Novel vs. Complex: Comparing Our SEC Comment Letter to an Olivia Rodrigo LEGO Set

Being somewhat under the weather recently, my daughter has had a fair amount of downtime at home. To my surprise, building LEGOs resurfaced on her in-house activity list. A lot has happened with LEGOs since I was a kid. Apparently there are now construction kits for just about anything. Case in point: My daughter’s latest LEGO set was a 1,228-piece Olivia Rodrigo “dual guitar.” This thing is insane.  It’s half rock/half acoustic and features hidden compartments, exclusive figurines, and 3D superstar decorations unique to Olivia. As my daughter proudly displayed the finished product in her room, I complimented her on working so hard to build something so complicated. Her response (which I believe is how she starts every sentence with me), “No dad, you have it wrong…this was actually pretty straightforward to build.”

The more we discussed it, the more I realized she was right. Yes, the end result was an incredibly intricate masterpiece, but the actual step-by-step building process was not all that different from when I was her age. Each step typically featured 3-5 pieces with clear graphic instructions on how they fit together. What has changed is the toolkit: LEGO now even offers a digital building assistant that lets you follow instructions interactively, rotate the model in 3D and track your progress as you go. There may have been a ton of steps, but each one was quite simple.

What was novel, then, wasn’t necessarily the underlying building process. It was how the familiar LEGO framework has been adapted to create something that would have been hard to imagine when I was a kid: a replica guitar from one of today’s recording superstars. My daughter—and to a lesser extent, Olivia Rodrigo—had shown me there was a big difference between something being “complex” and something being “novel.”

I’ve previously written about the evolution of exchange-traded funds (ETFs) over time, and noted that the “complex” ETFs of 15 years ago that held high-yield bonds or bank loans are now quite common. Today, ETFs hold everything from structured products to digital assets. And, as Olivia sings in Expectations, “Past mistakes are just new information.” In my case, the new information was realizing I’d been using the word “complex” when what I really meant was “novel.”

Luckily for me, within a few weeks of publishing my newsletter, the Securities and Exchange Commission (SEC) gave me a second chance by requesting public comments on so-called novel ETFs. You can find my thoughts on this here: s7202624-1022279-3312326.pdf

For those in the TLDR (too long; didn’t read) camp, there are a couple of main points worth reiterating. The first is not to try to define what “novel” means, since what seems novel today is a subjective concept and could become commonplace within a few months or years. The second is the importance of effective ETF arbitrage for these funds that hold more novel underlying assets. The ETF should function normally if there is liquidity and price discovery in the underlying assets. This applies even for funds that hold digital assets or one day, prediction markets. It’s probably also worth reiterating that “novel” and “complex” are not mutually exclusive terms. There are plenty of novel ETFs that are more complicated than a traditional long-only equity strategy, for example, those with ceilings or floors based on certain market conditions.

At the end of the day, the ETF wrapper has proven remarkably adaptable through the years, and I see no reason why that would change, even for “novel” underlying assets. This is also not the first time that the ETF structure has been questioned. From flash crashes to liquidity crunches, ETFs have been stress-tested before and have passed with flying colors. As Olivia might say, “Do you get déjà vu? Hmmm.”