“We think we have a better mousetrap. We have spent thousands of hours researching the investing approach, have done extensive back-testing over a decade and this strategy outperforms.”

Michael Waring, chief executive at Galileo Global Equity Advisors, made that comment following the recent launch of a rules-based gold ETF on the Toronto Stock Exchange. Not only is that product the first of its kind, it’s also the first ETF by Galileo, and is based on an investment approach that’s significantly different from existing gold ETFs which are based on market capitalization.

Known as U.S. Global Gold and Precious Metal Miners ETF, the Canadian ETF (whose symbol is GOGO) is starting a few months after a similar ETF was launched in the U.S. That ETF is known as the U.S. Global GO GOLD and Precious Metal Miners ETF and comes with the symbol GOAU. Both have the same investment goal: to provide investors with access to companies that produce precious metals either actively (through mining or production) or passively (through a royalty stream.)

While GOGO is in the process of building up assets, the U.S. fund shows that three companies — Wheaton Precious Metals, Royal Gold and Franco Nevada — all have a weight of at least 5 per cent. Companies in Canada (51.07 per cent); South Africa (17.66 per cent); the U.S. (14.92 per cent) and Australia (9.60 per cent) have the largest weight in the ETF.

In selecting the stocks, the manager focuses on metrics, other than market cap. While the methodology is proprietary, Waring said the so-called secret sauce, includes “five or six measures of profitability and efficiency. And that determines the weighting in the fund.” He expects the ETF will have about 30 stocks. “The model produced the ideal number of names,” said Waring, adding the ETF is rebalanced each quarter.

So why is rule-based investing better than investing via market cap? “By focusing on the more profitable companies, you get more capital gain than if you invest in the bigger companies,” said Waring adding that in the recent past in Canada, market cap investing has come unstuck by the rise and fall of Nortel, RIM and Valeant.

U.S. Global’s approach is highlighted by the ETF’s market breakdown: 10 per cent of the assets are in large cap stocks (those with a market cap of more than US$10 billion); 68.70 per cent in mid-cap companies (US$1 billion – US$ 10 billion) and 21.28 per cent in small caps. “The aim is to reward outstanding capital allocators, and management teams that are efficient in their operations,” said Samuel Pelaez, Galileo’s chief investment officer.

Rules-based ETFs aren’t that common in Canada, but have been offered. For instance, Claymore Investments used such an approach when it launched its Canadian operations a decade back. When Claymore was sold to BlackRock in 2012, Som Seif, Claymore’s chief executive used rules-based investing when he formed Purpose Investments in 2013.

Galileo is entering a market sector that’s largely been the purview of VanEck, a New York-based global money manager. That firm manages two gold ETFs: the VanEck Vectors Junior Gold Miners ETF (GDXJ) which is home to 75 securities; and the VanEck Vectors Gold Miners ETF (GDX) which holds 52 securities. The two ETFs house about US$12 billion of client assets.

For the GDX, Newmont Mining, Barrick Gold, Franco-Nevada, Newcrest Mining, Goldcorp and Agnico Eagle each have a five per cent stake. Companies in Canada (53 per cent); the U.S. (16.1 per cent); Australia (14.2 per cent) and South Africa (6 per cent) have the largest weight.

Financial Post