Michael Venuto - “I Would Suggest Seeking Out High Active-Share, Global Growth Themes" | #87

Episode Summary

Executive Summary: Meb Faber interviews ETF veteran Mike Venuto on the evolution of ETFs, arguing the industry is still early, with beta commoditizing toward zero while differentiation shifts to structure, transparency, trading costs, and underlying portfolio design. They explore smart beta, ETF ownership distortions, fringe/characteristic indexes, crypto-related products, and how investors should think about real costs and future opportunity sets.

Main Topics: State of the ETF industry (Priority: 5/5): Venuto argues ETFs remain early in their growth curve, with assets still expanding at roughly 20% annually, and with more room to take share from mutual funds and especially hedge funds. Race to zero and the true cost of ETF ownership (Priority: 5/5): The discussion emphasizes that headline expense ratios miss important costs such as bid-ask spreads, tracking error, securities lending revenue sharing, and share-price friction. Smart beta and active share economics (Priority: 5/5): Venuto explains his 'smart cost' framework, which isolates the cost of the differentiated portion of a strategy rather than the cheap beta overlay, helping investors judge whether active tilts are worth paying for. ETF ownership concentration and market effects (Priority: 4/5): The pair discuss how ETF flows can concentrate ownership in certain securities and sectors, potentially distorting price discovery and creating opportunities in underowned names or sectors. Fringe and characteristic-based indexes (Priority: 4/5): Venuto highlights new index categories built around characteristics previously captured by active managers, such as spin-offs, insider buying, customer satisfaction, and other behavior-based signals. Structural factors and leveraged/precise exposures (Priority: 3/5): They explore ETF structures that manufacture return streams, including put-write strategies and precision leverage products, as a way to create targeted exposures rather than simply hold securities. Crypto and blockchain as investable themes (Priority: 4/5): They debate the investability of cryptocurrencies, bitcoin as a store-of-value asset, and the likely ETF wrappers that regulators may allow first, such as futures-based or equity/infra-related products.

Key Arguments: ETFs are still in an early phase of adoption; their growth is strong but not yet a bubble in asset-class terms. ETF growth has not destroyed mutual funds outright; it has more directly disrupted hedge funds and moved strategies into more transparent, liquid wrappers. Expense ratio alone is an incomplete measure of ETF cost because spreads, tracking quality, securities lending, and execution matter. Smart beta should be judged by the cost of the active/differentiated portion versus the free beta overlap. Some ETF-heavy segments may become overowned, reducing price discovery and creating potential opportunities in neglected stocks and categories. Future product innovation will increasingly come from characteristic-based indexes, structural return designs, and targeted thematic exposures. Crypto is interesting but still immature; the first successful ETF-like wrappers may be futures-based or equity proxies rather than direct spot products.

Data Points: ETF industry growth rate: about 20% annually - Venuto says ETF assets have grown at roughly the same rate for the last 10 years, but off a much larger base. ETF share of 40-Act assets: about 18% - He cites ETFs as representing roughly 18% of 40-Act assets and still growing. Average ETF ownership of U.S. stock market cap: 6.8% - Venuto’s tool estimates the average U.S. stock is 6.8% owned by ETFs today. Average ETF ownership five years earlier: 2.67% - He compares current ETF ownership with the level when he started the tool five years earlier. REIT ETF ownership: around 15% - REITs are described as the most over-owned segment by ETFs. Large-cap ETF ownership: 4.5%-5% - He says large caps are only about 4.5% to 5% owned by ETFs on average. Mid-cap ETF ownership: 5%-6% - Mid-caps are described as modestly more owned than large caps. Small-cap ETF ownership: about 9% - He notes small caps are more heavily owned by ETFs than large and mid caps. Micro-cap ETF ownership: under 1% - Micro caps are described as largely left out of ETF ownership. PowerShares RAFI-weighted Russell 1000 fund expense ratio: 39 bps - Used in the smart cost example to show why expense ratio alone can be misleading. Overlap with S&P 500 in smart cost example: 72% the same - He says the RAFI fund is 72% similar to the S&P 500. Smart portion cost in example: 106 bps - Using the S&P 500 fund at 9 bps as the beta baseline, he calculates the differentiated portion at 106 bps. S&P 500 fund expense ratio: 9 bps - Used as the free-beta benchmark in the smart cost calculation. Bitcoin recommendation window for GBTC: October of last year to August of this year - Venuto says they recommended GBTC during that period before the premium became too high. Bitcoin lost per year from bitrot: 2%-3% - He cites lost private keys/bitrot as creating an effectively deflationary effect. U.S. ETF issuers mentioned as sharing short-lending revenue: some give 100% back; others take a percentage - Used to illustrate how tracking error and economic costs can vary widely across funds. Number of ETF issuers/public issuers referenced in ecosystem: about 18 - He notes there are roughly 18 public issuers as part of the broader ETF ecosystem.

Pivotal Quotes: "“ETFs are so transparent that nobody looks, they just accept the name.”" — Mike Venuto: On why investors need better tools to analyze what is actually inside an ETF rather than relying on the label. "“What am I paying for the smart portion of an ETF?”" — Mike Venuto: Introducing his 'smart cost' framework for evaluating active or smart-beta products. "“I think ETFs have destroyed more [than mutual funds]—they’ve destroyed hedge funds.”" — Mike Venuto: Arguing that the biggest structural disruption from ETFs has been to hedge funds rather than mutual funds.

Implications: ETF selection will increasingly depend on structure, ownership, and real trading economics—not just fees. Investors who understand these layers may find better returns, while new thematic, characteristic, and crypto-linked products expand opportunity sets.