Value, Momentum and Launching ETFs with Wes Gray

Episode Summary

Executive Summary: Wes Gray discusses ETF Architect’s rapid growth, the move from managing funds to white-label ETF infrastructure, and how the active ETF rule created a major opportunity to convert assets into more tax-efficient wrappers. He also explains his evolving factor-investing framework, emphasizing simplicity, long-term discipline, and practical implementation in value, momentum, rebalancing, and newer products like box spreads and tail-risk strategies.

Main Topics: ETF Architect’s growth and business model (Priority: 5/5): Gray explains how ETF Architect became a fast-growing ETF white-label platform by helping advisors and managers launch or convert products into ETFs, especially after the active ETF rule expanded opportunity. Focus vs. opportunity in building a firm (Priority: 5/5): The conversation opens with lessons learned from lack of focus: saying yes to too many ideas can hurt scalability, but early-stage firms may need flexibility to survive. Tax efficiency and ETF conversions (Priority: 5/5): Gray details the firm’s specialization in 351 conversions from SMA, hedge fund, and mutual fund structures into ETFs to reduce taxes and frictional costs for investors. Value investing: durability, data, and simplification (Priority: 5/5): Gray argues value remains real despite long underperformance, and that the strategy has been simplified over time by replacing complex models with simpler screens that work as well or better. Momentum and the limits of explanation (Priority: 4/5): Momentum is described as inherently simpler than value because it is essentially price-following; Gray notes that understanding why it works matters less than whether it is empirically robust. Portfolio construction, rebalancing, and factor implementation (Priority: 4/5): The discussion covers why higher-frequency rebalancing and concentration can improve factor exposure in theory, while ETF mechanics and frictional costs determine what is practical. New strategy ideas: box spreads, tail risk, and managed futures (Priority: 4/5): Gray explains why ETF Architect is exploring box spreads and tail-risk products as affordable, tax-aware alternatives, while noting managed futures remain tax-challenging inside ETF structures.

Key Arguments: ETF Architect succeeded because it identified a large demand for cheaper, tax-efficient ETF wrappers and built infrastructure to serve it. The active ETF rule (6011) materially expanded the market by leveling the playing field between active and index funds. Converting assets into ETFs via 351 transactions can unlock tax efficiency for wealthy investors and institutions holding non-tax-efficient wrappers. Value investing still works over long horizons; multi-year underperformance is normal and not evidence the factor is broken. A Bayesian framework implies one needs decades of new out-of-sample data to conclude a long-established factor like value no longer works. Simpler value models are often better than complex ones if they achieve the same outcome and are easier for investors to understand and stick with. Size is not a true independent driver of returns; it often proxies for cheaper valuations or beta exposure. Sector constraints can hurt long-only value investors by limiting access to truly cheap stocks, though they are necessary in long/short risk management. Momentum is easier to implement and has changed less because its core idea—buying winners—is already simple. Box spreads may provide a tax-efficient, economically similar alternative to T-bills for certain investors because they are generally taxed as 1256 contracts. Managed futures are attractive in concept but remain difficult to implement efficiently in an ETF because commodity futures can create unfavorable tax treatment.

Data Points: ETF Architect AUM: $5.6 billion - Gray cites the scale of the white-label ETF business across 47 funds. Number of funds: 47 funds - Current ETF Architect platform size. ETF strategy AUM: over $1.5 million - Justin misspeaks, then corrects himself; Gray jokes it has more zeros now, implying substantially larger actual AUM. Active ETF rule: 6011 - Gray says this rule opened the market by leveling active and index ETF opportunities. Conversion cost, older level: about $300K - Approximate historical soup-to-nuts cost for an ETF conversion/setup. Conversion cost, later level: just under $200K - Gray says costs have been reduced through experience and process improvements. Potential future conversion cost: about $150K - Gray speculates costs may fall further over time. Typical tax-loss harvesting cap: $3,000 - Gray notes this is a major limitation for using losses against ordinary income. Small-cap comparison universe: top 1,000 vs. next 2,000 stocks - Gray describes a simplified study comparing equal-weight large-cap and small-cap universes. Value weighting example: PE ratio of 30 vs. PE ratio of 5 - Used to illustrate how value exposure, not size, may drive performance differences. ETF tax treatment example: 60% long-term / 40% short-term capital gain - Gray describes how box spreads are commonly treated under 1256 contracts. Government shutdown example: Treasury payment delay risk - Gray notes box spreads may avoid some Treasury shutdown-related payment risk.

Pivotal Quotes: "The one area where I think we've had our most screw ups and potential issues is in lack of focus." — Wes Gray: Gray reflects on the biggest lesson he would give his younger self about building firms and scaling businesses. "The better way to think about it is like, let's use Bayes theorem... we need at least 50 years out of sample data to ever make any sort of empirical conclusion that like value doesn't work." — Wes Gray: Gray explains why long-term factor underperformance is insufficient evidence that value has ceased to work. "What drives the value effect? Valueness, not size." — Wes Gray: Gray argues that size is often a proxy for cheapness or beta rather than a distinct source of value premia.

Implications: The episode suggests the ETF wrapper is becoming the preferred vehicle for tax-aware investing and that factor strategies remain viable if kept simple, disciplined, and cheap. It also highlights continued innovation around niche exposures and friction reduction.