, getting to the…what we consider the starting gate, to me, is not launch. The starting gate is really, when you get to the gravitational orbit of $20 million to $30 million, then you’re in the game. And then, there’s obviously, different orbits of $50 million, $100 million, etc., that unlocks different doors.

Wes: And one last point on that, because I’m sure you could confirm this, Meb. But if I had the AUM that was firmly committed to me via verbal communications, we would probably be Black Rock right now. And it’s just… Everyone’s like, “Oh, I’m good for $10 million when you launch this thing.” The issue is, they might say that because they’re your friend or your relationship. But if they’re… Let’s say they’re working at an RIA or something, right, they may be truthful in that statement. It’s not that they’re being nefarious.

It’s just that when they actually… When it comes time to, “Okay, we’re going to put $10 million in the fund,” and they go talk to the investment committee, who talks to the compliance officer, and then the officer’s like, “Well, yeah. But we have a minimum five-year track record and $100 million AUM. So how are we going to put $10 million in this ETF? What are you talking about?” So it’s just… Whenever you’re… We never rely on commits. And you should never, either, if you’re out there getting excited about how much AUM you’re going to have. You need to have Lannister money, right, like, “Game of Thrones.”

It’s got to be money-good, and these people pay their debts. It can’t be verbal commitments, and it’s really important that you discount promises. Unless you control that capital, it’s your uncle, or there’s some legal or structural reason why you know you can move that money into this fund, I would just discount it to, basically, zero.

Meb: And then, on top of that with all the platforms, a lot of people will get ready to facepalm based on all the challenges with the various gatekeepers. We’ve had people in the past that say, “Your fund’s not approved because you don’t have enough employees.” Or, “Your funds are not approved…” The big one we see all the time is, “They’re active,” as if that’s some meaningful gate, whereas the entire mutual-fund industry is active. But somehow, that matters for ETFs. And it’s just… Look, I mean, the world is learning, they’re figuring out what ETFs are. This is a lot of legacy risk-management problems.

And then, remember too, a lot of the platforms have conflicts of interests of wanting their own products to have an advantage, and/or… We forgot to talk about this. One of the biggest issues of the mutual fund world that the ETF rule, I think, just destroyed was all these huge mutual-fund supermarkets and platforms, where the mutual funds pay an enormous fee to be on the platforms. I mean, in some cases, it’s like, 40 basis points. That’s almost half a percentage point, which for many ETFs, is almost the entire cost. And so, there’s a lot of legacy conflicts of interest. And a lot of investors don’t know that, by the way.

And so, it’s going to be fun to watch the mutual-fund industry eat itself and implode, because all the brokerages now also have zero-transaction-fee ETFs. So there’s zero cost to trade these. Many of the mutual funds still charge, and on top of that, you’re getting kicked in the nuts by the mutual funds having to compete with these massive cost structures on the supermarkets…which generates, like, $1 billion a year for Schwab, by the way. You avoid all this with ETFs. It’s such a better structure, and totally ignoring the… We calculate the tax benefit on the average-equity ETF versus the mutual fund that’s active at 70 basis points, which is more important than the entire management fee alone. Anyway, end of Meb rant. Let’s go back to it.

Wes: Yeah, no. Obviously, 100% on all that. This is not meant to be a sugar-coating on launching an ETF and how easy it is. Again, this is just like reality, and we’re trying to help people do this as efficiently as possible, and set them up for success. Because it really is important that they consider this option for all the reasons you just mentioned. This is the future, and yeah, it sucks. But this is a…at least for the foreseeable future, seems like a viable way to deliver an investment-management product. So now, we’re at the… Like, okay, this thing’s launched…

Meb: But wait, you forgot. Hold on. You probably went to the NYSC or NASDAQ. What you used to do in the olden days, pop some bottles, we ring the bell, now, we push a button on the NASDAQ. Now, it’s probably virtual. But one of the memorable points of my career was doing an NYSC bell ringing, it was super fun. They had the biggest boardroom table I’ve ever seen in my life, it’s like a football field. You must can sit 200 people around this boardroom table. All right, but that sucker’s launched, now you’re in the game, it’s the real world, you’ve got to start raising assets.

Wes: Exactly. And I skip the exchange listing on your point, because nowadays, it’s like, okay, no one cares. But yeah, in the old days, it was way, way cooler. So you lunch this thing, and now is when the bills start piling up, because you have all these counterparties, right? Your custodian, broker-dealer, fund admin, audit, tax, us managing your compliance. There’s all these pieces that just deal with managing the regulatory edifice of the ETF, not to mention the portfolio manager component, like dealing with the crates, the redeems, the custom baskets, and rebalance, and what have you. And this is where the real cost comes in.

And again, this is highly variable. But just for simple math, if you threw it on your Excel pro forma because you don’t want to think too hard, what we usually tell people is, “Listen, you’re looking…” And this is where we would underwrite anything that’s actually a variable cost, but we’ll just deal with it and eat it, if we’re wrong. You’re looking at a $225,000 fixed cost, and then usually, you’re on a $25,000 variable cost, which could range from $5,000 to $50,000. And that’s really about how much marketing materials do you want to submit, because every time you submit, you’ve got to pay. And then, also, your AUM… The SEC charges an AUM fee, and we just pass that through.

So you’re looking at $250,000, easy math, soup to nuts, to operate an ETF in a given year. Can you get cheaper than that? Of course, you can. Can you get more expensive than that? Sure. But that’s just a ballpark on a platform like ours, just running the thing, soup to nuts. You take that to the bank, put it in your pro forma amount, $250,000.

Meb: I don’t think you can get much cheaper, by the way. I mean, having done this 11 times and getting ready to launch some more. But again, to really let this sink in for listeners, whether it’s $200,000 or $250,000 or $300,000 or $150,000, to me, shouldn’t be the big calculus. The big calculus is focusing, in my opinion, on the top line, how do you get AUM in the door. All right, keep going. So there’s the variable fee, there’s the fixed fee.

Wes: You got it. The easy way to think, again, is like, okay, to start the thing…the legal stuff in Phase One, let’s say it’s $50,000. To your point, can it be $30,000? Sure. But just to be conservative, let’s say it’s $50,000. Then, you have the ongoing cost. the fixed cost, you’re looking at probably $225,000. And then, you have this variable cost that we estimate around $25,000, so let’s just say it’s $250,000 in total. And then, if you have the good problem of AUM… And as we always tell people, AUM solves all problems. Eventually, as you get scale…because the operator, like us, we get passed through variable costs, three or four BPS here or there, there’s an additional scale cost.

So you’re looking at your fixed cost…or fixed plus initial variable is, like, $250,000. And then, obviously, if you get to $100 million or $200 million or $300 million, we start charging a marginal cost of anywhere from, let’s say, 4 to 10 basis points. But what does that mean? That means that once you hit the fixed cost, you’re kind of through the operating leverage pain. And now, let’s say you charge 50 basis points, and let’s say we kick through a variable cost of 5 BPS on anything that’s at scale. Well, now, you’re… You know, do the math. You have a pretty nice gross margin there. And that’s why people like the ETF business.

But to your point, Meb, you do have to fight through, “How the heck to I get to that $5 million, that $25 million, that $50 million?” If you can get to that $50-million mark, and you’re at least in the ballpark of potentially being break-even, or even maybe profitable, now you set yourself up for an epic call option, where you can leverage this operating leverage in the ETF structure. And if you do a good job on distribution and marketing and telling your story, it’s a very attractive business model, essentially.

Meb: Yeah. And we’ve seen many cases of this when a product finds the product-market fit. I mean, the classic from the olden days was WisdomTree’s DXJ which, for years, had sat, bouncing around $100 million, $200 million. And then, when Japan’s stock market was taking off…it was yen hedge, that sucker got to, like, $15 billion or something. And the beauty of the asset management model that the mutual-fund industry and everyone else understands is that of the 150-odd industries, asset management still has one of the highest profit margins out there.

And so, in my mind… Again, we keep harping on this, but I think it’s so important. If you’re going to marinate a fund and have no plan on how to raise assets, you’d better have $500,000 to $1 million to subsidize that sucker for 3 or 4 years. To me, that’s a really foolish way of doing it, but people do it. But then, the big next ones are $20 million. At least, you’re in the game, you can breathe easy when you’re not writing huge checks. Fifty is things… Okay, like, this is happening, you’re probably cap-positive cash flowing. And then, above that, it just becomes an equation of how much exponential does the revenue go? And obviously, you need to have everything…kind of all the puzzle pieces, working together to get to that.

But once you hit $100 million, $200 million, $400 million, $500 million, the profit margins just are… It’s often, for most people, no harder to run a fund at $20 million than $200 million, $2 billion, $20 billion. And I forgot to… We didn’t comment on this, but I think it’s really important. The ease of running a fund… Let’s say you run an equity strategy that rebalances once a year. Let’s call it this innovative new strategy called “Dogs of the DOW,” right? You buy 10 DOW stocks each year with the highest dividend yield, and you only rebalance once a year. If you’re the actual manager trading whatever, money’s sloshing in and out every day, in a mutual fund, you’ve got to go buy and sell stuff, which is why it’s so tax-inefficient.

With an ETF, theoretically, you could check in once a year to make the rebalance, and then you do nothing, it all happens behind the scenes. And so, as a manager… And I’m oversimplifying a little bit. But as the person who has designed that strategy, it’s so much harder to deal with separate accounts as a mutual fund as an ETF. There’s obviously dividends and corporate actions and stuff, but by and large, you’re not doing a whole lot on the inflows and outflows that happen behind the scenes.

Wes: Yeah, no, you got it. And this whole model that we’re mentioning here is where, literally, your job as a sponsor of someone who wants to get in this business is, you manage the Excel spreadsheet. You tell us what to buy, what to sell, and just send it on over, and then, just educate the marketplace about your idea. You don’t do anything else. So you can get rid of every single person in your firm besides, obviously, yourselves, the marketing people, probably, and your R&D folks. And so, this is like, you don’t do anything operationally or in the guts or the dirty work. You’re just in the rock star profile, which is what a lot of people are good at and what they want to do.

Meb: Give me a case-study example. We’ve done a couple white-label funds, but 99% of the time when someone emails me about starting an ETF, I say, “Email Wes at Alpha Architect.” Sorry, by the way. You’re going to get a bunch of inquiries. Don’t abuse that, listeners. Only email Wes and crew if you’re serious.

Wes: Or if you’ve got good jokes, too. I like dumb jokes, so you can send those over.

Meb: You have been successful at rolling out a handful of funds. Maybe give us a case study of someone who’s done it, and the bells and whistles of how it’s worked.

Wes: Yeah, actually, the ones that we’ve done to data have all been very different, and they’ve all had success in their own way, right? So the first one we did… And this is a shout-out to [inaudible 00:53:44], if anyone knows her out there. She’s the one that actually convinced us to get into this white-label business. Because we’d always been very particular about just keeping things private, you know, “Let’s just use this same structure for our own purposes.” And she kind of convinced us, like, “Hey, this is a good idea. You guys should be in this. Why not use all this stuff you’ve built?” And so, in her situation, she’s total bootstrap, and I think she’s got $20 million in her fund.

But it’s just essentially her, alone and unafraid. She raised a little bit of initial capital, had an initial big-seeder around the $5-million mark. And it’s just been her, and that’s pretty much it, just working it. And she’s been… For all intents and purposes, that success, if you get to that $20-million mark within a year… Especially given that she hasn’t burned a lot of money on hiring a salesforce or anything. And she will slowly grow that, it’s a long game-play, and I could see that fund being $100 million in three years from now, and so on and so forth. So it worked, right? The other group we dealt with, they actually had… They do machine-learning AI things. They had a legacy software business, newsletter business, where they had already had a pretty large following.

And even their own software clients were like… Scott is the gentleman’s name. Like, “Scott, dude, honestly, could you just put this in an ETF, so we could just buy the thing and get the tax efficiency? It’s getting annoying, having to enter in the trades all the time. Can you just hook us up?” And so, he’s like, “Well, yeah. Why not?” And then… So in their situation, they also have a very, very small operational footprint, but they already had this intellectual demand from a lot of people, that they like their ideas, but they didn’t have a way to efficiently deliver it to them. And those guys have already raised, like, $70 million in one year with, again, very minimal footprint on sales operations. It’s pretty much Scott and some of his friends from the old software business, and it’s amazing.

So that’s another approach. They’re kind of leaning on an effective distribution strategy that wasn’t traditional, but they were able to translate those followers into ETF buyers. And in the third case study, just because it’s relevant for…given the spectrum, is, we’re working with a group now, Almanac, which essentially, for all intents and purpose, is a cheap SEI camp. So they’re trying to help RIAs who just hate dealing with ops and infrastructure, and just want to focus on working with clients and maintaining good relations. They’re, like, actually $1.5 billion right now, and they also have a lot of clients that are super tax-sensitive.

So they decided, initially, to launch an ETF. And then, they realized very quickly, “Hey, we’re very good at doing RIA, ops compliance. This ETF thing is this whole nightmare, let’s just have Alpha Architect do it.” And so, in their situation, we’re now going to be operating all the ETF mechanics and materials. And what they use their ETF as is, for people that want an allocation to, essentially, a risk-parity idea tax efficiently, that’s part of their models in their $1.5-billion RIA complex. So they were kind of a “bring your own assets” example. So these are three different…totally, completely different approaches to figuring how to launch an ETF successfully, and then within a year, have it where it’s viable and this could work.

And everyone has their own different story. And we’re in the middle of a ton of discussions where, also the same thing. Every single one of these, there’s a different background of how they’ve convinced us why this is something that we’d be willing to sit behind and partner with them on. And so, it’s happening out there, and there’s no one way to do it. There’s many ways to cross the finish line, we think.

Meb: This is a trend… And listeners, you can check out all the funds that Wes is talking about, and the white-labels at their website. But this is a trend that I would have bet on a long time ago, to have really accelerated that hasn’t but is now, which is RIAs that are launching their own funds…registered investment advisors, or you could put brokers or any money managers under that same umbrella. You’ve had a few over the years that have been successful, but it hasn’t been a dam-breaking stampede. But for many of the issues or reasons we mentioned earlier of why this is thoughtful, we did it where we cannibalized separate accounts’ business, where we closed two hedge funds…just did them at ETFs, again, for the transparency, the tax benefits, and then the organizational challenges.

But there’s a few other use cases that I think are really interesting. One…and Wes, if anyone could figure this out, it’s you, is, you mentioned the 1031 concept. I’m surprised that some really large individuals’ family offices, broker at Morgan-Stanley, you have what’s called on the private side these not-switch funds. What are they called, where you can put in a highly-appreciated…?

[Crosstalk 00:59:09]

Wes: Oh, exchange funds. Yeah.

Meb: Exchange funds, thank you.

Wes: Yeah, yeah. You contributed some property, and then you get the pool. Yeah.

Meb: Yeah. I’m surprised that an innovative ETF issuer hasn’t figured out a way to do this where, let’s say you’ve got $100 million of highly-appreciated stocks, or $1 billion. You put it into the ETF structure, you’re the initial seed. You then get ETF shares back, which can then, essentially, wash the capital gains through the structure. That seems to me like a doable idea, so I’m going to put the onus on you to figure it out. I don’t know how to do it.

Wes: It’s funny you mention that, because we’re actively in the middle of trying to figure that out. And there is some rumours out there that some people have solved this. It’s obviously what we’re trying to figure out, what they did. You’ve obviously got to be very, very careful, because you’ve got to make sure you comply with, obviously, tax rules and all this good stuff, which we obviously recommend. And the other thing that I know you definitely can’t do, or you’ve got to be very, very careful of…because I get this question all the time, and trust me, I’ve thought a million times sideways, is, one rich person or individual who’s… Let’s say they’re some billionaire. Because I would think of this if I was a billionaire, like, “Wow. I could just run my family office in an ETF and have a tax deferral forever. I’m going to just do that.”

Well, the problem is, you can’t do that, because you need to have distributed ownership in an ETF. And we usually recommend, for a long story, but no one investor should ever be more than 20% of an ETF where that’s identifiable, i.e., you’re an affiliate of me. Because now you’re a control person, people can sue you. So unless you can find a bunch of rich other family offices, or you form a syndicate, we’re all going to do this idea and post up 20% apiece. You could actually do something you’re talking about here, but it’s just… In my experience, herding uber-rich people is like herding cats. So good luck, if you can do that. I’ll be more than happy to help you if you can figure that out.

What you’re talking about, of an SMA or even a hedge fund or a mutual fund, of being able to move into an ETF structure, and potentially pull…like, keep your basis, but move those securities in there, and now, you have an ETF versus an LP interest, that is something that is potentially doable. We haven’t done it yet, but actually, we’re in the middle of exporting that for someone in real time, and it sounds like it is possible. So no promises, because this is going to be a live podcast. But it’s certainly something that if that sounds like you, feel free to reach out. And we’re happy to potentially explore that option with you.

Meb: Well, and the use case in my mind, for the family office…and I’m surprised you haven’t seen more of this, is, many, many, many family offices internally manage active strategies. And there is nothing that rich people hate more than taxes. And why in the world would you do an active strategy and not just wrap it in the ETF structure? And you get the added benefit that if it’s a strategy that’s worth a shit, other people invest. So theoretically, if you’re a family office and you’re doing, I don’t know, some strategy based on, “Hey, we only invest in stocks where there’s a high family interest,” or, “that insiders are buying,” whatever it is, and you generate a few percentage points at Alpha per year, but you’re probably paying 70 BPS, if not more…because these guys are getting taxed at the highest rates, why would you not launch an ETF?

You then have the ability to not pay taxes on it or defer taxes. But also, you get the added benefit of potential appreciation from other people, agreeing that you have an amazing strategy. So if you have $50 million, it could be $500 million, $5 billion, and all of a sudden, you have a revenue stream.

Wes: Yeah, no, it’s… You’re just letting other people help you lower your fixed cost, and you’re doing what you wanted to do, anyway. So eventually, you end up getting paid to manage the money in a tax-efficient way that you wouldn’t in the first place. So I agree with you. I’m also surprised. But my experience is, it’s been the coordination issues, where somehow, it’s got to be a syndicate of family offices that agree, and they have equal wealth, so they could contribute to the seed, effectively. But yeah, it certainly seems like a good idea, and someone should probably do that at some point, for sure.

Meb: Yeah. There’s a couple other areas that I… This is like a “Shark Tank” for ETFs that I haven’t seen really develop, that I tweeted one last night. But no one was awake, I think. I said, “There’s a few people that have tried something similar, but you have a lot of opportunity, in my mind, if you’re a charity, to say, “Look, people love giving us money.” But we could invest in ESG-style companies that fulfil our mission, or what we’re trying to do or we believe in, and the management fee can go to the charity. Likewise, you could do it for endowments. There’s a bunch of these student-run endowments. UVA has one, Virginia, my alma mater.

We had a great episode with Tulane, who actually did this with a mutual fund. But again, you could do it and have the tax benefits of the ETF called “Burkenroad” and “Peter Ricchiuti.” And then, again, same thing. The management fee goes to the endowment at the school. That seems like such a no-brainer, and I’m curious… Oh, and the last… Under that same banner was all of these… There’s all these idea conferences, so [inaudible 01:04:51]. There’s one called “Invest For Kids” coming up, where they have people…famous hedge funds come and pitch a stock.

And I said, “Why don’t you launch an ETF based on that?” You invest in the stocks that they get pitched. And theoretically, if they do a good job, you could charge a management fee, again, that would benefit this. Or there’s a magnitude more than the donations you’ll get for the virtual conference. What do you think?

Wes: Yeah. I mean, I like the idea, especially in a world where people are every keen on impact investing and being social responsible with their money. It seems like that could definitely be a win-win, right, where you’re going to manage your money you wanted to manage, anyways, a sort of nice, efficient, regulated vehicle. And then, any of the proceeds that come in there essentially get donated to some cause that everyone thinks is a reasonable idea. I mean, why not? I mean, honestly, as a cold-hearted, rational Chicago economist, the counter-argument is, like, “Well, just run the ETF vehicle efficiently at low cost. And then, people could save the money on the fee, and just donate it to whatever cause they want.”

Meb: The presumption, in my mind, is, you would have to nail some value-add. And someone tweeted to me last night and said there’s actually a fund that does this in Australia that’s already donated $10 million in benefits. And it reminds me of the hedge fund in the UK, I think, The Children’s Fund. Anyway, it’s an opportunity. You guys, if we got Red Cross listening, hit up Wes.

Wes: Yeah. And I mean, kind of, the idea of our platform is… Honestly, we’ve already eaten the fixed cost, right? We’ve built all the software [inaudible 01:06:30] systems. And so, the way we look at the white-label business…because we’re obviously in the main ETF business, is, we look like… That’s our gold-mining business, right? We’re already out gold mining, this is more like the shovel-selling business. So we’re not trying to get super-rich, here. But to the extent that someone can convey that they’re a low-risk candidate, and they’re not going to put reputation or fixed-cost risk on us, we’re open to a lot of different deals, where our whole thing is, we like ETFs and we think, to your point, there’s so many more use cases for them.

But the issue is the launch cost, the set-up cost, and the brain damage of doing it is non-trivial. So I mean, the cost that we’ve talked about here are, obviously, just rack rates and what the standard-issue things are. But we’re open to any good ideas. And the in-state is, how do we economize on our own platform or inefficiencies to make sure that other entrepreneurs can come in and be successful? We’re trying to just open the umbrella where there’s just so many great ideas, but launching an ETF is such a pain in the ass and still is.

Meb: Well, the good news is, most of the people that I mention have big pockets. So endowments, family offices, charities. And so, I know CalPERS listens. But all the other endowments have written some articles, should most of these be managed by a robot? I don’t understand why, if you’re an endowment. The amount of drama and brain damage and fees, and headache… I mean, CalPERS, it’s just like, never-ending story. Why wouldn’t they say, “Well, dude, we’re just going to launch an ETF. We’re going to buy the global market portfolio with tilts, and we’re going to have Wes do it. And we’re going to save $200 million a year in costs, and it’s probably going to be what we’re doing, currently. And everyone will be happy.”

Wes: Yeah. I think that our people that do that, it’s scaled with, obviously, like, iShares and some of the monsters. But there’s definitely no one that…where someone said, “Hey, I’ve got $25 million or $50 million seed. Would you work with me,” I’m not so sure an iShares would be like, “Oh, yeah. Let’s do it.” I don’t even think they wake up for $50 million, anymore. I know Vanguard doesn’t. A billion-dollar business, for them, is like, “Whatever. That’s a rounding error.” So yeah, I mean, we’re open for that business. And then, it’ll also be unfair to say, like… We’re not the only one in white-label business. There’s others out there, like Mike Venuto at Tidal Services. They have a really good offering. So you should check out… You can always go direct.

Meb: They have a good example, by the way, a use case, where they helped to launch RPAR, which is nearing $1 billion in assets, but is a good example of an RIA. It’s, like, a $10-billion RIA, located here in LA. Good guys ARIS. And they seeded it to where it’s large enough that it’s automatically viable from day one, and it’s a good example… I don’t want to speak for them, but it seems like we did what we were talking about earlier, with wrapping up a lot of the separate accounts into an ETF strategy that’s more tax-efficient.

I am shocked that you have not seen more RIAs to this. I’ve said that a million times. But also, we know why the mutual funds haven’t, because they’re going to hold on to those cash flows, as long as people are willing to pay them these huge fees. But I mean, I am consistently shocked how every giant mutual fund asset management on the planet hasn’t either launched ETFs or gotten into the game. But I’m a broken record there. I don’t know.

Wes: Yeah. I mean, I’m with you, and… But you nailed it. I mean, the general case study that we’ve seen is… Because we, a lot of times, talk, probably like you do, to the people that aren’t at the C-level, they’re right next down. And the issue is that most asset-management shops, you’re going to get bonused and compensated on, like, well, what’s the revenue over the next three to five years? Well, guess what? If you want to be around in 10 years, you’d need to do an ETF. But guess, also, what? You’re going to have to take a huge revenue cut in the next three to five.

So the C-level executives, they’re like, “Well, why don’t I do that?” Whereas the younger group is like, “Well, you need to do that, or we’re not going to have a job.” And so, there’s, a lot of times, just conflicts of interest in doing the efficient idea, I think.

Meb: A decade long is far too long for any business career risk to work out. Because the older crew has just been like, “Dude, I am just going to sunset my dividends, let this… As all the people die and get divorced, they forgot they own these funds. I’m just going to let that sunset.” The younger crew is like, “I’m not going to be here in 10 years.” So the only asset managers that are disrupting themselves that will be around in 10 years… I mean, you look at that chart of ETF and high-fee mutual-fund flows, the example I still give, though, is that it hasn’t even really begun in a lot of areas.

The asset-allocation mutual funds still have, like, $800 billion in assets and are multiples more expensive than the ETF… Anyway, end of rant. These guys are going to go ahead… I think a lot of these are terminal shorts, but we’ll check back in in 2030.

Wes: I do, too. But to give a shout-out to our deep-value friend, Toby, he makes a point. You’ve got to watch on terminal shorts like that, because if they’re free cash-flow generators, if they… If someone woke up and had a good idea, they could then fund with a lot of capital backing, like a moon shot that works out. And now, your terminal short turns into a Tesla, probably.

Meb: Now, you’ve got to do a basket. It’s a terminal of old-school…

[Crosstalk 01:12:16]

Wes: Yeah, I got you. Yeah.

Meb: …calcified asset management along the innovative ETF [inaudible 01:12:21].

Wes: Yeah, yeah. And then, he put a screen for, like… If there’s ever a millennial or younger person in charge, get rid of that one, because they might actually make a good decision.

Meb: Well, you know, you’ve seen a couple of shout-outs. One is, there’s been a lot of success across [inaudible 01:12:37] launching ETFs. And you mentioned Toby [inaudible 01:12:41] with the freedom strategy, the Romo guys, the Canadian Corey partnership. Arc [SP] may be the most successful of the cycle, with Cathy Wood just blowing the…knocking the cover off the ball. I don’t know how many billions in AUM they have now, but it’s a lot. And remember, the early days of her going down this active route, and then shifting the narrative a little bit, which really… I mean, obviously, their performance has been otherworldly, the narrative to more disruption and innovation.

Let me give you one more idea. We could do… This is going to be a five-hour podcast. But I’m surprised you haven’t seen… You’re seeing it elsewhere in the economy, where… And I’m not going to use the influencer word, but just brands. And people and companies leverage that influence into the asset-management industry. So the example would be, there was someone trying to do a Donna Nary at Iconic Beta. And she was promoting some ideas, potentially, about Quincy Jones, and pairing a brand with a concept. So his was streaming.

Obviously, you could do… I mean, you could think of it from a 10,000-foot view with Jay-Z or Snoop or Mark Cuban. But whatever it may be, that seems to me that that potentially has lags at some point. What’s your thoughts there?

Wes: Yeah. I mean, again, one of the key benefits of an ETF is, you’re a live [inaudible 01:14:12], accessible pretty much everywhere. Or you have an open-architecture broker platform, so you have access to this incredibly scalable marketplace. And to the extent you can get the idea out there, or the brand out there, or what have you, I mean, yeah, I’m with you. I just don’t think a lot of people are familiar with this aspect of how they can monetize their IP or their noteworthiness. One really cool example…I won’t mention specifics, but I was like, “Wow, that’s really compelling,” is, we got called by a bunch of these PhD weather scientists.

And they didn’t know anything about asset management, but they were like, “Man, we heard about this whole finance business. And there’s apparently people making money on picking stocks that are not as weather-resistant, or have bad carbon footprints.” They were like, “We’ve been saying this for 20 years. I mean, we all have dissertations in this, and the way they do it makes no sense, whatsoever. We have this proprietary database, and this is how it directly ties to equity values.” And I was like, “Yeah, you guys should definitely probably think about asset management, because you are light years ahead of actually doing real research in ESG. You should monetize that, and asset management is way better than doing some consulting gig you do for $20 an hour right now.”

But they just had no idea that that was even a concept. And so, I’m sure there’s tons of people out there that aren’t in our business that have really good ideas or really cool innovations. But in the ETF wrapper and the accessibility and the scale component, there’s people that could all of a sudden build a $100-million business, and they didn’t even know it existed, basically.

Meb: I posted on Twitter, opening up to questions. And we got one from my favourite anonymous account, Jake at EconomPic. And he says, “Wes, what is the most important aspect of a new ETF launch success?” And there’s four choices, ticker symbol, elevator pitch, academic support, and market environment. Again, it’s ticker, elevator pitch, academic support, market environment.

Wes: I would say, if I had to pick one of those, it’d be market environment, because it would be totally disingenuous to not say that luck in anything, but especially asset management, is probably 90% of it. So if I launched the most whiz-bang, amazing, trend-following fund that the world has ever seen, well, guess what? I ain’t raising shit right now, right? But let’s say we’re right after 2008, and trend-following in some form or another and kicked butt, well, I’d probably raise $1 billion dollars, right? So I think market environment, which is really just luck, I would argue, is certainly a…one of the biggest… If you PCA’d the variability, it’s probably a big driver of success, I would say.

Meb: You know, that’s tough, because a lot of it has to do with randomness. When we talk to people launching funds, I say, “Assuming you don’t have a billion-dollar seed, you need to think long and hard about…” Going back to the…earlier in the conversation when I said there’s the four things we think about. The first one is, does this product exist? I cannot tell you, every day I wake up to seeing one of these old-school, mutual-fund companies or other companies that launched the…I don’t know, 500th large-cap growth-fund ETF. How are you possibly still…?

And by the way, it’s not extreme concentration. You and I exist on the outer rim of the universe. They’re like, “Hey, we’ll overweight each company by one or two percent.” It just doesn’t even… It’s not even a concept that even has potential. So assuming it has all those other things, yeah, the market environment…particularly if you’re a fund where nothing else exists. For example, there’s only one African ETF. And if Africa goes gangbusters, guess who’s going to get the inflows? Particularly, it applies to thematics. If you’re the only fund focusing on submarines, and submarines become the biggest industry in the 2020s, then you’re obviously going to get the inflows.

But the market environment is the gasoline on the fire. We talked before the podcast, we’ve seen this with our [inaudible 01:18:47] strategies, finding a lot of interest as the market has been hitting new highs and people feeling, I think, a lot of disconnect about that. But the other ones, I think, academic support and elevator pitch, appeal to your early adopters or the people that get it and are willing to invest without a track record, and are going to be there for a while. Ticker, in my opinion, sort of is like…pushes down on the accelerator. It’s gravy.

If you’ve got a bomb ticker, it’s going to help, but it’s not going to kill the product. I’ve seen plenty… I mean, do you remember…? God, what was Bill Gross’ ETF when it first launched? It was, like, TRXT, and raised a gazillion dollars. And then, eventually, they got the ticker for bond. But ticker helps, but…

Wes: Yeah, ticker’s definitely useful. The other one, for me, is, honestly, just… We always look for cockroach entrepreneurship kind of style where, because it’s such a big component and because costs are a big component, you need to have the mentality of, like, “I’m looking at this as a 10-year play.” If you’re in the ETF business, like, “I’m just going to wing it and try to get rich real quick,” because luck is such a huge component, it’s unlikely you’re going to get lucky. But if you have a little bit of luck and you have time and grade, if you can sick in for 10 years, maybe, well, eventually, luck has a good chance of rolling in your favour. So being able to stick it out for a long time and luck, those two elements, I think will boost up your probability of success in the end.

Meb: Yeah, and I think an important… We talk a lot about differentiation. You guys have a lot of cool tools on your website. And professional advisors, if you want to access, hit up Wes. If he’s in a good mood, he’ll give you access to them. He says you’ve only got to own $100 million of his funds, and then, you’ll get access. But there’s so many awesome institutional tools that he has, but one of which looks at concentration of factors. And you can sort by which funds. If you really care about value, who’s really doing hardcore, in-the-paint value.

And as you think about launching funds, listeners, true differentiation in existing in this future of asset-management disruption…if you have Vanguard at one side at zero-fee, you need to be, in my opinion, weird, different, concentrated, to be able to charge a fee. Because that’s the whole point. If you’re a closet indexer, you don’t deserve to charge a fee, but you’ve got to be pretty weird and different. We’re only two of the not so many that are willing to be that different and have egg on our face for half the time.

Wes: Yeah, yeah, for years. The other one that… Just a new one I ran across. This guy named Mike Aikens at etfaction.com, I’d just recommend everyone go check their website out. They’ve done a really good job of basically opening up due-diligence tools that go well beyond the standard stuff that everyone uses, and they’re also contemplating different ETF ideas. But the way he’s gone about it, where he launches a technology platform to help educate and inform investors and clients about how things work for the unique lens that they’re trying to go after, that seems like a great way to help you differentiate these weird, wacky strategies like URIs.

You’re not going to be able to lean on Morningstar to convey that message, because they’re just in the old-school methodologies of conveying and educating. So a lot of times, if you’re being innovative, you’re going to have to build a platform that helps communicate your innovation in a way that’s not done traditionally. Because if it could be done traditionally, it probably means it’s not that innovative, because that’s why Morningstar already has a way to assess it. So they’re a good example, and there’s a lot more out there, where people are just leveraging software-engineering design to help edumacate the world about why they’re unique or different.

Meb: Awesome. Well, Wes, I think I’ve held you for a long time. Any other final thoughts, CalPERS, as you’re listening? Let’s see. It’s mid-September. I’m wearing a Broncos hat. Football’s opening this week, and hopefully, Broncos, fingers crossed, get a big “W” Monday night. I’ve been in a Marine-layer depression for the Von Miller news, but he’s potential…can return this year. But CalPERS, if you’re listening in September, that means you could get an ETF out by year-end, if you really press Wes on it. Any final thoughts, anything that we didn’t cover today that you think is important?

Wes: No, I just think that the whole point is, if you really believe in your idea and something unique, and you think ETF is a wave of the future, [inaudible 01:23:46] a lot of other people in history, like…include yourself, Meb, just…I recommend people lean on us to help them move forward. Even if we don’t do business all good, we just want to promote a good thing. And so, just make sure that everyone’s aware that they can always reach out to any of us, to try to get in the game and be successful.

Meb: Awesome. Well, listeners, take Wes and crew up on it. Don’t waste their time, only if you’re serious. But they’re a good group based out of Pennsylvania. I’m sad to miss the march for the fallen, Wes, in person. We’ll be doing the LA version. We may have to do a course correction. Since half of California’s on fire, I think getting a little closer to the ocean may be a reasonable strategy. What I’ll miss most about the one in Pennsylvania is not the camaraderie, it was not the beers afterwards, it was not the extra mile you made everyone walk after dinner. But it was the local airport and the massage chairs they had in the airport. I spent probably two hours in a massage chair.

Wes: And I was not aware of that, but most people like the pickles. Remember how the [inaudible 01:25:00] used to keep the pickles out there? That’s [inaudible 01:25:03] the number-one thing I hear. But that’s a new one, they’ve got free massage chairs out there.

Meb: No, they’re not free. You had to put in, like… I probably spent, like, $30, where… It was, like, two dollars for every 10 minutes, and I just… Hopefully, no one else was waiting in line, because I just sat in there for, like, two hours. I was so sore.

Wes: Yeah, that happens when you do 20 miles out there.

Meb: Well, if you’re in the SoCal group, hit me up to join us. It’s, what, 28 miles? How many?

Wes: Yeah, yeah, 20 miles. And I have you guys’ course. And then, obviously, just on Twitter, I have people hitch up direct. But yeah, it’s virtual this year. So we actually covered the nation. And if you just go to our website, alphaarchitect.com/mftf, we have that database of folks like yourself, Meb, the team leaders. And just ding your team leader in your region and follow their map, and show up and represent for gold-star families and show your gratitude, and have an opportunity to get outside and get in shape. Why not?

Meb: How many different pods are there, going?

Wes: So we have 30, actually. And I mean, literally covered the country. And I mean, it’s going to be a way bigger event than the actual normal event, going virtual. People are just penned up in their house and want to go out and do something outdoors and for a charitable cause, so I guess it makes sense.

[Crosstalk 01:26:26]

Meb: Very cool. Fun. Wes, where do people find out more information? I’m sure they can hit you up, Wes, at Alpha Architect. But websites, any other resources, places to go?

Wes: Yeah. I mean, just…you know, alphaarchitect.com is just… Anything on there is… That’s probably the best way to start. Or just directly email us, hit us on Twitter. We’re pretty much open-architecture, so there’s 20 different ways you can reach out to us.

Meb: Awesome. Wes, thanks so much for joining us today, as always. We’ll have to do it again soon.

Wes: Yes, sir. Appreciate it, Meb.

Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes, and subscribe to the show anywhere good podcasts are found. My current favourite is Breaker. Thanks for listening, friends, and good investing.