In the dynamic landscape of modern investment, Horizon Kinetics critically examines prevailing strategies, particularly the widespread adoption of indexation. With the 25th anniversary of iShares ETFs highlighting their performance, a disparity emerges: annualized equity ETF returns have hovered between 7% and 8%, while fixed-income ETFs, adjusted for inflation and taxes, have often yielded negative returns. This underperformance is particularly striking given the significant uplift provided by the Information Technology sector, which now constitutes a substantial portion of the S&P 500. This concentration, however, presents a paradox: while some investors fear missing out on IT's growth, a more profound concern is the inevitable capital loss should these valuations contract. History demonstrates that such periods of market concentration and extreme valuations typically conclude with significant adjustments. Therefore, we advocate for sidestepping traditional indices, focusing instead on strategies that offer rational, fact-based expectations of higher long-term returns, recognizing that index investment vehicles themselves can distort market valuations by drawing disproportionate capital flows into mega-cap and IT stocks, leaving other valuable sectors undervalued.
A compelling strategy involves investing in securities exchanges, which act as indispensable facilitators of market activity, much like a casino operator profit regardless of the specific games played. These entities thrive on transaction volumes and volatility, displaying a remarkable track record of outperforming regional stock indices globally over two decades. The inherent power of their business model lies in their ability to provide exposure to a wide array of assets, many of which are underrepresented in traditional indices. This model allows them to maintain robust financial characteristics regardless of regional economic fluctuations. Additionally, we emphasize localized inflation investing and scarcity investing as crucial elements for wealth preservation and growth. While official inflation metrics like the Consumer Price Index may not always reflect the full reality, localized inflation, impacting specific commodities or economic sectors, can significantly affect purchasing power. Gold, for instance, has demonstrated a dramatic price surge unrelated to generalized inflation, driven by supply constraints and evolving demand dynamics. Similarly, oil royalty trusts have proven to be superior hedges against oil price inflation compared to direct investments in oil corporations, thanks to their asset-light models and direct access to cash flows. These examples underscore the importance of identifying and capitalizing on unique market inefficiencies and structural advantages that offer sustained, compounding returns over time.
Extending this philosophy, the concept of scarcity investing applies not only to commodities like oil and gold but also to other critical resources such as potash and natural gas, and increasingly, water. These sectors face inherent supply limitations coupled with growing demand, creating opportunities for significant localized inflation. For instance, the global demand for potash, essential for agricultural productivity, is projected to rise due to population growth and increased caloric intake, while arable land remains static. Similarly, the burgeoning demand for electricity from AI data centers is driving a surge in natural gas consumption, particularly in regions with abundant supply and established infrastructure. However, water is emerging as the ultimate limiting factor, especially in areas vital for AI infrastructure, due to its scarcity and the immense volumes required for cooling and power generation. Companies that control strategic land or possess royalty interests in these critical resources, often small-cap entities overlooked by major indices, offer unparalleled opportunities. These investments benefit from inherent economic power, often exhibiting superior returns on equity and pricing power, and are insulated from the short-term focus of the broader market. By focusing on these non-correlated, localized inflation beneficiaries and leveraging the power of compounding, investors can strategically position their portfolios for long-term growth and resilience.
By understanding these underlying dynamics and adopting a strategic, patient approach, investors can unlock significant value. The market's inefficiencies, driven by a myopic focus on short-term gains and index tracking, inadvertently create opportunities for those willing to look beyond conventional wisdom. Investing in foundational assets and essential services, particularly those with scarcity value and inherent pricing power, offers a pathway to robust, resilient returns that are less susceptible to the ephemeral trends dominating headlines. Ultimately, success lies in a deep, fundamental understanding of economic realities and a disciplined commitment to long-term value creation, transcending the fleeting anxieties and excitements of the day-to-day market.