“i” is for Imitation

/, Phil Bak/“i” is for Imitation
S&P 500: When The Best Defense, is Getting Defensive..

By: [author-name],

It’s the shoe polish that gives it away. That is how you know where you are. Standard issue is an eighth inch thick, and shiny. But for the young and hungry, the ones hoping to climb that ladder, the shoe polish can reach as much as a quarter inch thick. Shiny shoe polish; that is how you know you are at Blackrock.

As an organization, iShares – built by Barclays Global Investors and now controlled by Blackrock – has done as much for investors as any company not called Vanguard. That is a fact that nobody can deny. iShares has succeeded in their mission of democratizing investments and has been a major part of a sea change in the asset management industry that has brought increased investment access at decreased costs to investors. That is one part of the story.

“I love your ideas, Phil, but my Blackrock wholesaler warned me about investing in fund companies below $10 Billion in total AUM”

Yes, that was said to me by a financial advisor in late 2017. Word for word.

The idea was that there was fund liquidation risk. The Blackrock wholesaler wanted the advisor to think  that there was a risk that our funds would liquidate if we didn’t reach some magical round number in other investment dollars.

I responded by pointing out that the risks of a being in a liquidated ETF are overstated – the fund would return the net assets to all investors in full, and the only damage was that the investors would have to reinvest the capital and might face a taxable event… that was the wrong response. It has since occurred to me that fighting a battle on the terms of your opponent is always a losing endeavor. Very clever corner you boxed me into, Blackrock Midwest Wholesaler.

The messaging around liquidation risk and minimum required asset levels has been remarkably effective at keeping innovators at bay, and keeping market share protected. Even more effective is the willingness to brazenly steal ideas, but I’ll get to that soon.

On the liquidation risk, the messaging has become so widespread that it is not only regurgitated by journalists and financial professionals, even the SEC has bought in.

The SEC published their 2018 exam priorities, which included:

“With respect to ETFs, our focus will be on funds that have little secondary market trading volume and that face the risk of being delisted from an exchange and having to liquidate assets.”

Anything and everything that could adversely impact investors is fair game, and this issue is no different. The SEC is right to explore fund liquidation risk. I just don’t think that low volumes are the signal of doom. The true signal of doom is not low volume, or low assets. It is low issuer conviction.

Just as Usain Bolt was once a toddler struggling to stay upright for three steps at a time, every ETF no matter the size once started out as a brand new fund. Some took a long time but built liquidity, some were pushed by large distribution networks and gathered liquidity quickly. Others never made it.

But conviction, that is what truly tells you whether a product will stand the test of time. Anyone who has talked to me or anyone on my team about what customer satisfaction means to the future prospects of a company, and anyone who has talked to us about why we invented, pioneered and championed reverse market cap weighted investing, they would know the lengths that we would go to just to ensure the survival of these funds. They are special to us, and we believe in them with a missionary’s focus.

And what about a fund company that does not have conviction? A company that will sell you magic beans, or both sides of the same bet, just so long as they can skim a dozen basis points off the top? Well, behold, all eighty eight (!!!) ETFs that have been closed by iShares over the years:

Eighty eight funds. I could not bear to imagine ever closing a single one of our funds, but I do not think that anyone at Blackrock is losing sleep over any of these ETFs. It is easy to open and close these things when you have no conviction about what they are, what purpose they serve and who they are meant to help.

It is easy to do when you have no skin in the game about each fund’s investment outcome.

If this sounds personal, it is. Sure, iShares stole my AirShares weighting methodology way back when carbon credit trading was going to be the next best thing, but there can’t be anyone at iShares who still remembers that. And that was the old iShares. The new iShares, the Blackrock iShares, they are all about innovation. Right?

Just look at their 2018 product launches.

  • April 5, 2018: launch of iShares Bloomberg Roll Select Commodity Strategy ETF. Roll yield captured systematically in an ETF? Sign me up. But, hopeful startup Elkhorn was trying to build a market for the Elkhorn Fundamental Commodity Strategy ETF (RCOM), launched on September 21, 2016.
  • April 12, 2018: launch of iShares MSCI USA Small-Cap ESG Optimized ETF. Sounds cool. Except Nuveen’s bright young team had already launched the Nushares ESG Small-Cap ETF (NUSC) back on December 13, 2016
  • June 28, 2018: launch of iShares Robotics and Artificial Intelligence ETF. Way back on October 21, 2013 the true innovators from Robo Global out of Dallas launched the ROBO Global Robotics & Automation Index ETF and spent years building an entire fund category on their own from the bottom up.
  • September 13, 2018: iShares announces that the SIZE ETF will no longer track the MSCI USA Risk Weighted Index but will now track the MSCI USA Low Size Index, an index that steals the reverse cap weight idea that we pioneered and spent over a year working day and night to explain the benefits of which to investors.
  • October 23, 2018: Blackrock announces ESG portfolio tools*. Who could argue with an ESG portfolio? Except industry thought leader Linda Zhang launched Purview Impact Solutions Strategy to do exactly that ten months prior. Purview was a female owned entrepreneurial effort that watched as Blackrock claimed to mimic her portfolios in part to “further the advancement of female empowered businesses”.
  • October 24, 2018: Blackrock launches the iShares ESG U.S. Aggregate Bond ETF. Again, picking on Nuveen’s NuShares who had been working tirelessly to build the market for the award winning Nushares Enhanced Yield U.S. Aggregate Bond ETF (NUAG), launched on September 14, 2016.

*Interesting side note, but the new portfolio tools include an ESG model portfolio builder. The ETFs that comprise that portfolio were listed in the press release issued by Blackrock as follows:

Fund Name  Ticker  Expense Ratio
iShares ESG U.S. Aggregate Bond ETF  EAGG  10 bps1
iShares ESG 1-5 Year USD Corporate Bond ETF  SUSB  12 bps
iShares ESG USD Corporate Bond ETF  SUSC  18 bps
iShares ESG MSCI USA ETF  ESGU  15 bps
iShares ESG MSCI USA Small-Cap ETF  ESML  17 bps
iShares ESG MSCI EAFE ETF  ESGD  20 bps
iShares ESG MSCI EM ETF  ESGE  25 bps

 When comparing the US large cap equity allocation in ESGU versus the non-ESG version of the same index, the allocation to Blackrock themselves has increased by a whopping 225% from 0.209% to 0.47%. I guess that IP theft is not a part of their ESG criteria.

As for the SIZE ETF changes I referenced above, it is not much of a competitive threat to RVRS anyway. Applying reverse cap weighting to the S&P500 caries significant advantages due to the total number of assets across swaps, futures, options, index funds and other derivatives. Ill save this for another day, and for our upcoming white paper on this topic. But like seeing a drunk make an ineffective pass on your girl, their failed attempt to steal my idea* makes it no less pleasant to witness. What will be interesting will be if/how they utilize the SIZE historical performance from prior to the index change.

*Funny story about this, actually. The request for this change was made by an investor to Blackrock. I had pitched this investor who was highly cynical about the concept of reverse cap weighting. I shared our research with him, and I guess I turned him around on it. And just as he betrayed my confidentiality, karma came back around as someone at Blackrock gleefully told me exactly who had made the request (“don’t be mad at us, Bro”), and they betrayed his confidentiality in kind.

So here we are. And if you own an iShares ETF, Blackrock wants to vote for corporate governance on your behalf. Yes, that’s a new thing. Remember this post as this issue comes to light in the coming months.

And don’t pity us. We are on the verge of clearing a quarter-billion dollars in total AUM in a little over two years in business. And while I am sure that three too many lawyers at Blackrock are soon to be huddled together to figure out how to apply pressure against me, from a distance, it will not work. It will not work because even though Blackrock is the largest asset management firm in the world and Larry Fink personally passed $1 Billion in personal fortune earlier this year, we have our own mission, and we have our own conviction. We will be around long term, despite what that Blackrock wholesaler wanted his client to believe. We are building a small but growing client base built on mutual respect, and on faith in our strategies, not on skimming off the top of theirs. And despite how many people hit me with a conditioned “what are your assets” response, I would not want it any other way.

And besides, in my opinion, their SIZE ETF faces significant liquidation risk.

Posted By: Phil Bak 11/15/2018

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