Fantasy Football Arrives To Wall Street and Freedom Is At Stake

December 30, 2019

We have arrived at that time of year when there's virtually no Wall Street compliance or regulatory news. Just before the onset of Christmas, the regulators and prosecutors issue a ton of press releases -- and then, as the holiday season falls upon us, all of those folks go on vacation or use their remaining sick days. Until the second or so business day after January 1, we are in the dry season. Here I am, an old man in a dry month. Given the lack of news, I tend to sit down at my computer and start typing about whatever comes to mind. Of course, as I age, my mind ain't what it used to be. With that warning, here's what I got for the end of 2019. The other day I watched the segment below on CNBC -- click the "PLAY" button and share my experience:



I really, really enjoyed CNBC's Freedom ETF segment. It's rare these days that I come across any thought-provoking content on television. Most of what passes for broadcast/cable business news these days is self-serving crapola spouted by folks talking their book. The perma-bear warns that we shouldn't be fooled by the 5,000% rise in the market that he missed -- or the perma-bull urges us to put every penny into the market because it's going to go higher. Then we have those morons who predicted 12 of the last 2 recessions. And let's not forget all those geniuses who "claim" that they predicted the Great Recession before anyone else. Yeah, sure you did. And you're still working for a living why?

As to CNBC's Freedom ETF segment, I loved it. Not because I'm going to invest in that ETF (I'm not). Not because I love or hate the concept (I am enthusiastically ambivalent). I loved the segment because it made me think about something that I had not thought about. It's fun when some previously dormant synapses get fired up. In any event, my curiosity being piqued,  I looked up the "Freedom 100 Emerging Markets" ETF, which rolled out in May 2019. According to a Form N-1A filed with the Securities and Exchange Commission on February 20, 2019
https://www.sec.gov/Archives/edgar/data/1592900/000089418919000983/aaet-freedom_485a.htm, the "Alpha Architect Freedom 100 Emerging Martkets ETF" (quite a mouthful!) is designed to "track the total return performance, before fees and expenses, of the Life+Liberty Freedom 100 Emerging Markets Index. According to the N-1A, the "Principal Investment Strategies" of the ETF is:

The Fund uses a "passive management" (or indexing) approach to seek to track the total return performance, before fees and expenses, of the Index. The Life + Liberty Freedom 100 Emerging Markets Index is a freedom-weighted emerging markets equity index.

Life + Liberty Freedom 100 Emerging Markets Index 
The Index is designed to track the performance of a portfolio of approximately 100 equity securities listed in emerging market countries. Thereafter, country inclusion and weights are determined based on quantified data covering 79 personal and economic freedom factors. Factors are categorized into three main types of freedoms: the rights to life (such as absence of terrorism, human trafficking, torture, and political detentions), liberty (such as rule of law, due process, freedom of the press, freedom of religion, freedom of assembly), and property (such as marginal tax rates, access to international trade, business regulations, established monetary and fiscal institutions, and size of government). A quantitative model is used to weigh the countries based on human and economic freedom metrics as described below.  Securities within countries are then selected based upon market capitalization ("market cap") and liquidity metrics (90-day average daily volume of shares traded on a public exchange or "Market Liquidity") and are subsequently market cap-weighted. The Index excludes state owned enterprises ("SOE") from the security selection process. The Index was developed in 2017 by Life + Liberty Investments, LLC, the Fund's index provider (the "Index Provider"). 

The Index Universe
Construction of the Index begins with the universe of common and preferred stocks (or their depositary receipts) of emerging markets countries, (collectively, the "Eligible Emerging Markets"). 
 
Market Capitalization Screens 
The Index Provider determines the emerging markets eligible to be included in the Index at the time of each annual reconstitution of the Index based primarily on the market capitalization of each emerging market relative to the aggregate world market capitalization. Eligible Emerging Markets with a market capitalization of at least 0.15% of current global market capitalization plus an average market capitalization of at least 0.15% for the prior three years are included in the Index. After inclusion, an Eligible Emerging Market is retained in the Index so long as its Freedom Score (defined below) does not fall below a disqualifying level. 
 
Country Selection and Weighting 
The Index methodology continues its rules-based process by further screening each Eligible Emerging Market by its composite freedom score ("Freedom Score"). This score determines each Eligible Emerging Market's inclusion and weight in the index. The Freedom Score is derived using a combination of 79 quantified personal and economic freedom factors compiled by [ ], a leading independent global think-tank.  The Freedom Score is translated by the Index Provider into a relative weight for each Eligible Emerging Market which can be positive or negative. Eligible Emerging Market countries with positive weights are included in the Index. Based on the Index rules, the higher a given Eligible Emerging Market's Freedom Score, the higher its relative weighting in the Index. The lower a given Eligible Emerging Market's Freedom Score, the lower its relative weight in the Index. As of February 14, 2019, ten Eligible Emerging Markets were included in the Index (each, an "Index Market"). At the conclusion of this step, the country weights are established. 
 
Component Selection and Weighting
The index securities' universe includes all companies, other than SOEs, that are domiciled in each of the selected emerging market countries.  The third-party index calculation agent (Solactive AG or "the "Calculation Agent") determines the country of domicile for each security included in the index securities universe. The top ten securities within each Eligible Emerging Market are identified, based on market capitalization and Market Liquidity. All securities must meet a minimum trading volume on a public exchange and market capitalization requirement, otherwise they will be excluded. Either local shares or depositary receipts can be used in the Index depending on which is more liquid and whether the country of domicile has restrictive foreign ownership requirements. The Index Components are then individually weighted within each country based on their market capitalization. SOEs are defined by the Index Provider as companies with 20% or more government ownership and are excluded from the Index. The Index may include small-, mid-, and large-capitalization companies; however, the rules of the Index will naturally favor large-capitalization companies with Market Liquidity. At the conclusion of this step, the individual security weights within each country will be established.

Portfolio Construction
The Index is assessed annually in January of each year at which time the Index is reconstituted and rebalanced by the Index Provider. Component changes are made after the market close on the third Friday of January and become effective at the market open on the next trading day.

The universe of so-called "emerging markets" in the index is described as follows:

The starting country universe as of February 14, 2019 for the index includes the following emerging markets: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Greece, Egypt, Hungary, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, South Korea, Taiwan, Thailand, Turkey, and United Arab Emirates (each, an Eligible Emerging Market).


Saudia Arabia, China, and Russia on a freedom index? Note that the Index discerns between mere "emerging market" nations and those that adhere to such "freedom" factors as the rights to:

life: absence of terrorism, human trafficking, torture, and political detentions;
liberty: rule of law, due process, freedom of the press, freedom of religion, freedom of assembly; and 
property: marginal tax rates, access to international trade, business regulations, established monetary and fiscal institutions, and size of government.

As I see it, we are now able to merge serious investing with all the passion of the office Fantasy Football League. You form your own Fantasy Football League and Perth Tolle, the founder of the Life + Liberty Indexes, forms her own Index. You do your homework on which players you want to draft, and Tolle applies her research to which countries will be included in her Index/ETF. You pick your players in a draft and Tolle competes in the marketplace with other ETFs. Each week your fantasy team rises or falls in the standings, and each day Tolle's ETF rises or falls in price. As needed, you add players; and, as needed, Tolle will adjust her holdings. Football seasons and the stock markets are filled with disappointment. The seemingly unbeatable can't win. On the other hand, the underdog and the under-appreciated often have their day.

In raising the Fantasy Football League comparison, I do not do so to belittle Tolle's concept, which I truly and sincerely find intriguing. Already on the scene is the Environmental, Social and Governance ("ESG") trend whereby purportedly socially-conscious investors screen potential investments. Tolle has gone a step farther and expanded mere investing criteria into both an underlying index and an attendant ETF.  To an extent, Tolle has created an investment vehicle where you can literally put your money where your political mouth is! I guess that someone could set up a Socialism Index and attendant ETF, or a Neo-Nazi Index and attendant ETF, or South of the Equator Vegetarian Denuclearized Index and attendant ETF. Be prepared for the ensuing idiocy that always follow such innovation to the Nth degree.

Think about the potential for disruption Tolle is creating. Evangelicals could create an index to fund companies that best reflect their views and shun those that don't. Progressives could create their own desired index. The LGBT community could create its index. Second Amendment advocates will lock-and-load theirs. Will the LGBT fund do better at year's end then the Female-Owned-Operated-Company Fund, or the Family-Values-Anti-Gay-Agenda fund? Will an ESG-guided fund outperform an All-White-Male-Board fund? 

Since its May 2019 launch, FRDM has posted a low of $22.89 and a high of $27.92. I'm not saying that Tolle is on the right or wrong track. The success or failure of her ideas in the marketplace will largely be answered by both the volume of trading attracted to the ETF and its profitability. Ultimately, FRDM does force us to ponder some very important questions. Can you make money espousing liberty? Is their a price to pay for freedom? 

Alas, the price of liberty is eternal vigilance minus management and custodial fees and adjusted for dividends.