Exotic ETFs: 11 Funds For When Tracking The S&P 500 Isn't Good Enough
What a wreck index funds have made of the comfy, lucrative business of money management. They’ll provide a portfolio covering the whole stock market for free, or close to free. But if there are destined to be any crumbs left for managers of specialized portfolios, Mebane Faber, the cofounder and principal owner of Cambria Investment Management, aims to pick them up.
Faber’s menu of 11 exchange-traded funds includes no plain-vanilla portfolio tracking the U.S. market. One covers the globe with an outsize allocation to places like Turkey and Russia. Another selects high-yield companies but defines yield in a way that will befuddle coupon clippers. Yet another is a crash insurance policy.
Can you make money running quirky funds? Maybe. With $900 million to oversee, Cambria is merely breaking even now. But new money coming in the door generates fees that drop almost directly to the bottom line. If one or more of its products hits the big time, Cambria will do quite well. “The goal is to build something that can easily scale 100x,” Faber says.
Pursuing that goal means taking some chances. Consider the Cambria Global Asset Allocation ETF, a fund assembled from positions in 24 other funds (some from Cambria) that own pure plays in such categories as U.S. Treasury bonds and overseas stocks. The composite has 18% of its equity allocation parked in shares from emerging markets, triple the norm for world allocation funds. The three largest stock positions are in Russian, Brazilian and Turkish firms.
For the customer, this is an intriguing proposition. Faber may be correct with his theory that you can improve the long-term return on a global portfolio by overweighting the sketchiest countries. The price is right. The parent fund has no management fee of its own, and the collective expense ratio of what’s underlying is an affordable 0.33% a year.
For Cambria, this is a bet that hasn’t matured. With $62 million in assets, it generates $200,000 of annual fee revenue, only two-thirds of which stays at Cambria. The rest goes to other vendors of the underlying funds, like Vanguard. So Faber is barely covering the fixed costs (legal, custodial, accounting) of keeping an ETF alive.
But he’s looking at a big potential payoff if he’s right about emerging markets—and right that old-fashioned mutual funds are dinosaurs. There’s $1.3 trillion just in the mutual funds that blend stocks and bonds. Easy pickings, Faber says, for his global allocation ETF. Mutual funds are tax-inefficient (because they disburse unwelcome capital gains), and they tend to be expensive. Their median expense ratio of 1% is double that of exchange-traded funds.
The ETF industry has two cost advantages. Unlike mutual funds, ETFs don’t have to transact with arriving and departing shareholders; market makers do this dirty work. More important, they eschew high-paid analysts who follow individual companies. Almost all ETFs track either a well-known index like the S&P 500 or, like Cambria’s funds, a custom index created with mechanical rules.
With decades ahead of him, Faber, 41, is playing the long game. He has been doing that since he got a call 12 years ago from a Los Angeles lawyer named Eric W. Richardson. Faber was living in Lake Tahoe, California, and paying more attention to the ski slopes than his job as a quantitative analyst. Richardson had been general counsel for some startups and possessed a broker’s license. He wanted to start his own money management firm—taking the name Cambria from a coastal town northwest of L.A.—and needed help.
The pay was miserable, less than Faber had earned in his first job after getting a degree in biology and engineering at the University of Virginia. But Richardson gave him equity, a little at first and eventually 50%. Faber moved to Hermosa Beach, California, and made ends meet by sharing a house with two roommates. “I traded in my skis for a surfboard,” he says. Not a bad life for a young man without a family (a wife and kid came much later).
Richardson and Faber started out running separately managed accounts for individual investors. In time, they got an assignment providing portfolio advice for another firm’s ETF. Then they cut out the middleman. They started their own funds, Richardson doing most of the legal work.
Marketing consists of Faber making Cambria visible, via research reports, seven books and 1,950 blog posts. Publisher SSRN keeps a scorecard of its most downloaded papers. One on market efficiency from Eugene Fama, the Nobel economist, is near the top. Ahead of it, in first place, is something Faber wrote on global allocation.
With $900 million to oversee, Cambria is merely breaking even now. But new money generates fees that drop almost directly to the bottom line. “The goal is to build something that can easily scale 100x."
The pair raised $3 million of venture capital via crowdfunding, giving up 6.2% of their company. Richardson was down to a one-third stake in January when, at 51, he died of a heart attack.
Minus his mentor, Faber carries on, with help from eight other employees. Their stock in trade is investing themes—like yield. How to market that?
There is no point in duplicating the giant dividend-focused ETFs sold by Vanguard and BlackRock. So Faber has a variation on the theme: calculate a yield from a sum that adds, to cash dividends, the money a company spends on net buybacks of shares. The Cambria Shareholder Yield ETF favors companies that score high on this measure.
Redefining yield makes sense. A buyback is the same as a cash dividend followed by a reverse stock split. (The arithmetic for this is simple, yet it eludes many politicians and journalists who condemn buybacks.) In the Cambria portfolio are cash-spewing companies like O’Reilly Automotive and United Continental, overlooked in conventional yield funds.
Bullish on ETFs as the future of money management, Faber is cautious on stocks, especially the domestic ones. The S&P 500 trades at 31 times its ten-year average earnings. “Until recently the U.S. was expensive and in an uptrend,” Faber says. “Now it’s expensive and in a downtrend.”
Okay, Faber has a theme for bear markets: the Cambria Tail Risk ETF. The name alludes to how stock prices, plotted on a logarithmic scale, populate what looks like the familiar bell curve, but the curve has fat tails. Which is to say that there is a risk, abnormally high by statistical measures, of a sudden drop. The fund’s long-dated put options create, in effect, a crash insurance policy. Until recently the fund didn’t do well. But the fall correction is giving it a shine.
Offer enough variety and something will turn into a hit. Already available or pending are Cambria portfolios tracking commodities, marijuana vendors and companies run by billionaires. Could Faber scale up 100-fold? It’s not inconceivable.