ETF Stream: Let's begin with your premise, that investors hoping to benefit from the robot transformation should be viewing such services as yourself?
Richard Lightbound: Yes, were privately-owned US company and what makes us unique is our team of advisers - we now have a team of six and we intend to grow that as the scene grows and evolves particularly with AI. This group owns about 30% of the company.
ETF Stream: And they provide you with your AI and robotics expertise? You're tapping into their circle of knowledge.
Yes, in many ways they provide the top-down understanding of developments in the industry. They help us understand what AI really means, where the technology is going, what's relevant. Then we add much more financial bottom-up analysis of the companies and we meet in the middle. It always involves getting out there, meeting the managements, getting to know them and we do that on a global basis. People ask how you can do that with five people, but when you are private and you are not distracted and you are passionate about it, then you just get it done.
Why do this with an ETF structure? It sounds like an active strategy?
It's a good question. If you go back four or five years, we saw that something interesting was happening, but there was nothing (from an investment perspective) available. That's why we started the company and our original strategy was that we would be an active fund manager; we would launch an active fund and go out and distribute it. Then we recognised as we got out talking to the companies and looking at the ecosystems was that this was early, this was big, this was complex and it was moving quickly. So we though that the best way to help investors get exposure - ourselves included - was to create broad, diversified access to the themes. Really understand all of that technology, find the most appropriate companies that were relevant. And we looked at it and thought it was best suited to putting them all in an index; we then license the index globally to partners. In Europe, as you know we work with ETF Securities. In the US we have a big ETF partner but we have other partners in Asia. We will work with one good partner in each territory.
Is there an element that you know the broad story with AI and robotics, but what you don't feel you - or anyone else - can do is pick the particular winners in any given sector or sub-sector?
Yes, we think it is difficult. If you look at 2017, across the 12 sub-sectors we can see it was a pretty spectacular year with 11 of the 12 sub-sectors with positive performance, you had 10 of the 12 with a performance of over 23 percent. But to pick the winning sub-sectors - let along the winning companies - is actually very difficult. Since the index went live four years ago, we often ask investors which sub-sector they think would have been the top performer, they always say machine vision and sensing, AI but it's actually logistics. Which sub-sector, we are trying to find the technology that is absolutely critical.
Within the broad sub-sectors, how many companies are represented in each?
In terms of percentage, we have 88 companies in the index at the moment and logistics is represented by around 8 companies. So less than 10 percent. Nothing is force-weighted, but with each sub-sector, having spoken to the experts, it is our job to identify the bets companies that are best positioned.
What is the passive element here?
Well, we describe this in two ways. This goes beyond being a passive index. It's a research-driven process that then feed into a traditional passive index. We do all the research, we take our database of 1,000 companies through a series of screens (300 of which are listed) that they fit into a sub-sector, that have a minimum revenue contribution (we have a threshold); the we look for companies that are in a position of leaderships (we don't want everyone); and then we have an ESG policy. That process which is ongoing but it always gives us a stable list of about 100 companies. It is a pretty stable list of 100. As new entrants emerge and start to tick those boxes, they start to become eligible for a very formal index inclusion process. As an investor, you can't do that amount of legwork and find easily this portfolio of companies. We do that for you. That is the separate research committee, and then we have the index committee (with separate members) which is there to ensure that the strict rules and filters per the methodology get applied.
Are those filters then designed to arrive at a certain size and type of company?
Correct. When we first started and we looked at the universe of companies, no surprise that 75 percent is small and midcap companies. And that is a good outcome. That is where you want exposure as an investor. But also we wanted to make sure that this vehicle, this index, was investable and had the capacity to grow. There is now ¬£4bn of AUM tracking across different markets. We've always had a liquidity and market cap filter. We have moved the liquidity filter up once during the four years and what we did last year was introduce a single stock ownership cap. Every quarter, when we go through this rebalance we will accumulate all of the AUM academically; we put a 10 percent buffer on top and we then look down the tube to ensure that no individual company has no more than 5 percent ownership. If they do, we will freeze their position for the rest of that quarter, within the index. So we can continue to feed into smaller companies, but we are never at risk of over-ownership.
What would be the problem if you did over own?
Well, our numbers are really quite big now - we work with Samsung, Legal and General - the number are quite significant and we could have a situation where with the very small cap companies, we might own 20 percent of the company if we didn't have that filter. And if for any reason the company failed any of our filters and we had to remove them, that could cause a pretty significant market event. As an index provider, we are very conscious that that's not what we want to be doing.
And that's the danger of going down the market cap ladder?
Well, we would never have out this structure together if we didn't feel the capacity was there in the first place. We are firm believers this is early days, and there is a lot of growth. The companies themselves will grow, they will become bigger companies, new entrants will come in and there is a lot of M&A we well. We think the overall investable universe will continue to grow. What we have also done with weighting is we don't weight by market cap. There is a two-tier, equal weighting system and the outcome of that is that the mature companies that have got a higher revenue association to the theme will end up with a higher weighting and a 2% weighting. The bellwethers and we have 24 of them. Then the non-bellwethers, the rest of the portfolio, 64 companies end up with just below 1% weighting. We are never over-exposed to a particular company; we have the five percent cap, we have the quarterly rebalance. This is structured to capture the growth over time an d to smooth out the ride. Even though 75% is small and midcap, there are really only four or five companies that would fall below $0.5bn market cap. Look at the average market cap, it is ¬¢7bn or ¬¢8bn. There isn't a long, heavy tail of lower market cap companies.
Did the index start out with the same number of members?
Yes, it was about 74 when we first launched. When you look at the biggest reason for change it has been M&A. Nine companies from the index have been acquired, which is a pretty good takeout rate, The second biggest reason is us introducing new companies. The third biggest is companies moving from non-bellwether to bellwether. Then you have had a few where they have fallen out because they become non-qualified for filter reasons.
And the success - does that have the potential to cause its own issues in terms of weight of money?
It's a valid question. The growth has been phenomenal. That responsibility rests with the index committee here. We also have an external, non-employee member sitting on the index committee, from the outside index community. That is an individual expert. That insight helps us to stay on top of the rules to ensure there is capacity and we are not going to do anything that triggers a significant market event. But the 5% single stock ownership really caps the issue. And we only have four companies that are impacted by that. And it is only marginal. We trim things. We don't have to halve it.
Presumably the fund is also deigned - because of the nature of this - for growth?
Yes, the universe of investor opportunities will continue to grow. We have our eye on other sub-sector that we will add. There will be new areas of technology. And we are still looking at very low penetration rates. Ecommerce, first instance, is still low single digit and there an awful lot of growth to come.
Some of these sub-sectors might themselves get much bigger - would you look at doing a healthcare robotics fund for instance?
We have already started to do sub-indices. We've done it geographically. We have an Asia view, a US view, an all-world ex-US view. We also done application-only views and you're right, as these areas continue to grow we could very easily bundle the manufacturing with moving parts and some of the AI for industry 4.0. Or maybe autonomous vehicles. We have avoided the terminology, but as themes we have a rich understanding.
When it comes to technology, and just in terms of delivering the fund, this is a way of investing that wouldn't have been possible even 10 years ago?
Yes, it would have had to be provided by an active fund. We deliberately thought this wasn't the way We want people to understand what is in the fund. Even two or three years' ago, people called us smart beta. Well, maybe we are, maybe we aren't. But we have identified a theme we are particularly passionate about, everyone needs to pay attention to it, and we decided we wanted to support it. We're just getting bigger.
In terms of the ETF industry, you have effectively just gained a new client. Can you go through that process of your involvement in the LGIM discussion with regard to their takeover of ETF Securities?
We got to know L&G very well in the past few months. As early as was appropriate, we were given an opportunity to meet the senior people at LGIM. We're thrilled about the relationship.
Is there the potential for more money to flow through you from LGIM?
Yes, I think we have had phenomenal success with ETF Securities; from the distribution point of view, they found us to be a door-opening product. It worked really well and with LGIM it opens up a whole new set of opportunities and more distribution. We are a little bit neutral on what the clients want to do with the index. We can customise. So it really depends on the different institutions and markets and with LGIM unit trusts are something they are familiar with and can distribute very successfully.
So you don't feel restricted to the ETF structure?
No, there is an index fund in Korea, for instance. Our business model is simple; we have research which support what we do with the index; the index is our lead strategy; to get exposure and the third part if we can customise. But we won't compete; we won't set up a fund ourselves.
What is it that you see that excites you with the technology that you see coming through here?
We think sensing will be the massive enabler. Gathering data, facial recognition, voice recognition software. Human to robot interaction. An Alexa at home will be a perfectly normal thing as the AI kicks in. On the consumer side, it is such a young industry the same for healthcare. Using AI for medical diagnoses. AI is a buzz word but it's going to have so much of an impact. And the data has such a value.