Dispelling the Monopoly Narrative

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Ann Berry: Hello everyone and welcome to the Public Podcast. I'm your host Anne Berry and today's show is brought to you by Tema ETFs. Joining us today as our guest is Yuri Khodjimurian, CFA and Chief Investment Officer at Tema ETFs, an issuer focused on bottom-up investing in unique structural themes like their toll, that's ticker T-O-L-L ETF. We're going to unpack that further. Yuri, welcome to the Public Podcast. Great to have you on.

Yuri Khodjamirian: Thank you very much.

AB: Yuri, let's start right there with that lead-in and talk about the $TOLL ETF that you at Tema have launched and how that's indicative of the way that you approach investing as a team.

YK: Yeah, absolutely. I mean, $TOLL is probably an exemplary ETF of the kind of thematics that Tema is trying to bring to the market. I think a lot of thematic issuers often go for what I would term kind of more fatty type themes like artificial intelligence or what may you, that are more related to what I would call aggressive growth. At Tema, we're trying to be very thoughtful about kind of the companies that go into a particular theme and also the themes that have long-term durability. So $TOLL or the monopolies and oligopolies ETF, basically investing companies that operate in monopolistic or oligopolistic industries. And this is kind of, you've probably heard the Warren Buffett term moat. Think of this as kind of an ever-expanding moat with crocodiles in it that hopefully lasts rather than kind of a couple of years.

AB: And that's sort of the idea behind it. And it's all about quality companies within it, right? Rather than maybe necessarily going just for growth, which a lot of thematics tend to do. So I took a look at some of the companies that are listed. This is as of June 30th in the public disclosures, Yuri, you've got, I think your top two holdings as of that point in time, included the credit rating agencies, you've got S&P and Moody's in there. And then you've got a number of French industrial companies. I saw that your weighting's France, you know, France is about 15% as of that point in time. Take us through some of those names. Again, you've got the rating agencies. What are some of the others and why are they in your ETF at the size that they are?

YK: Yeah, absolutely. I mean, look, what we're looking for are companies that operate in an industry that is essentially either has one, two, or three players maximum, which are concentrated where there's essentially monopolistic or oligopolistic structure. So if you take the credit rating agencies, there are three in the entire world. And in fact, really there are two, S&P and Moody's effectively control most of the market between them. There's also Fitch, but it's a kind of smaller player, more distant kind of third player in that market. Similarly, with the French industrial company, so we own Airbus, which is a manufacturer of airplanes. And as we all know, there are only two manufacturers of airplanes in the world. There's Airbus and Boeing. And so we've gone for Airbus in our portfolio. Essentially that kind of gives you a flavor of the types of industries we're looking for, right? Two players really concentrated market share between those two players. And that creates a lot of really fascinating dynamics because one, we believe that this industry structure is going to maintain for a very long time. So if you take aerospace, right, what you get there is this is a highly regulated industry. It takes forever and costs a lot of money to develop a new airplane. People have tried different manufacturers before, but nobody's really succeeded apart from Airbus and Boeing. And that's because safety is really important. It takes ages to certify and test a plane and to develop one to make a lot of money. And so that's the kind of durability of that monopoly that we think will endure over a long, long period of time. And it's a similar thing with credit rating agencies. What's happening with them is they get as they rate more and more companies, they get more and more data and information about other companies. And that maintains their advantage because for competitors to come in and recreate that database, it's going to be very, very difficult to do. That advantage maintains for a long period of time and in it creates really fascinating kind of financials, which we think benefits the stock price over the long term.

AB: Well, let's talk about that, Yuri. Is it necessarily the case that having a high amount of concentration in an industry does translate into, for example, decent growth, not use the term aggressive growth for some of the other companies out there? Let's just say decent growth for these companies, above average margins, strong free cash flow. Are those characteristics you always see in the kinds of industry structures that you're talking about?

YK: Yeah, I mean, it's a fascinating question, right? I think what the most important metric where it kind of comes out is probably return on invested capital, which is a moniker of high quality companies. So all of the companies that operate in monopolistic industries tend to have higher returns on invested capital. Now, obviously, you know, our funds tries to select the best monopolies, ones where there's sort of durable advantage over a long period of time. And that means that necessarily maybe you'll have a monopoly where you have high returns, but the companies don't say invest in a new innovation and squander that advantage. And over time, industry structure collapses because new competitors come in. Because remember, it's a competitive capitalistic market, right? So people are always trying to go after this high, they see these high returns are like, oh, I could have a piece of that. And they try to enter. And so what we're looking for are monopolies that are very strong, right? They're taking some of these cash flows and not instead of enriching their shows or reinvesting back into their business and creating stronger and stronger modes. And that's why you can't just kind of pick a few of these companies and hold them over the long term. You want to be able to spend a lot of time analyzing and understanding the ones that are going to be very durable over a long period of time.

AB: Yuri, walk us through a couple of the factors that create these monopolistic or oligopolistic structures in the first place. Regulation is one, you've already pointed to that with respect to Airbus. What are other sources, create of the kinds of moat you're talking about?

YK: Yeah, exactly. And that kind of gets to the heart of what a monopoly is, these sources of competitive advantage. And if you read the industrial economic literature, or you know, you've sort of been in the stock market and look at businesses for long enough, you can kind of find five major sources of competitive advantage. Regulation is one. So think maybe even patented pharmaceuticals or some of these things that I've talked about in the aerospace area, you have a high switching costs. So that is if a customer there's an extreme cost for me to switch. Aerospace is a perfect example of that, right? Once these parts are certified, for example, if you're a supplier to Airbus, like we own an engine manufacturer, once that engine's been certified on that plane, it's going nowhere. It's not gonna be replaced by a competitor anytime soon. And that high switching cost is effectively why the monopoly persists over a long period of time. Then we have network effects. So that is where an additional user added to the network, creates so much value for the other users, it grows the value of the whole network for everyone who uses it. And a perfect example of that is a financial exchange, right? The more people trade on a financial exchange, the more liquidity there is, the higher the value to any individual user. And that network effect builds up a big value for that particular monopolistic industry like exchange. We can get onto how those dynamics play out over time in some other industries like tech. You also have economies of scale. So that is where how you build up enough sufficient scale that the individual unit cost of production goes down so much that no competitor can come in and compete with you. Semiconductor manufacturing is a perfect example of that. There are only a few companies that can manufacture the most leading edge semiconductors, which are by the way the most efficient way of manufacturing semiconductors. No one can compete with them on cost per transistor. And so therefore you have this advantage that other people can't get and it will take a very, very long time for them to reach, created almost impossible in some cases. And then the final one is kind of non-replicable physical assets. So this is where you have a physical asset in the physical world that you can't create again. Railroad is a perfect example of that. In the United States, you currently have six class one, which is large railroad companies, that effectively divide the whole country between them.

AB: Yeah. What's an example of that?

YK:...building, recreating that railroad network is virtually impossible. I mean, you'll never get the permission for what you will. And so, you know, one thing you can almost say with certainty is that in 30 years, it will be the same railroad companies that are around us now. Exactly, you can't replicate those particular assets over time. And so you've effectively created a, sometimes people refer to in the literature as a natural monopoly.

AB: If we're not flying around, they're not going away any time.

YK: So those would be like the five forces, right? Regulation, high switching costs, economies of scale, network effects, and non-replicable physical assets.

AB: Well, let's dig into one sector that has shown elements of those, you know, some of the five, not all of the five, but just gets a ton of coverage as a result. And that's the tech sector. And, Yuri, when we think about even the fact that the Magnificent Seven, right, is called the Magnificent Seven, there's a number around, there are acronyms around it, shows at least when it comes to capturing share of the public exchanges as concentration. And often that's because those companies themselves have achieved some of those monopolistic or oligopolistic benefits that you've described. Social media is one of those sub-sectors of tech where we see this kind of concentration in terms of the numbers of players. Let's dig into that a little bit. I mean, talk a little bit about what made those monopolies as clearly network effects, but why has it been so hard to disrupt the social media space?

YK: Yeah, it's fascinating. I mean, we get asked about the technology sector a lot because, you know, obviously spending a lot of time looking and understanding where monopolistic industries, we're actually of the view that the technology sector is very difficult to actually say there are real durable long-term monopolies. And remember, I'm talking decades here and not necessarily the kind of a couple of years or even 20 years for that matter. And the reason for that technology is almost synonymous with disruption, right? And so sometimes you'll have what might appear monopolistic structures, but suddenly some new technology will come along and completely disrupt and change the whole paradigm. Yeah, so TikTok's a perfect example of that. One of the fascinating things about TikTok, if you dig into its history, is that one point in 2018, TikTok was taking 25% of all Facebook ads on iOS devices in the United States. I mean, just let that sink in.

AB: Like TikTok. Like TikTok just came into that, yeah.

YK: A quarter of every four ads, one of them was a TikTok ad. This was when TikTok was nothing. So they used Facebook's network to build their own business and the results were staggering, right? I mean, if you look at the number of minutes people, especially younger people use and spend on TikTok versus Instagram or Snapchat, it's just, you know, the charts gone this way, right? And they built this advantage by using Facebook's network that Facebook has effectively given to them through these advertising dollars. And this speaks to another really interesting point about media and social media in general. They're all competing for our time, right? And time is actually quite a limited resource if you think about it. We all have how much you work or if you're Elon Musk, you have many more hours or whatever. You have 18, let's call it, or 16 hours in the day. If you're not sleeping that much, that's it. And that's what these media companies are competing for. And so that attention means that it's a much more competitive market than a market for dollars or freight or whatever it might be that kind of has infinite potential to keep growing and get bigger. The other side to this is advertising, right? Because what they're trying to do, these businesses, especially in the tech space, is they're trying to go for advertising dollars. And what I've found fascinating over the last kind of five years is companies that you would not necessarily associate with advertising have chosen advertising as their kind of new revenue stream. And the reason I bring this up is if everyone's converging on the same advertising dollars, that makes that pool of advertising dollars much more competitive than any other pool of money around. So if you take like Uber or Instacart or Amazon, you know, if you look at a typical Amazon page right now, most of that page are advertisement that other people have paid for. That to me is telling me that advertising dollar is not going to Google or Facebook, it's going to Amazon. And o it creates this competition and suddenly Uber is advertising on the app and Instacart is advertising retail when you're trying to buy your groceries. And so you're competing for the same dollars because it's a limited amount. Sure, it's growing, but it's a limited amount of money that you have. And that's why we think these areas like social media and search and kind of software are probably a lot more competitive than people give them credit for.

AB: It's interesting to dig into something that you almost said in passing there, Yuri. It feels like the ad dollars going to the Amazon and the Instacarts and the Ubers is because the advertisers know that there's at least a moment in that very precious thing that you identified, which is time. But there are eyeballs captive and concentrating, right? They're moving away from a social media tab or they're moving away from watching streaming or whatever it is we're doing to actually focus on that transaction and that point in time. So Yuri, when you look ahead, when you look into a crystal ball, and it's an unfair question, which is always the most fun kind of question, where do you see new platforms coming up in the tech space that are going to be successful in capturing my attention in yours? And perhaps it's not necessarily clear they're doing it yet. They may sneak up on us, but where do you have a sense that you've got some emerging players in that space?

YK: That's really interesting. I mean, I think what's coming out of this conversation, at least in our minds when we analyze these markets, is one thing I can tell you for certain, there's something's gonna come, right? The disruption that happens in the tech sector, it's kind of synonymous with its kind of existence and its nature. So I don't know specifically what platforms are gonna come up, but they certainly will come up, right? So we've had a wave of virtual reality, right? That could be a new thing, right? Remember, the metaverse two years ago, everyone was talking about that. Now, I think these things always go through a hype cycle in technology, right? They get hyped up, everyone talks about it, gets excited. Usually a really bad ETF launch is related to it. And suddenly the excitement dies off and suddenly we... But the technology doesn't go away and people keep working on it and keep analyzing and keep thinking of new ways. And suddenly it's on the scene. And remember, this disruption keeps happening faster and faster, right? Take the example of chat GPT. Now, it took chat GPT five days to get to a million users, right? Instagram, for example, two and a half months to get to that same number. And if you look at historic kind of services or platforms, as you say, that are vying for our attention or our time or our use in the technology space, they're progressively getting faster and faster and faster in terms of how quickly they come and capture our imagination or our use. And that's the nature of the technology sector. That just doesn't happen anywhere else, right? No new railroad is gonna pop up in the US all of a sudden.

AB: Well, let's dig into that and go, let's go full circle here in the conversations as we close out together, which is to that point, $TOLL, the ETF that you and the team have put together specifically to find the winners where there are monopolistic or oligopolistic characteristics. If I look at your top 10 holdings, you don't have a lot of tech in there and you don't have any in your top five. So if we go back to those five sources of competitive or monopolistic advantage that you identified earlier, Yuri, again, network effects, switching costs, economies of scale, regulation, nonreplicable physical assets. I know you've written a blog about this. It feels like listening to you as though you can almost rank them in your mind, right? Because the technology of social media play that we discussed is very heavy on network effects, right? There's a huge amount of reliance on that for those monopolies. Am I hearing or furring that perhaps the nonreplicable physical assets Monopolies are sort of your favourite in that line up. Maybe regulations, is there a way that you order them? And again, I'm just trying to play back to you what I've heard in the course of our conversation.

YK: Yeah, absolutely. I mean, that's how we think about constructing monopolies. We always think, like, what are these sources? Can I identify these sources? And more importantly, are they really durable? And I think physical assets always is kind of the contrarian statement here, right? Because very few people associate technology with something physical in this world. But that's really where we are finding kind of the monopolistic businesses. So take, for example, semiconductor equipment manufacturing. These are companies that have spent a very long time developing some very, very advanced technology. And over time they've concentrated so that in certain processes within semiconductor manufacturing, there might be only two companies that do this in the whole world. In fact, it actually houses the one absolutely true monopoly that exists in technology, which is a Dutch company called ASML. Now, ASML builds the leading edge lithography machines for semiconductor manufacturing. And just to give you a sense of what this is. It's a four, three, four story machine. Okay, it's three to four stories high. It costs $300 million. It has a sphere of glass in it that if you were to blow it up to the size of the earth, it wouldn't have a dent less than sort of like one centimeter in it. It's like perfection of technology. And ASML is the only company in the whole world that can do this. It's taken it years to develop this stuff and it's selling it to its customers. It's a hundred percent monopolist in this space. But again, it's a physical thing that they've created and built. And that's why we think that that's an interesting area where there's not that much competition in the technology space. The other areas where you can combine the digital space with something tangible, like a support work, or as you said, regulation. So we quite like the tax preparation software space. You think that that's related to, you know, a technology, but actually to get taxed, you need a support network of individuals who are experts in tax. Over time, that support network is really what drives the value of that particular software and the competitive advantage versus any new entry that might come in. And that's where we think kind of the real, maybe gems, hidden gems in technology of monopolies are, and probably not in the...

AB: That's fascinating. Let's talk a little bit about that tax preparation one, because H&R Block, you know, would be an example of that, Uri, but this is also one where just to push you a little bit, the IRS has at least announced, we'll have to see how quickly it rolls out, that it wants to have its own e-filing, you know, and software offering out there to make it more accessible to taxpayers. Is that something, is that a scenario where you could almost say, oh, look, the regulator is disrupting the provider?

YK: That's really interesting because obviously one of the things that happens in monopolistic type industries, which tax preparation, there's only a few players actually, the one we own is Intuit, not H&R Block. And H&R Block is a bit more in the old world of actual physical tax preparation in terms of people going into offices, which we think the best. Exactly. It is a support network, but there's no technology attached to it. So for me, what I like about Intuit is you have the technology of tax preparation, but you also have a call center and real support helping people prepare these taxes. The IRS, so governments is something we have to watch very carefully always in the monopolistic space because one, governments often don't like monopoly power. Now, all the monopolies that we invest in, sometimes they get, you know, people think that they're bad, but the truth is they've arisen because they've given a lot of value to customers over time. And if we pick the right ones, they're the ones that have not necessarily taken a huge cut of this particular value and the customers have accrued most of it. The IRS obviously looks at this and says, well, Intuits created a ton of value for people to prepare their taxes, but we think there should be a, you know, the government should also allow easy filing because we have all of the information. Then there was a bill passed, some money was spent on this and investigate the report. It's expensive for them to create that system. There's a lot of political, like, fighting over this particular thing, because in general in the United States, there's a view that the government, it's taking your taxes. Should it really be telling you how you file your taxes as well? So it's a big political divide. And so in general, what I see there is quite a limited risk. They already have free filing. So for individuals who have very simple tax returns, they can file for free with the IRS anyway. Exactly. And so the question is, why? And it's not like tax preparation software is that expensive. It's a couple hundred dollars. So is it really worth the government's resources? And what's happened is that you've seen the IRS bill actually defund this particular area. So the risk is starting to go away.

AB: Interesting. So many interesting insights coming out of this conversation. Thank you so much for joining everyone. That was Yuri Khodjianmaryan joining us from Temer ETF. Thanks again. We'll be back soon folks with even more updates from the tech world and beyond, and perhaps looking at the tech space slightly differently based on some of the insights that Yuri shared with us today. That's it from Public Live folks. Thanks for joining.

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