Saturday, November 13, 2010

Time For A Taxi Cab Medallion ETF

. This article was featured at The Reformed Broker, a noted financial blog. The article was subsequently quoted and linked to by the Wall Street Journal.

Half-joking, of course. Let's talk about the ETFization of just about anything. But before we talk about ETFization, we should talk about securitization.

Most people by now have heard of securitization in the mortgage context. It has a bad rep but it does not have to have one, if it is done correctly. Mortgage securitization has been around for many years. But as any business gets standardized and more competitive, the profit margins in these deals decline for the people who put them together. At the same time, these people's steak dinners, condo dues and private school fees do not decline, quite the opposite. So the friendly folks start looking for other things to securitize, and get very creative with it. Toll road revenues. Parking fee revenues. Communication tower rents. Restaurant franchise fees. You might not know but the Dunkin Donuts buyout happened at an untold leverage number precisely due to the "award-winning" finance package put together by people who, in another day and age, would have been designing fuel pumps for diesel locomotives. The theory is simple enough: find predictable enough source of cash flows, tranche them, slap an insurance from the esteemed AAA-rated mortgage insurers, have them rated, and sell them to income-seeking investors. Voila! Oh, the things you can get away with when everyone is chasing yield...

But exotic securitization and mortgage insurers are so 2006. We have ETFization now. The scheme is even simpler. Find an asset class. ETF it. Collect 69-99 bps on AUM. Wash. Rinse. Repeat. Rare earth metals came in the spotlight after an unfortunate fishing trawler incident in Asia and the resultant spat between the Middle Kingdom and the Land of the Rising Sun, that led to claims that the former had stopped exports. The shares of the rare earth miners skyrocketed, and Joe Sixpack could get into the action very quickly with a convenient new ETF, REMX, that debuted just in time for the news that exports have resumed. Then last Wednesday, the CEO of Alcoa, the third largest aluminum producer, said that he'd be very supportive of a physical aluminum ETF and that they'd be more than happy to supply the product. I would like to warn you not to be too surprised when next Wednesday, the CEO of Kraft Foods comes out in full support of the new physical cheese ETF.

What is happening here? ETFs are great. They enable efficient sector exposure and are more liquid that mutual funds. Some invest in geographies or securities (esp. low-priced stocks) that an individual investor might not be able to acquire efficiently. BUT the creation of ETFs brings in new money into the pond without improving the cash flows of the underlying assets. Your risk increases simply because the asset prices are now higher. But the higher prices might result in more interest, new share issuance or whole new ETFs. This might be creating a positive feedback loop.

Let's look at an example of how things evolve. GLD, the major gold ETF, has been around for a few years. A year or two later, we got GDX, gold miners, and SLV, silver ETF. Well, that's not enough for a hot sector. We got palladium and platinum to play with via PALL and PPLT.

You'd think that this is enough for sector exposure? Think again. We got GDXJ, junior gold miners, for people who think that GDX is too staid. Why have five mines in Canada when you can have one in Burkina Faso?

By now we should be done, right? Wrong. There is a better mouse trap. GLD and SLV are favorites for PM market alarmists, so we later got the "physical" gold and silver, PHYS and PSLV. That should wrap it up, this looks like an ETF buffet table. Again, wrong. Why should you limit yourself to gold miners, when you should really be playing the silver miners, SIL. And if having operating mines just does not sound rewarding enough, you can always try to strike gold with GLDX, the "gold explorers" ETF released last week. And, where would we be without the levered gold and silver ETFs, UGL and AGQ.

I am no Soros/reflexivity expert but I can tell you that this looks like market participants really wanting to believe in their investments, and acting it out.

On to my proposal for a NYC cab medallion ETF. For the uninitiated, the cab medallion is the NYC license that allows the operation of the iconic yellow cab with all duties and privileges. The number of licenses has been roughly fixed since the 1930s (yes) which has meant that the price of having one has been increasing steadily as a testament to NYC's foresight, Byzantine politics and anti-entrepreneurial attitude. There are roughly two types of licenses, owner-operator and "corporate". The more expensive corporate (fleet) licenses are rented out. The current price of a corporate license is $825k. The price in October 2004 was $343k. So you have the asset price up 140% in 6 years. It is also cash flowing, and the cash flow is inflation-linked, as rates go up periodically. So, unlike gold, there is the combination of scarcity, desirability AND cash flow. Of course, if a buyer of size enters the market, you know what will happen to prices and yields: the cabs will not be producing more cash just because the medallion prices went up.

And don't get me started on my idea for a pre-paid college tuition ETF with redeemable shares...

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