Missing an ETF Based on Institutional Quality... Should We Have One?

General
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Why Some Nations Succeed and Others Struggle

Why do some countries do so well, while others don’t? The 2024 Nobel Prize in Economics went to Daron Acemoglu and James Robinson, who explain this with one key factor: institutions. Their research in “Why Nations Fail” shows that it’s the institutions that really make the difference in a nation’s long-term success, not things like geography, culture, or resources. But while we can invest in everything from Bitcoin to Butterfly ETFs, there’s no investment option that tracks the one thing they say matters most: institutional quality. This gap in the market is a big missed opportunity, and we’re missing the chance to match our investments with the strongest predictor of long-term wealth.

Why Institutional Quality Really Matters

Countries with good institutions tend to show:

  • Less corruption
  • Better protection of property rights
  • More efficient markets
  • Higher levels of innovation
  • Better ways of using capital
  • More economic resilience during tough times

The Missing Investment Opportunity

Right now, we have:

  • ESG-focused ETFs
  • Funds that focus on governance
  • Democracy-based funds
  • Country-specific development funds

But none of these directly focus on institutional quality as their main factor. That’s a big missed opportunity for long-term investors.

What an Institutional Quality ETF Could Look Like

A new ETF could focus on countries with the strongest institutions, looking at factors like:

  • Rule of Law Index (World Justice Project)
  • Property Rights Protection (Heritage Foundation)
  • Effectiveness of Institutions (World Bank)
  • Corruption Perception Index (Transparency International)
  • Economic Freedom Index
  • Regulatory Quality measures

Why This Would Be Better Than Traditional Index Funds

This new approach could:

  • Avoid countries with unstable or authoritarian regimes
  • Focus on nations with long-term growth potential
  • Reduce risk by avoiding political instability
  • Invest in markets that have a proven record of creating wealth
  • Automatically meet ESG standards through institutional factors

Who Would Be Interested in This ETF?

This ETF could attract:

  • Long-term investors saving for retirement
  • ESG-conscious investors
  • Big institutional investors looking for stable returns
  • Private wealth managers focused on risk management

Why This ETF Makes Sense Now

With growing global interest in:

  • Quality of governance
  • Democratic values
  • Sustainable development
  • Managing risk

It’s the perfect time for an investment that focuses on institutional quality.

My Call to Action

If you’re an ETF provider or an institutional investor interested in making this idea a reality, there’s a chance to be the first to create something truly valuable. The market needs an ETF that puts capital where it can support good governance.

Feel free to ask questions, I’m curious about your thoughts.

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So, you’re suggesting an ETF based on a country’s institutional quality?

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Sullivan said:
So, you’re suggesting an ETF based on a country’s institutional quality?

Not just a simple institutional quality weighting. I’m proposing a ‘Smart Institutional Beta’ approach, where we combine an institution’s quality score with its growth potential. For example:
Switzerland: High IQ score (95/100) x Lower Growth Mod (0.7) = 66.5
South Korea: Strong IQ score (85/100) x Higher Growth Mod (1.2) = 102
Estonia: Good IQ score (80/100) x High Growth Mod (1.3) = 104
This helps keep the fund balanced, avoiding only rich countries like Switzerland, but also capturing emerging countries with strong institutions and growth potential. So, we’re not just buying ‘blue chip’ countries, but also future market leaders that have the right institutional setup to grow.

The Growth Modifier would factor in things like:

  • Demographics
  • Education levels
  • R&D spending
  • Economic complexity

This way, we get better diversification and better returns while still staying focused on the idea that strong institutions drive long-term wealth.

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@Emily
But if strong institutions already help drive growth, wouldn’t growth potential already be reflected in the quality score? By adding a growth modifier, it seems you don’t fully trust that institutions alone matter. If a country like China has a weak institutional score but a high growth potential, should we invest in it? Or would you pick a country like Canada with strong institutions but low growth potential?

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@Sullivan
You’ve raised a good point, and I’ll clarify my thinking. Institutions are crucial, but they aren’t the only factor for growth. Strong institutions are needed for sustainable growth, but other factors matter too in countries that already have good institutions. For example:
China: High growth potential but weak institutions (property rights, rule of law) = Excluded
Canada: Strong institutions but slower growth (demographic challenges) = Included but weighted lower
The key is that we apply the growth modifier after we’ve filtered for countries with strong institutions. We don’t compromise on institutions, but we adjust for growth once we know the country is solid institutionally.

So, it’s a two-step process:

  1. Filter countries with strong institutions first
  2. Then, consider their growth potential within that group.

This lets us stay true to the idea that institutions matter most, while still recognizing that some institutionally strong countries have better growth prospects than others.

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@Emily
I think people already do this. For example, if a country has both high institution quality and high growth potential, like the US, investors buy and hold. If it has high institution quality but low growth, like Canada, they buy and hold but don’t invest as much. For countries with low institution scores but high growth, people swing trade them.

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@Sullivan
You’re right that investors are already doing this, but it’s not systematic. The real innovation here would be to turn this general practice into a more organized and reliable system. It’s like how Fama-French made factors like size and value systematic instead of just something investors thought about casually.

Making this process systematic would have several advantages:

  • It removes emotional bias (no more ‘FOMO’ trading with high-risk, weak-institution countries)
  • It forces discipline (no more ‘just this once’ exceptions for countries with weak institutions)
  • It helps identify countries that are improving their institutions before the market catches on
  • The fund would follow a clear, rules-based process for rebalancing when institutions improve or decline.

This ETF wouldn’t change how investors think about institutions, it would just make it more systematic and accessible.

8

What about Canada, Switzerland, Denmark?

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Quill said:
What about Canada, Switzerland, Denmark?

Actually, ‘Why Nations Fail’ and other institutional studies show that there’s a broader group of strong candidates. Here’s a list based on data:
Tier 1 (Mature Institutions):
Nordics (Denmark, Sweden, Norway, Finland)
Switzerland, Netherlands, New Zealand
Canada, Australia
Tier 2 (Strong & Dynamic):
South Korea, Taiwan
Estonia, Czech Republic
Israel
Singapore
Tier 3 (Improving Institutions):
Chile, Poland
Baltic states (Latvia, Lithuania)
Slovenia, Slovakia
Ireland (great improvement in past decades)
Japan (solid institutions, unique governance model)
The key point is that institutional quality can evolve. South Korea, for example, has dramatically improved its institutions in recent decades. That’s why tracking these changes is so interesting from an investment standpoint. The goal is to measure not just strength, but momentum in institutions.

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You should share this on another forum.

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Remy said:
You should share this on another forum.

It seems like crossposting isn’t allowed there.

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OK, so which index would this ETF track?

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Jody said:
OK, so which index would this ETF track?

This would definitely be an index fund. It would track an ‘Institutional Quality Score’ based on these existing metrics:
40% Rule of Law Index
20% Property Rights Protection
20% Corruption Perception Index
20% Economic Freedom Index

Why these metrics? Rule of Law gets the highest weight because it’s such a critical foundation for everything else. Property rights are second, since wealth creation depends on them. Economic freedom and corruption help fine-tune the process.

After the quality score is calculated, we’d apply the Growth Modifier and adjust the weights of the countries based on their score. This allows us to have a more refined approach than just a pure ‘quality-focused’ ETF.

The goal is to make sure the ETF tracks both high-quality institutional environments and their potential for growth.