Who is the Boss? It’s founder-run companies with a 310% out-performance history. ETFs are not a new investment vehicle and have been around for over 20 years. Developed by Morgan Stanley to counter index mutual funds, ETFs have their roots in MS’s WEBS, or World Equity Benchmark Shares, which represented the components of various international stock exchange indexes. For example, the Malaysian WEBS included stocks that make up the Kuala Lumpur Composite Index. In their heyday, WEBS were offered for market indexes of 16 mainly developed countries including Australia, Canada, Hong Kong, Japan, Malaysia, Mexico, Singapore.
I use ETFs as a means of garnishing exposure to industries or sectors which would be difficult to replicate by investing in a few specific stocks. I look for ETFs with a twist or a focus that sets them apart from typical market-oriented products. Equal-weighted S&P 500 (RSP) is an example of the type of ETF I gravitate to.
Another such ETF is the new Global X Founder-Run Companies ETF (BOSS). BOSS is a bet that company founders will be better managers than subsequent generations of executives, resulting in stock outperformance. The ETF, with an inception date of 2/13/17, invests mainly in mid- and large-cap firms where the founders are still in charge. While the portfolio is expected to be equally weighted and rebalanced annually, sector exposure leans towards tech and healthcare.
The strategy behind BOSS is simple: firms run by founding fathers (and mothers) outperform over time. In a report by Chris Zook, Bain Capital shows that since 1990, founder-run companies outperformed the S&P 500 index by 310%. The most outperformance has been since the crash of 2008-2009.
The reasoning behind this is pretty straightforward. From the Bain report: In his blog, Ben Horowitz lists three reasons his VC firm prefers founder CEOs: founders have the moral authority to make the hard choices, they know the detail of the business and have better instincts, and they have a long-term perspective on investments and building a company that lasts.
Zook lists three basic business model and management style differences that clearly separate founder-run companies from firms managed by post-founder teams.
The first is the unique, spiky feature, or capability that gives a business special purpose. We call it business insurgency. My co-author James Allen refers to this as waging war on industry norms on behalf of underserved customers, as Netflix did for video rentals, or to create a new market entirely, as Google has done, following its mission to organize all of the world’s information.
The second element of the founder’s mentality is a front-line obsession — as the founder had. It shows up in a love of the details and a culture that makes heroes of those at the front line of the business and gives them power.
The third element is an owner’s mindset, the fuel that propelled the rise of private equity, whose essence is dialing up speed to act and taking personal responsibility for risk and for cost.
In addition, founders tend to have significant personal wealth tied to the companies they lead, and thus often focus on long-term value creation through innovation and entrepreneurial-ism. Global X adds: For example, the average annual compensation for founder/CEOs is 32% less than that of the average S&P 500 CEO, as founders understand that maximizing their salary could come at the expense of deploying cash to fund long-term growth opportunities, and thus hurt their equity value over the long term. In addition, these CEOs are careful to not take on excessive debt, as bankruptcy would wipe out the value of their equity stake. As a result, founder-run companies exhibit 52% lower debt-to-equity ratios than the S&P 500 as a whole.
The list of the top 15 holdings out of a current total of 96 is an interesting list of stocks, many of which are probably unknown to most investors:
While the 0.65% ETF fee is higher than many would like, the diversification this ETF offers is unique. As a traditional growth-focused portfolio, many of the fundamental aspects could seem expensive, especially in an overvalued market. For example, the average PE of the BOSS’ portfolio is 32, average price to book value is 2.97, and the average ROE is 9.5%.
I have taken a starter position in BOSS and expect to add to it over time. I like the concept and strategy, and it fits my overall ETF selection framework.
More information can be found in the Bain Report titled “Founder-led companies outperform” and at the Global X ETF website, both links are below.
This is one ETF worthy of your time for due diligence.
This article first appeared in the March 2017 issue of Guiding Mast Investments Newsletter. Thanks for reading. George Fisher