When mega-IPOs meet index investing

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Franklin Templeton ETFs

By Dina Ting, CFA, Franklin Templeton ETFs

(Sponsor Blog)

For decades, public markets were where companies grew up. Investors could watch young firms move from small-capitalization (cap) to mid-cap level and, for the rare few, into the ranks of the largest companies in the world. That journey today happens increasingly in private markets. We’re seeing now that by the time some companies list, they can seem to arrive already fully formed.

This shift is testing index construction. The impending listings from the likes of SpaceX, OpenAI and Anthropic have prompted index providers to revisit how quickly very large companies making initial public offerings (IPOs) should enter major benchmarks. Some index providers, including FTSE Russell and Nasdaq, have been racing to ensure benchmarks can capture the next generation of large public listings. Others, including S&P Dow Jones Indices, have preferred to keep established guardrails in place, maintaining a more deliberate approach to eligibility and inclusion.

In our view, this diversity of approaches is healthy. Index providers are trying to balance two important goals: reflecting the investable market as it evolves, while maintaining liquidity, stability and transparent rules. There is no single correct answer. A benchmark that moves too slowly may miss important changes in the economy. A benchmark that moves too quickly may expose investors to companies before trading history, float and fundamentals are well established.

An overlooked aspect of benchmark construction is that headline valuations and index weights are not the same thing. Most major equity indexes rely on free-float-adjusted market capitalization, which means they consider the shares actually available for public trading. FTSE Russell’s own preliminary analysis of SpaceX assumed a total market capitalization of US$1.5 trillion but available market capitalization of about US$70 billion, producing estimated weights of only 0.11% in the Russell 1000 Index and 0.08% in the FTSE GEIS All-World Developed Index.1

A company may dominate headlines yet enter a broad index with a relatively modest initial footprint. Over time, lockup restrictions — which typically prevent founders, employees and early investors from selling shares immediately after an IPO — expire, allowing more shares to enter the public market and potentially increasing the company’s index weight.

Another question investors may not have considered is whether these listings automatically make indexes more growth oriented. At first glance, the answer might seem like a no-brainer. Many of these companies operate in areas such as artificial intelligence (AI), aerospace and cloud infrastructure. Yet index construction is often more nuanced than headlines suggest.

FTSE Russell’s treatment illustrates this. Fast-entry IPOs have generally inherited the style characteristics of their assigned subsector until company fundamentals become available. However, the index provider has also acknowledged that relying solely on industry averages could create what it calls “market misrepresentation,” leaving room for alternative treatment in certain cases. For SpaceX, FTSE’s preliminary classification pointed to telecommunications, where the subsector average was 18% growth and 82% value.2

That may surprise investors who instinctively view anything rocket-fueled as growth. But it is a useful reminder: Index investing is rules-based, not headline-based. Style indexes do not simply ask whether a company feels innovative. They evaluate characteristics such as valuation, earnings, growth metrics and industry classification. As more mature private-market companies list, some may challenge traditional style frameworks.

This is where broader portfolio implications emerge. Broad-market index ETFs remain efficient, tactical tools for gaining diversified equity exposure, and country or style ETFs can help investors express more targeted views. But indexes are not static. New companies enter, sector weights shift, float changes, classifications evolve and concentrations emerge. Index exposure is therefore not necessarily something investors should set and forget. Continue Reading…

Picking up Nickels in front of a Steamroller

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Image Pixabay

By Michael J. Wiener

Special to Financial Independence Hub

Suppose a casino offered the following bet.  You roll six fair dice.  If anything but all sixes shows up, you get $20.  But if all sixes show up, you lose a million dollars.

There are a number of practical problems with this game.  The casino would demand a million-dollar deposit in advance, and the odds are way too sensitive to imperfections in the dice and to player skill at not throwing sixes.  But this is a thought experiment designed to shed light on real-world financial events.

Initially, few people would play this game, because losing a million dollars is too scary.  But if you watched someone playing, even all day, you’d likely never see a loss.  You’d just see the player collecting $20 every 10 seconds or so, building up to many thousands of dollars.  The fear of missing out (FOMO) would set in for some and tempt them to play.

Over the long haul, the casino expects to pay out $933,120 for every million dollars it wins.  So playing this game is good for the casino but a bad idea for the player.  However, it’s easy to forget about the losses if you only see everyone winning $20 every play.  Games like this are referred to as “picking up nickels in front of a steamroller.”  The $20 payoffs are the nickels, and the million-dollar losses are when you get flattened by the steamroller.

The yen carry trade

So what does this have to do with real life?  There are many “games” in real life that resemble this hypothetical game more than people would like to admit.  When interest rates were much lower in Japan than they were in the U.S., it seemed profitable to borrow yen at a low interest rate, convert it to U.S. dollars, and collect high interest on U.S. dollar deposits.

This sounds quite profitable, so why did I say it only “seemed profitable?”  Well, all was well as long as interest rates and the exchange rate between yen and U.S. dollars were stable.  However, a rise in the value of the yen and higher Japanese interest rates (the steamroller) could more than wipe out any profits from the interest rate spread (the nickels).

Unlike the hypothetical dice game where the potential loss of a million dollars is prominent, it’s less obvious with the yen carry trade.  You might convince yourself that the value of the yen and Japanese interest rates would change slowly enough that you could exit your positions profitably.  However, many others would be trying to unwind their positions at the same time, each one trying to be among the first to get out.

Excessive leverage

Rather than just invest a fraction of your wages in stock markets, you could borrow extra money to invest more.  The stock markets may gyrate, but they keep rising.  If you can just wait out the gyrations, you’ll be sure to eventually make more money (the nickels) than if you didn’t borrow.

The problem is that if you borrow too much, and your creditors see that you’re in danger of becoming insolvent, they may demand their money back or impose high interest rates that eliminate your profits.  A sudden stock market crash (steamroller) could wipe you out before you get a chance to wait out the market decline.  Modest leverage can be reasonable, but it takes some skill to determine how much you can borrow safely.

The great financial crisis

Many Wall Street firms made apparent profits selling insurance against mortgage defaults in the form of exotic financial instruments like credit default swaps (CDSs) and collateralized debt obligations (CDOs).  In this case, the nickels were the insurance premiums they collected, and the steamroller was the wave of mortgage defaults across the U.S. Continue Reading…

Should you Buy a Business instead of Starting one?

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Photo by Amy Hirschi on Unsplash

By Devin Partida

Special to Financial Independence Hub

For entrepreneurs, the path to success often begins with the critical decision of whether to buy a business or start one from scratch. The right choice boils down to a few key preferences, such as the level of risk you’re willing to take and your long-term goal of achieving financial independence. Identifying these factors is key to understanding which option is ideal for you.

The Blank Canvas of a New Business

Building a business from the ground up is the ultimate exercise of creative control. You formulate the business model, create the brand identity and hire the team. For opportunistic professionals, this flexibility allows you to jump on market openings the moment you spot them. The level of operational and strategic autonomy you have when starting a business is far greater than when acquiring one.

However, that creative freedom does come with a unique set of risks. In fact, roughly 50% of new businesses fail within their first five years. This staggering statistic underscores the difficulty of building consistent cash flow and securing a customer base while simultaneously proving your business model.

More likely than not, starting a business means navigating years of financial losses before turning a meaningful profit. If you’re the founder, your personal finances are likely to absorb the initial shocks.

Buying a Business means acquiring Immediate Momentum

Taking over an established business is essentially an investment in momentum. You get instant access to existing cash flow, a customer base and a working business model. The costly trial-and-error phase is completely mitigated, and you have the privilege of building off the previous owners’ inertia.

Yet, acquiring an established business often comes at a considerable cost. Acquisitions require significant seller financing or up-front capital, which often entails complex bank loan arrangements. While it is the less risky option, the initial investment will likely be more costly than building a new business on your own terms.

Additionally, buyers risk inheriting unseen liabilities or a toxic workplace culture. When you buy an existing business, you’re simultaneously purchasing someone else’s success and unaddressed problems.

Key Factors to Consider before making a Decision

Making the right decision requires a meticulous navigation of your preferences and resources, including:

  • Financial resources: Startups can allow you to develop your business at a pace that aligns with your financial reality. However, if you have substantial capital to invest, buying a business can generate far quicker returns, directly accelerating your timeline to Financial Independence.
  • Risk tolerance: Starting a new company is statistically risky, requiring a high tolerance for volatility and economic uncertainty. While taking ownership of a working enterprise is more predictable, approaching it without adequate knowledge brings considerable financial dangers.
  • Industry expertise: Building a successful business requires deep market expertise and an aptitude for strategy. Alternatively, taking over a stable operation allows you to rely on existing teams while you learn.
  • Desired level of control: Founders typically want a blank canvas to execute a specific vision. Buyers must be willing to adapt to existing workflows and culture.

Essential Due Diligence Steps before Finalizing an Acquisition

Before officially acquiring a business, entrepreneurs are advised to conduct a thorough evaluation of the company and develop a strong understanding of its financial and operational standing.

Financial Verification

Even if a company’s overall revenue is healthy, it doesn’t showcase the full financial reality of owning it. Before making a purchase, you must review several years of tax returns and bank statements to understand the business’s financial history. Understanding the Seller’s Discretionary Earnings — which is the calculation of an owner’s entire financial benefit — is also nonnegotiable. Continue Reading…

Rising or Falling Markets? Roll with it!

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Image Outcome/Shutterstock

 

Luck’ll come and then slip away
You’ve gotta move, bring it back to stay
You just roll with it, baby

— Roll with It, by Steve Winwood

 

 

 

 

By Noah Solomon

Special to Financial Independence Hub

There is never any shortage of pundits opining on what could make markets rise or fall. Tragically, the greatest cheerleading has tended to occur when markets were at their riskiest and the loudest fearmongering has tended to occur when markets have harboured the greatest opportunity. However, this does not change the fact that anything can happen at any time:  markets have and always will continue to periodically present investors with dynamically evolving combinations of risk and reward.

To never suffer losses is an unrealistic objective for those who wish to receive a satisfactory return on their investments. Rather, it is far more efficient (and financially rewarding) to roll with it: which entails adapting to changes to (1) maximize gains when markets offer above-average returns with relatively low risk and (2) to minimize losses when markets offer below average returns with above average risk.

This month, I present a framework for investors to dynamically manage their portfolios to meaningfully participate in rising markets while limiting losses in bear markets.

The Sine Qua Non of Successful Investing

If 100% of your portfolio is sitting in cash, then it is impossible for you to lose money (at least in non-inflation-adjusted terms). However, if markets rise, you will miss the proverbial boat and suffer significant opportunity loss. At the other end of the spectrum, if your portfolio is 100% allocated to equities, while you won’t miss the party if markets advance, you will most certainly suffer substantial losses in the event of a bear market.

The Latin phrase sine qua non means “without which not,” which refers to something that is a necessary or indispensable requirement. The sine qua non of successful long-term investing entails constantly assessing and reassessing the magnitude of potential losses relative to potential gains. When downside risks are elevated and potential gains are muted, you should hold a more conservative portfolio. Conversely, when the risk of loss is eclipsed by potential gains, it is prudent to take more risks with your investments.

Theory, Practice, and Yogi Berra

Baseball legend Yogi Berra stated, “In theory, there is no difference between theory and practice. In practice, there is.”

If you dial up your risk profile when the odds favour doing so and take some chips off the table when the probabilities dictate as such, your long-term performance will inevitably be well above average: so far so good. Unfortunately, accurately assessing and reassessing these probabilities as they ebb and flow over time is no easy feat.

You can’t Predict Behaviour

First the bad news: I don’t believe there is any accurate way to calculate the relative magnitude of upside vs. downside risk over the short term … and by the short term, I mean periods of at least one to two years! One need only to observe markets over the past three decades to appreciate that investors can persist in irrational behaviour for longer periods and with greater voracity than might seem possible.

In hindsight, most investors should have exercised prudence long before tech stocks reached their peak in early 2000 or real estate sung its swan song in 2008” but they didn’t. Similarly, they should have been scooping up bargains en masse either before, during, or not long after markets bottomed in early 2003 and March 2009: but they didn’t.

Excesses and financial aberrations cannot be explained by classic financial theory. Rather, their root lies in human behavioural biases and emotions, which can prove sufficiently powerful to propel asset prices to unrealistically optimistic and pessimistic levels. Greed and fear are impossible to precisely gauge or time and are arguably the largest determinants of prices over the short term. Given these facts, attempting to assess the relative risk of loss vs. opportunity cost over shorter horizons is an exercise in futility.

Valuations are a Proxy for the Margin of Safety

Valuations serve as a proxy for the margin of safety that is embedded in asset prices, and by extension for how vulnerable prices are to delivering subpar or even negative average annualized returns over the next 5-7 years.

Market Responses to Various Environments by Valuation Level

  • When valuations stand near the high end of their historical range, even strong economic and earnings growth may fail to result in higher-than-average annualized returns over the next several years, while anything short of such an environment is more likely to result in anemic performance or even losses.
  • When valuations stand near the middle of their historical range, prices are most likely to track economic conditions and profit growth.
  • When valuations reside near the bottom of their historical range, average or even above-average returns can persist even in the face of subpar economic conditions and/or profit growth, while more favourable or even average conditions are likely to produce strong gains.

Risk and Reward: Probability Distribution by Valuation

 

As valuations increase, the probability distribution shifts to the left, indicating a lower likelihood of gains and a higher probability of losses. Similarly, a decline in valuations results in a rightward shift in the distribution, portending an increased chance of gains accompanied by a lower risk of losses. At extremes, when markets are priced to perfection, there is almost no amount of good news that can prevent subpar returns over the next five to seven years, and when they are priced for Armageddon, strong returns are likely to ensue over the same timeframe in all but the most cataclysmic circumstances. Continue Reading…

Inflation is Kryptonite to anything but Short-term Bonds

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By Dale Roberts, Retirement Club/Cutthecrapinvesting

Special to Financial Independence Hub

Bonds may be the adult in the room, but they are certainly afraid of inflation. Bonds usually do their thing: they go up when stock markets get hit hard. They provide ballast. During periods of expected high inflation, or during rising inflation bond prices go down. That can create and contribute negative returns. The bonds can contribute to a portfolio decline.

But not all bonds are the same. Ultra-short bonds carry no price risk, while long-term bonds can carry extreme price risk. It’s crucial that investors understand the ‘types of bonds.’ To intermediate- and long-term bonds, inflation is Kryptonite. How do we battle that force?

As always, the following is not advice.

As a refresher, be sure to have a read of:  Stocks are the unruly kids. Bonds are the adult in the room.

Too funny, a rare case when Cut The Crap Investing actually ranked high on search.

Inflation up. Bonds down.

Bond yields rise during inflation primarily because investors demand higher returns to compensate for the reduced purchasing power of future fixed interest payments. Furthermore, inflation often prompts central banks to raise interest rates, which directly drives up yields, while existing bond prices fall to align with new, higher-yielding securities.

As interest rates rise due to inflation, new bonds are issued with higher coupon rates to attract investors. Existing bonds, which pay lower interest rates, become less attractive and must drop in price to remain competitive, which simultaneously increases their yield.

Join us at Retirement Club

We’ve had some recent experience with the inflation scare of 2021 and into 2022. The bond market (XBB-T) experienced one of its worst performances in 2022, losing around 11% or more as inflation surged, reversing a four-decade bull market in fixed income.

In the above chart we see that bonds provided no ballast. Quite the opposite. That said, we have to keep in mind that bonds have done their thing in every major recession. They stink the joint out, one time, and investors turn on them.

Traditional global stock and bond portfolios have delivered wonderful returns …

Asset Allocation ETF Page – to the end of December 2025

Inflation fighters and the all-weather portfolio

In mid-March we had a refresher on what works during inflation with:  How do we defend against stagflation?

If you have dedicated inflation fighters in the portfolio you’re not too worried about bonds delivering negative returns. We know that stocks don’t always go up. It’s the same for bonds.

In the following chart, we’ll start in 2021. Markets think ahead, of course, and enough investors loaded up on inflation-fighting assets as inflation storms gathered in 2021. The Purpose Real Asset ETF (PRA-T) is a nice one-stop inflation-fighting shop.

PRA-T was up 23.5% in 2021 and 15.9% in 2022.

Add 20% PRA-T to 80% XBAL-T and we have annual returns over 10% with no negative years from 2021 through 2023.

Continue on into 2026 and it gets even better. PRA-T is up almost 16% in 2026.

Go short and clip the inflation price risk

Ultra-short-term government bonds (CBIL-T) do not carry price risk: they are cash-like. In fact, they will provide greater and greater income as inflation expectations and yields rise. Continue Reading…