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Friday, November 02, 2018

An ETF Startup Sticks to Value, With a Twist

Reported by Neil Anderson, Managing Editor

Three value investing veterans just launched their startup's first ETF, and they're planning more. The twists is that they're using their own new take on value investing, "rationally redefined."

Thomas Cole
Distillate Capital
Co-Founder, CEO
Last week Tom Cole, co-founder and CEO of Distillate Capital, confirmed the release of the Chicago-based shop's first fund, the Distillate U.S. Fundamental Stability & Value ETF. And this is just the beginning.

"I think we're going to do more ETFs," Cole tells MFWire, adding that they also "have no objections" to offering SMAs to institutional clients down the line. "We will, over time."

Jay Biedler
Distillate Capital
Co-Founder
Vident subadvises the new ETF, while U.S. Bank handles administration, custody, and transfer agency. U.S. Bank's Quasar handles distribution, while Morgan Lewis & Bockius provides legal counsel and Cohen & Company is the independent accounting firm.

Cole and Distillate co-founders Matt Swanson and Jay Beidler all previously worked together at Institutional Capital, LLC (ICAP). While there, Cole worked on a project looking into the problem of why traditional value investing has been struggling. So, they "set out to reengineer the valuation engine."

Matthew Swanson
Distillate Capital
Co-Founder
"People didn't think value worked any more ... The old metrics were not working," Cole says. "The work that we began there is what we are pursuing now."

"Traditional value strategies aren't working, but human biases are alive and well," Beidler tells MFWire.

The trio launched Distillate in June 2017 and funded an account internally (the new ETF is their product for outside investors). They "went back to very basic principles," Cole says.

"Fundamentals ultimately matter to stock prices and cash is the ultimate way to gauge value, so we developed a cash flow valuation model," Cole says. "There is still a lot of value to be gleaned."

The accounting for intellectual property looks very different from the accounting for physical property, Cole says.

"What we're bringing to the party is a different take on valuation that accounts for today's economy," Cole says. "We're bringing a different tact to the way we look at risk. We've also moved away from a market-cap weighting structure."

"A lot of investors are frustrated with value investing strategies," Beidler says. "We hope to tap into some of that frustration ... offering an explanation as to why that is and a solution."

The fund is designed to look at roughly the 500 biggest publicly traded U.S. companies and then take Distillate's valuation model and find the companies that rate well in terms of both value and quality.

Swanson praises U.S. Bank and Vident for their support in the launch.

"They've been really invaluable in getting us to this point," Swanson tells MFWire.

The Distillate team remains independent for now, Cole says.

"We explored the idea of partnering with somebody," Cole says. "We like the idea of focusing on one thing."

"The most important part of that independence is that it gives us an opportunity to take a long view and time horizon," Beidler says. "There is a lot of impatience in the industry."

The trio expect to reach mainly high net worth individuals, family offices, and RIAs at first, yet Cole aims to eventually "reestablish connections" in the institutional channel, too.

"The fourth person to join us will likely be a marketing executive, somebody that knows the high net worth, RIA, family office market," Cole says. "Over time, we'd consider some other [marketing and distribution] options."

Beidler, an alumnus of Brown and of U Chicago, previously spent a decade at ICAP as an analyst.

Cole, an alumnus of the University of Wisconsin-Madison, spent 28 years at what eventually became UBS Global Asset Management before joining ICAP in 2012. He rose to chief investment officer of ICAP in 2016.

Swanson, an alumnus twice over of Northwestern University, spent more than 17 years at ICAP where he served as an analyst and PM. 

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