(MENAFN- ValueWalk) >Horizon Kinetics' commentary for the third quarter ended September 30, 2025.

Table of Contents

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• What We're Doing Now:
  • The Index Risk Avoidance and Active Management Redux Edition, Part II
  • First Batter Up: Sidestepping the Index by Investing with the House...Securities Exchanges
• Next Batter Up: Localized Inflation Investing vs. Scarcity Investing
  • Preamble: Is There Inflation? You Gonna Believe the CPI or Your Lying Eyes?
• What is Localized Inflation? And Why Could It Be Important to Me?
  • A Historical Example of an Important Wealth Preservation Risk and an Effective Hedge

What We're Doing Now: The Index Risk Avoidance and Active Management Redux Edition, Part II

The 25th anniversary of the modern era of indexation investing coincided with last quarter's Commentary. Since their introduction in May 2000, the iShares ETFs have supplied a bounty of data about the performance record of ETFs. It's not what people expected. We'll get to that in a couple of paragraphs.

Although the SPDR S&P 500 dates to 1993, in 2000 it was still a rounding error within the equity market. All 80 ETFs that existed that year totaled about $65 billion,1 a mere 0.4% of the U.S. stock market.2 By year-end 2023 assets in passive funds finally exceeded those in active funds; lately, to pick a single ETF totally at random, the iShares Bitcoin Trust ETF alone is close to $90 billion.3

The ETF era began in earnest that year, with a continuously and massively expanding annual inflow of funds, in particular drawn from active managers. The 2000 to 2025 ETF record is every bit as important as the seminal Ibbotson and Sinquefield study of asset returns from 1929 to 1975.4 It is a question-raising counterpoint to accepted wisdom and asset allocation practices.

Ibbotson and Sinquefield introduced the expectation that stocks should return 10% or more annually over time. Yet, in the past 25 years-across the spectrum of large and small cap sectors, growth and value, domestic and international-with virtually no exceptions, annualized equity ETF returns were in the 7% to 8% range. Fixed-income ETFs-across the maturity spectrum and even for inflation-indexed investment grade bonds-returned 3.5% and below; adjusted for taxes and inflation, they were negative.

That return shortfall is all the more surprising-and should be worrisome-given the massive one-decade lift from the Information Technology sector which, inclusive of Amazon, Meta and Alphabet, now comprises 46.1%5 of the S&P 500 market value. One person's worry can differ from someone else's.

Most investors worry, as expressed in the valuations, about the opportunity cost of missing outperformance in the IT sector-now synonymous with the AI/datacenter phenomenon. Few worry about the virtually inevitable capital loss cost of participating: with IT's index dominance, there's nowhere to hide, no saving diversification grace to be had, should IT valuations contract if/when any of a range identifiable emerging risks make themselves felt. All such episodes of market concentration and valuation extremes end similarly.

Note: The May 2000 start date of this time series aligns oh so closely with the peak of the technology bubble. Some might argue that this is a selection date convenience that invalidates the conclusions. That argument ignores the extraordinary expansion in revenues and valuation multiples that has fueled the current market. Because now it's a peak to peak measurement. In any case, May 2000 also-and this is the very point-coincides with the inception of the ETF era and its supportive impacts.

It can also be asked,“Is 25 years not 'long term' enough that the IT sector, in particular, must still be accorded special deference?” For instance, at the Dot Bubble peak, Technology represented almost exactly one-third of the S&P 500 by weight.6 The remainder of the index had rather low valuations-it's not clear at all that the year-2000 starting point for long-term stock market performance is unfairly maligned by the Dot bubble. On a weighting basis, the IT sector was well exceeded by Health Care, Consumer Staples, Consumer Discretionary, and Financials. At that peak, the Consumer Staples forward P/E was below 15, and Financials were about 12.5.7

For a sharper compare-and-contrast, a generous selection of large-capitalization growth companies in late 1999, ranging from the likes of Abbott Labs and The Hershey Company to M&T Bank had an average ROE of 25%, about the same as a selection of Technology companies like Intel, Microsoft, and Oracle.

Yet, while the trailing 12-month stock performance of the Technology stocks averaged 166% (yes, indeed), the aforementioned blue-chip economic super-performers' average return was negative-to be exact, -15%.

The year-forward average P/E of the Technology companies was 122x earnings, while the estimated P/E for these“normal” stocks-not normal, actually, in terms of their extraordinarily high returns on equity-was 15.7x earnings.

Clearly, the non-technology portion of the market was not at all disadvantaged, in terms of valuation or profit possibilities, by a starting date of May 2000. That two-sides-of-the-coin result in the stock performance of these two groups was created by the suction pump effect of the bubble market pulling money out of the“blue chips” into the dot. The notion that the stock market can reliably generate 10% annualized returns should not be accorded any special protection from objective evaluation.

In deference to the World Series, now in full swing, this Commentary's major points will be organized rather like a baseball lineup.

First Batter Up: Sidestepping the Index by Investing with the House...Securities Exchanges

Part I, last quarter, introduced the idea of sidestepping the index entirely, yet with a rational, fact-based expectation of a higher-than-index long-term return. Also the idea that there's more than one way to do this. The academic literature about efficient markets and modern portfolio theory-and the ever-burgeoning indexation movement-asserts that this scenario shouldn't exist.

That it can exist is in part an effect of the market impact of the index investment vehicles themselves. Originally intended to measure market performance, with the idea of participating in a very modest way that doesn't alter that which is being measured, indexed investing has become“the market” and the marginal trade. When such a great portion of the finite volume of investment funds that is available at any given time flows into one gravitational vortex of the market-in this era, the mega-cap and IT stocks-there must necessarily be an investments funds volume deficit elsewhere, the shallows well away from the deep, crowded pool of the efficient marketplace. Many such areas, in fact, where valuations are distorted downward instead of upward.

Securities Exchanges, as prefaced last quarter, are the most conceptually familiar of these alternative, contra-index equity classes. As the venues where transactions take place, they sit, like a croupier at a casino, atop the market action, ultimately indifferent to the fashions and tempests of the moment. All the while, they collect their spreads and benefit from periodic volatility as well as long-term rising volumes.

Herewith, a review by the manager of our Blockchain Development ETF (actively managed, of course), Brandon Colavita. You should note, in this section, another paradox around scarcity value: although the four major incumbent securities exchanges operationally encompass the totality of the stock market, they themselves comprise only a 0.4% aggregate weight in the S&P 500. As with other strategies we employ that have an implicit inflation hedge character, there is precious little of it available to an index buyer.

The securities exchange model is so powerful that nearly every exchange with a 20-year public track record has outperformed its respective regional stock index, in most cases by a wide margin. It's a global phenomenon: The U.S., Japan, Hong Kong, the UK, Singapore, you can see the list in the ac-companying schedule. The business model pro-vides global exposure to a wide variety of assets, many of them either absent from-or only margin-ally available in-the indexes themselves. It allows them to maintain their favorable financial charac-teristics regardless of where it is implemented, re-gardless of the economic variables of each specific region.

Our preference is for portfolios to exhibit conviction-weighted compounding over extended time horizons that are consonant with the longevity of their anticipated business model success. Current exposures of our strategies are not just a function of initial allocations, but of the performance of the individual securities we hold. As long as conviction in a position remains, it is allowed to compound without the impediments-the decision risks, taxes and friction-of trading.

In this way many of our portfolios manifest a natu-ral trend towards concentration. With time, the best performing companies have become some of the most influential positions, while lesser perform-ing securities have self-limited their impact.

Not every idea will have the same level of success. But we are confident in comprehensive fundamen-tal research that incorporates and reconciles the quantitative with the qualitative. That means the business model, not merely the financial metrics; market and index structure, not merely weightings, arbitrary sector designations and volatility stats; the long-term economic and competitive context over short-term index-relative returns. Enough so to let each thesis play out uninterrupted. While the strategy exhibits low turnover, the underlying holdings are constantly evaluated, since research analysis-not passion-is what dictates changes.

There is no litle irony that-as long-term investors who espouse and practice minimal turnover-a central theme and allocation is the securities ex-change business model, which depends upon mon-etizing the financial markets' ever-increasing turn-over and trading. Of course, exchanges are captur-ing other parties' needs to transact; their own busi-ness, while adaptive to new trading instruments and sources of volume, is highly persistent. CME was founded as the Chicago Buter and Egg Board in 1898; today, their largest contracts are interest rate futures, while some of their fastest growing are related to cryptocurrencies.

This inherent adaptability-growing with, not despite, the introduction of new,“disruptive” assets and trading methods-has been a feature of the securities exchanges for as long as the available data show, and they have about the greatest longevity of any publicly traded business in the world. The NYSE dates to May 17, 1792, and the London Stock Exchange's history goes back to 1698 in the venue of Jonathan's Coffee House.

Since 1957, when the S&P 500 was established, cre-ative destruction has ravaged, merged or replaced half of the original companies.8 By 2003, of the 341 surviving descendants (including products of mer-gers and spin-offs); 41 were foreign companies; 11 were in the process of bankruptcy proceedings; an-other 119 are no longer in the S&P 500; 63 were taken private. And that was two decades ago. As to the original Dow Jones members...today they're hardly recognizable, like Distilling & Catle Feeding.9

While constant trading is the antithesis of our portfolio management practice, that is decidedly not the investment world's preference. There is no reason to believe that human psychology will change or that markets will cease to innovate, so in this sense our portfolios benefit from the ever in-creasing transaction volume and velocity.

Prior Commentary editions have cited reasons for the global outperformance of exchanges.

• Trading technologies have improved, the vari-ety of investment instruments has increased, and markets have been opened up to retail and international liquidity pools for a far larger cli-ent base.
• Assets that were formerly difficult or relatively illiquid to trade, or almost exclusively the province of institutional trading-whether bonds or gold or futures like oil and volatility-have become equitized in the form of ETFs, available to any and all, and in the smallest denominations.
• The turnover of“equitized” assets-including, in a sense, equities themselves, like the SPDR S&P 500 ETF-manifest astounding turnover. The SPDR, even with $600 billion of assets, trades $44 billion worth of its shares daily, which means 100% turnover every 14 days.
• In some cases, trading hours have increased, markets have gone electronic, platforms have introduced low-latency matching engines (sub-20-millionths-of-a-second transaction speed for some platforms). The list of adaptive developments goes on.

But all of these are operational details of adjusting to the moment or an era; they are necessary to any going concern, but don't really explain why ex-changes are so different than other businesses. Ex-changes are where businesses go, where the world goes, to lay off risk and hedge, to raise capital, to buy and sell securely and with transparency, where there is the presence and availability of all the other buyers and sellers and the liquidity afforded by their joint presence in the same place. It's the venue, the (regulated) bazaar, that allows our capi-tal markets to operate.

Another reason for the extraordinary performance of exchanges aligns perfectly with our portfolio management philosophy: it is the incredible ability of these exchange platforms to let their products compound without impediment, and without the need for commensurate capital investment to support new levels of volume.

Though not all new products are successful, after the initial offering, whether an ETF or a futures con-tract, exchange volume is largely the result of mar-ket response to the pure utility or function it provides to potential participants-as opposed to any marketing initiative or incentive the exchange could offer to induce transactions. Coca-Cola and Philip Morris spent scores of billions of dollars to secure expanding and persistent sales; the securities ex-change is simply open for business.

In the case of derivatives, if the product solves some market need for hedging or speculation, then there is a fair chance of success. If the contract grows in popularity, the exchange infrastructure-its fixed cost-is already in place. That infrastruc-ture is, essentially, a trade execution and processing computer system, so it can typically do so with min-imal marginal costs to the exchange itself. Pro-cessing a thousand orders is not much different for a computer than processing a million. And the most popular products, as defined by market demand, typically become the highest-volume products on the platform.

Here are the top contracts in the U.S. exchange traded derivatives markets in 2024, along with their annualized trading volume increase in the past 20 years.

Overall, market volume has expanded at more than a 10% annual rate over this 20-year span. Which, as is obvious, exceeds the growth rates of GDP (4.4%) and U.S. corporate profits (6.0%). One will note not only the diverse range of assets absent from the equity indexes-including the mundane like soy oil and wheat-but that even the volumes of those quotidian agricultural commodities have exceeded corporate profit growth. Moreover, as impressive as the rates of core product offerings of the early 2000s have been, newer products have taken center-stage.

• As ETF growth has exploded, so too have ETF derivatives volumes-futures, options-such as those relating to SPY and QQQ.
• Bitcoin is now a top #20 contract; the asset itself did not even exist until 2009, and futures trading didn't commence until 2017.
• Although electricity demand has been prety flat in the US for 20 years, the volatile nature of the markets (pricing, weather events, regional dislocations) has led to an increase in contract volume of over 30% annualized over a period of 20 years.

A wheat farmer facing uncertain weather halfway through the growing season might wish to hedge that risk by selling some of the future crop in advance-that is, for future delivery. Similarly, a utility company facing possible summer drought conditions for its hydro-electric power plants might purchase some futures-electricity for future receipt-to make up for any output shortages.

Note the difference between the return to the exchange itself of electricity contract volume, and the returns to the S&P 500 of electric utility sector.

In practice, it hasn't matered which contracts succeed, only that capital markets continue to operate in order to accommodate the innumerable changing needs of a working economy. A working economy requires a bridge between the physical world (like commodities-wheat, gold and oil) and the financial world (currency, interest rates, stock indexes), a place where both immediate and future supplies can find buyers, buyers can find sellers, risks can be hedged, or prospective returns magnified. Exchanges are the crossroads between the physical world and the financial.

This is why the securities and derivatives exchanges have always been able to capture new assets, new financial vehicles, and new technologies (indiffer-ent to the winners and losers). And why they have grown in excess of the underlying price of those same assets. How does that happen?

Put simply: trading begets more trading. More ac-tivity typically leads to tighter spreads, providing beter execution prices for traders, and making platforms more atractive. Each trade or each tick helps reflect new information on assets, and even the smallest price movements can incentivize activ-ity for those looking to capitalize on perceived mis-pricing. Similarly, new positions can require offset-ting positions in other assets, as traders need to efficiently manage margin and collateral to fit their allowed exposures

The prior charts highlighted exchange performance versus local country indexes and exchange-traded derivative volume growth in the US. But how did those individual contract volumes respond to different levels of price appreciation in the underlying assets? We've broken out the prior volume chart by commodities with more discrete pricing to compare.

We have multiple examples of price trajectories, but volume growth has been robust in nearly every instance. Natural gas exhibited a significant price decline in the U.S. over the prior 20 years. Contract volumes were impressive. WTI was prety flat, but volumes still grew at a robust rate. Bitcoin contract volume was even able to outpace the massive appreciation in underlying market.

Gold was the one outlier, but consider these points. First, this chart only highlights exchange-traded contracts on U.S. exchanges. Including all global ex-changes covered by the Futures Industry Associa-tion, gold contract growth was actually over 12% annualized over the prior 20 years. This is another reason why we hold so many exchanges across the world. Global exchanges do not exhibit a high level of correlation to one another and we are still able to capture market activity no mater where it oc-curs. Second, the exchanges were not required to make binary bets on the asset to capture growth. And finally, the exchanges did not require much in terms of capital expenditures to service these con-tracts.

Next Batter Up: Localized Inflation Investing vs. Scarcity Investing Preamble: Is There Inflation? You Gonna Believe the CPI or Your Lying Eyes?

It's almost impossible to read a Horizon Kinetics paper of the past half-decade without a reference to inflation's preeminence as a threat to capital preservation, and its near inexorable approach. It's also almost impossible to see inflation in the reports of official figures like the Consumer Price Index.

One reason is that measuring inflation, at least as practiced by economists, is surprisingly challenging. Partly because consumer behavior shifts in response to price changes: If beef prices rise enough, consumers will substitute cheaper food items. Therefore, the price of the basket of foods that enters the CPI calculations will not measure the full price impact. Yet price increase certainly does impact that family.

More than that, it is well-nigh impossible to develop a consensus around whether such inflation even exists. That's because different societal constituencies have radically different perceptions of the magnitude of inflation: food and rent price increases might be near-intolerable for low-income consumers, yet almost below the notice of high-income consumers (and of policy makers as consumers, too).

Even the elegant example of the Big Mac Index, which made its first appearance in The Economist magazine in 1986, fails to determine a societally internally consistent level of inflation. The engagingly simple idea was that this particular fat/salt/sugar delivery vehicle (yes, protein, too) embodies its own basket of inputs. Not only various food commodities, but also labor, rent and energy costs, among others. Nor does determining the average price of a Big Mac entail any data collection, methodology or policy controversy; the data source is simply the price charged at the digitized restaurant counter.

Yet the Big Max Index is also problematic: as of April of this year, the average pre-tax price of that commodities-on-a-bun construction ranged from $4.68 in Texas to $6.72 in Massachusetts, a 44% differential.10 The U.S. is large enough that cost pressures can vary greatly by region.

To continue this exercise in inflation indeterminacy:

• For the 12 months through August 2025, the CPI increased by 2.9%.
• For the 12 months through this August, the restaurant industry's Total Food Away From Home category experienced menu price inflation of 3.9% -and, for full-service restaurants, 4.6%.
• The 16-month average Big Mac price, from year-end 2023 to April 2025, is up an annual 9.2%.11

The restaurant sector is a more important factor in GDP than one might think. In addition to food sales, it includes 15% of the entire U.S. workforce, plus real estate rental costs, plus supplies purchases, and so forth. A problem in the restaurant industry is almost by definition a problem for the U.S. economy.

Moreover, the above figures underreport inflation. Restaurants have not raised their menu or output prices as much as the input prices they pay. The reason is that limited-service restaurants-fast food restaurants in civilian parlance-assert that their customers resist menu price increases in proportion to the menu inflation rate. Price increases result in diminished traffic. The inability to raise prices will naturally result in compressed profit margins.

That is seen in the Producer Price Index for Food Wholesaling: The food input costs with which the restaurant companies must contend rose by 10.0% in the 12 months through this August.

That illustrates the problem. Vast sections of the public have been experiencing a troubling increase in inflation for some years now, a phe-nomenon objectively confirmed by restaurant industry menu prices. And restaurant sector in-vestors apparently perceive the problem, too, as manifested in poor returns since the convenient inception of the Advisor Shares Restaurant ETF (EATZ) almost five years ago. EATZ ap-preciated by an annual 3.3% during the period, and the McDonald's figure is 8.4%.12 McDon-ald's is number 43 in the S&P 500. Neverthe-less, neither the perception nor the data is reg-istered in the government's headline inflation statistic, the CPI.

What is Localized Inflation? And Why Could It Be Important to Me? A Historical Example of an Important Wealth Preservation Risk and an Effective Hedge

If an accepted measure of inflation has yet to be achieved, it follows that there can't be a coherent government policy around it. However, even if there were such a policy, the risk to-or investment opportunity for-any individual is more likely to be localized inflation, meaning local to a specific com-modity or locale or one very narrow segment of the economy, rather than generalized inflation.

For instance, if the price of oil were to soar, as happened in the 1970s, you might think to mitigate the problem by owning appropriately sized investments in the oil industry. Here's how that would play out:

The Capital Preservation Risk: If you spend 5% of disposable income on petroleum-related products like gasoline, heating oil and natural gas, then, all else constant, a doubling of oil prices would reduce your disposable income by 5%.

Ostensible Solution: Allocate 5% of your investment portfolio to petroleum producers. Then-if the portfolio is at least the size of your annual spending and saving- it would increase enough to offset the energy-based loss of purchasing power.

This might seem like a logical course of action, but in practice, that strategy failed. There is a vast difference between owning a corporation that drills for oil, and owning the cash flow directly connected to the price and production volume of oil. A lot happens in a corporation's income statement between the revenue line and the net income line. Also on the balance sheet, and between the starting and ending valuation multiples of the corporation's shares. That strategy worked this way...

• Oil averaged $1.82 per barrel in 1972, and by 1974 increased over five-fold to $11.
• The price of Exxon at year-end 1972 was $2.73 per share (adjusted downward to reflect stock splits), but by year-end 1974 had declined by 26% to $2.02.

While ExxonMobil is a hedge against inflation in theory, in practice any meaningful inflationary trend is likely to be accompanied by higher interest rates. Higher rates reduce the value of most capital assets. This is rational, since the company's reserves replacement costs will increase, perhaps substantially-everything from labor and equipment to new land leases and reserves. Thus, an Exxon investor will never have access to the entirety of the company's putative earnings, the woulda coulda shoulda earnings.

Although the long-term share price of ExxonMobil-one of the best-performing energy companies-is clearly correlated with the price of oil, it does not seem to outperform oil. Particularly when it would be most helpful, during an oil price spike. This can be seen in the accompanying chart, spanning 23 years from a then-relative low in oil prices to a recent relative high.

A better way to benefit from localized oil price inflation is through an oil royalty trust. Perhaps the best example, because of the longevity of its record, is Sabine Royalty Trust (SBR).

Between year-end 1999 and October 2025, oil rose from $26.91 a barrel to $58.51, or by 2.17x.

• During that period SBR appreciated from $14.50 per share to $69.81, nearly a 5.2x increase, exclusive of dividends.
• The dividends received during those 25 years totaled $96.42, or 7.2x the 1999 SBR share price.
• Summed, over a 12-fold return for SBR unit holders.

Yet, Sabine Royalty has obviously not self-liquidated. Although net royalty acres are fixed at inception, advances in petroleum geology engineering mean that as of 2024, SBR's proved oil and gas reserves are substantially higher than in 1999, despite all the production from those reserves over the course of those 25 years, and despite Sabine Royalty incurring no capital expenditures for 25 years.

Sabine Royalty is an example of a direct beneficiary of localized inflation. Because the cash flow is distributed monthly, with no reinvestment requirement, oil or natural gas price increases will automatically be translated in short order to distributable income. Its business model is to just collect royalty checks, pay the 0.7% of revenues (!) it incurs in administrative costs, and send the remaining 99.3% to unit holders.

That makes it a suitable hedge against oil and gas price increases. Nor need one anticipate inflation to make good use of such an instrument-it's not a binary win-or-lose choice. One merely prepares for the possibility of localized inflation and receives a robust cash flow.

As to how much can happen on an income statement between the revenue and net income line, a side-by-side picture of the ExxonMobil and Sabine Royalty income statements shows you what you need to know. Importantly, the fact that one of them is very, very large, and the other is very, very small is completely irrelevant to their inherent profitability or value as hedges against higher energy prices.

Read the full commentary below.

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