By Dan Weiskopf, ETF Professor
You’ve Got Mail is about Business Competition, Platform Changes and Communications [I]
It is February, so everyone is thinking about their Valentine. This brings us to the cinematic love story “You’ve Got Mail.” Of course, the ETF Think Tank is not about movie reviews. For this reason, we point out that the movie’s genius lies within the multiple metaphors it incorporated. First, it was about the foreshadowing of the changing commerce landscape. Second, it showed how people in 1998 were going to learn how to communicate using different mediums in the future (mail, telephone, email, instant message, cellphone, texting, direct messaging and Metaverse). Third, in a twisted way, it was also the movie that highlighted the complexity of the modern family. Finally, it was very early in telegraphing that paying with cash would become nearly obsolete in the future.
ETF Nerds, who remember the movie, may remember a couple of key zingers by Frank Navasky (Greg Kinnear). As an example, in a moment as the couple ponders what Kathleen Kelly (Meg Ryan) should do as the corner bookstore owner in this changing competitive world, he says “You are a lone reed standing tall, waving boldly in the corrupt sands of commerce.” At another point, he also says “Name me one thing we get from technology?”
Growth Should Deliver Value and Value Should Deliver Growth
All this brings us to our core message in this report: growth must deliver value and value must deliver growth. Of course, value investors who read this may say that this statement shows a huge misunderstanding of value investing, and to others this may be obvious. Nevertheless, as we review a comparison between these two factors, we need to consider this reality: markets are always a pricing mechanism for investors who are accessing risks and rewards through economic and competitive change. Sure, interest rates and free central bank money are a cause for investor sentiment angst, but as the saying goes, ultimately “in the absence of value price matters”. Our answer is to find a balanced approach to value and growth and avoid extremes in either direction. We know that rates will rise a minimum of 100 Bps, and possibly even 200 Bps in 2022. Clearly, this means that free money is gone, and some wild days are ahead for investors. But even if these conditions have changed, we would not recommend that investors move to extremes.
Using the largest traditional Vanguard and iShares funds, we illustrate the Performance Gap between the value and growth factors. In Chart 1, we highlight just the Vanguard Value (VTV) and Vanguard Growth (VUG) ETFs. In Charts 2 and 3, we bring in similar iShares funds to confirm. These charts highlight the historical peak in performance spread between the Value and Growth factors and ironically also highlight how the S&P 500 (SPY) has held up well relative to the decline in growth. In these illustrations we also highlight the ETF solution managed by Distillate Capital, which is involved in the ETF Think Tank.
Value, according to the partners at Distillate (DSTL), is measured by the cash flows, stability, and leverage to define quality of the balance sheet across 100 companies selected from a 500-stock universe, similar to the S&P 500. The process is “passive,” but arguably active due to the robust nature of the process. The ETF rebalances quarterly, and is selecting the highest quality 100 names, vs 200-500 from some of the other funds listed below. In this context, we note that this fund has high active share and low overlap to these other more well-known traditional funds. Since its inception, it also appears to historically ride down the middle of the performance graph while delivering Alpha over the S&P500. Finally, using the ETF Think Tank tools, we highlight that the Fund has high active share and low overlap versus SPY (17%), VYV (26%), VUG (8%) and IWF (11%) and IWD (21%).
Chart 1: Vanguard Value vs Growth – Straight Forward Simple Illustration
Chart 2: Value vs Growth Return Spread for 2 Years Ending February 10th
Chart 3: Value vs Growth Return Spread for 2 Years Ending February 10th
Chart 4: Value vs Growth Since October 24, 2018
Talking About a 180-Degree Change? Is Change really worth $180 Billion or $180 Trillion?
Now for the nuance about the changing landscape affecting platforms mentioned in our first paragraph. Business strategies and platforms are about delivering change, which arguably is about growth and disruption. Anyone who does not recognize that industry/business change is upon us will likely become a dinosaur like Frank Navasky. Remember, in the movie he preferred radio and VCRs to MP3s and DVDs (What would Frank think about the new social media world in 2022?). With certainty, Frank is probably a deep value kind of guy, who still uses dial-up and would have gone down with the AOL ship rather than switch to Amazon (whose growth reminded everyone this past week that growth is alive in the Clouds). (See update on what happened to AOL after its $182 billion acquisition by Time Warner). Our point with this nuance is that Time Warner spent $180 billion and got the change wrong! There is risk with change!
It is ironic that so many ETF Entrepreneurs today have also pivoted to the Blockchain. As ETF Nerds, we focus on the ETF wrapper as a structure that delivers our investments. But as visionaries, we are aware that disruption and growth will require us to pivot and be open to change. To this point, we share some quick thoughts around how transactionally based platforms may change.
If “structure matters,” in the absence of value, change will find growth. During our Thursday Get Think Tanked Happy Hour, we had a great discussion with Julie Chariell, Senior Analyst Fintech at Bloomberg Intelligence. The ETF Think Tank Distilled piece covers some key points that Julie made, but in addition we think it is important to highlight the following points.
$185 Trillion Payment Rails Will Be Disrupted
When we look at traditional credit card companies like Visa, Mastercard and American Express, we see these companies investing and positioning for blockchain. Automation and delivering value on all ends of the client relationship is essential in this highly competitive, $185 Trillion Total Addressable Market (TAM).[ii] Talk about the opportunity to create tremendous value and growth from inevitable disruption! Watch out copper pennies…. Dial up will be no more! Just maybe, copper will be converted into Bitcoin as change is embraced. According to a Bloomberg Intelligence report, “Visa estimates that new flows represent a $185 trillion market.”
We find a lot of smaller companies behind the scenes building the infrastructure rails that bridge the gap between digital platforms. Many companies, large and small, have been cut in half – but let’s not forget that many will thrive unlike AOL, because they are getting the pivot right. Getting things right when change occurs can lead to a hockey stick experience when breakeven cash flows find a level and incremental revenues explode and go to the bottom line. The point is, ignoring change in a trillion-dollar opportunity is dangerous on all fronts, but also an opportunity.
What is the Value Proposition for Traditional Transactional Platforms?
No one can know who the exact winner in the next ten years will be, but certainly the speed with which disruption is taking place across Fintech is like no other period. Having said that, one of Steve Job’s business rules was to never be afraid of cannibalizing yourself. “If you don’t cannibalize yourself, someone else will.” So even though an iPhone might cannibalize sales of an iPod, or an iPad might cannibalize sales of a laptop, that did not deter him.[iii] We think we are in a period of time where wirehouse firms like Morgan Stanley, Merrill Lynch and UBS must think boldly to compete against independent platforms like Schwab/TD Ameritrade. Evidence came in January with the news that UBS would buy Wealthfront for $1.4 billion to get at its $27 billion in assets, and more importantly help reposition the firm in the mindshare of the Millennial and Gen Z investor. Of course, they need to do this to position themselves for the Great Wealth Transfer which is creating a jump ball for $68 trillion of wealth. The inevitable strategic aggressiveness of firms like FTX, Coinbase and Robinhood to move with a focus centered around innovation and technology will force these traditional firms to make uncomfortable moves. In addition, do not discount the pressure from firms that are public like PayPal, Block, Sofi, and Bakkt. More importantly, there is no way to discount the change that is upon us from FTX, which in January raised money at a valuation of $32 billion and is now pursuing offering a trading platform in the U.S.[iv] Platforms are changing at lighting speed, and client alignment is all about ease of use, innovation and “FREE.” Note that Overstock’s t-ZERO’s platform was also just approved by the SEC. What will happen next with Nasdaq and NYSE? Who needs a 2-day settlement when Blockchain’s solutions can cut it in half or even be zero?
Summary
Forgive the heavy thoughts around Valentine’s Day. If you don’t like the movie – forgive the metaphor and analogies. For those few who don’t know the movie and for those who simply want to see it again, you can, of course, rent it for $3.99 or buy it for $14.99 on Amazon Prime. However, do take some advice: (1) don’t go knocking at your sick betrothed’s door without a proper head’s up – call first! (2) Value can be found where growth exists, and it is not always in the largest ETF pools. (3) Be careful when there is a potential 180-degree change. Be on the lookout for change in how the investments in your portfolio are embracing disruption. Disruption and cannibalization offer value for all investors. (4) The Great Wealth transfer is an opportunity for financial advisors who embrace ETFs. If you aren’t growing your business, the question is whether you have aligned yourself with dial-up. Call us for help! The ETF Think Tank is more than just financial advisors.
[i] See Anthony Noto’s interview about Crypto…”if you don’t innovate and use crypto as a technology you run the risk of your business getting smaller.” https://www.cnbc.com/video/2022/02/14/sofi-ceo-anthony-noto-crypto-is-incredibly-uncertain-must-be-small-part-of-portfolio.html?&qsearchterm=anthony%20noto
[ii] BI Consumer Finance, North America Dashboard 1. Visa Is a Payment, Not Just a Card, Network: Company Outlook by Julie Chariell is Senior Analyst, Fintech at Bloomberg Intelligence
[iii] https://www.goodreads.com/quotes/908575-one-of-job-s-business-rules-was-to-never-be-afraid
[iv] FTX Crypto Exchange Finalizes LedgerX Acquisition, FTX US to Offer Stock Trading Soon
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