The exchange traded fund industry has covered almost every corner of the markets. But the business is always on the prowl for new and exciting asset classes, sectors, global regions or investment styles that haven’t been explored.

For instance, I stumbled upon an intriguing mutual fund investment idea that could be easily translated into an ETF. Babson College Professor Joel Shulman heads a newly launched a mutual fund that tracks entrepreneurs. Since Babson is my alma mater, I reached out to Prof. Shulman and picked his brain on the idea of turning his mutual fund strategy into an ETF.

For five years, Prof. Shulman has headed a privately managed fund that has consistently outperformed peer benchmarks. Late last year, Prof. Shulman brought together his past research and created a stock Mutual Fund of Global Entrepreneurs called EntrepreneurShares, which is based on the entrepreneurial characteristics of managers in more than 400 of the best-managed, publicly-traded, entrepreneurial companies in the world.

“We have a very strong risk-adjusted alpha and high up capture ratio,” stated Shulman. “Over the past six years our extended performance ranks very high in our category.”

The fund is based on the Index of Global Entrepreneurs, which has generated annualized returns of over 12% for the past 5.5 years.

U.S. small-caps account for 60% of the EntrepreneurShares fund. It should be noted that small-cap stocks usually have limited liquidity and higher volatility. Small-cap companies often outperform in the early stages of bull markets.

“We have an up capture ratio of approximately 180%,” Shulman explained. “Consequently in positive equity markets our fund performs very well.  In down markets we perform the same as the market (or slightly worse). Our fund provides no benefit in a negative market. Thus, if investors believe that market conditions are weak then they should not buy our fund. However, they probably should not buy most other equity funds either. We believe that the markets are well positioned for a strong rally in the second half of this year (personal opinion on the stock market—not a promise).  Therefore, if the markets recover, entrepreneurial companies should perform very well.”

Prof. Shulman begins the selection process by pulling companies from a pool of 33,000 global publicly traded companies and selects entrepreneurial companies based on 15 attributes:

  1. Organic growth opportunities (not through acquisitions of other firms)
  2. Above average ownership stake among key stakeholders
  3. Low SG&A
  4. Above average return on invested capital
  5. Sustainable growth
  6. Manageable deb
  7. Active strategic alliances/partnerships/licensing
  8. Aligned executive compensation packages
  9. Low executive turnover
  10. Transparent governance
  11. Long duration of key managers
  12. Low or no dividends
  13. Family involvement
  14. High EBITDA Margin %
  15. Other significant stakeholder relationship

Through research at Babson College, it has been revealed that organizations with entrepreneurial culture, organic growth and aligned compensation tend to perform better. Companies with entrepreneurial characteristics tend to have leaders who “keep organizational costs lean, debt levels low, and expansion projects within reach,” according to a research paper Shulman wrote in 2009.

Shulman points out that non-entrepreneurial firms tend to create oversized organizational structures, payrolls and layers of red tape that would cut into efficiency. In comparison, entrepreneurial companies employ simplistic organizational designs that have less bureaucracy, allowing these firms to adapt to market conditions.

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