Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: their processes, challenges and philosophies and security selection. I'm David
Speaker 1: com I lead mutual fund and active research at Bloomberg Intelligence.
Speaker 1: For the better part of the last decade, the story
Speaker 1: in the markets has been simple, passive is winning. But
Speaker 1: recently that narrative has started to shift, and the question
Speaker 1: is whether that shift is real or just another cycle
Speaker 1: and a very long debate. Today, I wanted to look
Speaker 1: at that through a more teumatic lens. What's actually changing,
Speaker 1: where active might have an edge and what tends to
Speaker 1: get more competed away over time. So here to talk
Speaker 1: about that is Phil mckinnis, Chief investment strategists at Vantis Investors. Phil,
Speaker 1: thank you for joining me today. Thanks David, it's a
Speaker 1: pleasure to be here. I'm excited about this. So we're
Speaker 1: hearing a lot right now about you know, the shift
Speaker 1: back to active. What part of that narrative do you
Speaker 1: think is overstated or misunderstood. I think there's there's a
Speaker 1: couple of things that are really important to really contextualize it.
Speaker 1: Because you have the types of strategies that are out there.
Speaker 1: You also have the vehicles through which people are accessing them.
Speaker 1: And so if we're talking about active relative to passive,
Speaker 1: I think right alongside it you have to talk about
Speaker 1: ETFs and mutual funds because for a long time, you know,
Speaker 1: many of the ETF options, or the predominant ETF options,
Speaker 1: were passive of some sort, right, there was some sort
Speaker 1: of index based mechanism. And so if we think about
Speaker 1: kind of market share there between mutual funds and ETFs,
Speaker 1: you know, ETFs had around fourteen percent, sixteen percent market
Speaker 1: share if we go back to say twenty fourteen, go
Speaker 1: back to a little bit more than a decade ago.
Speaker 1: If you think about, you.
Speaker 2: Know, the end of last year, that split is a
Speaker 2: fair bit different. Right, You've got mutual fund share coming down,
Speaker 2: You've got each you have share coming up mid high thirties.
Speaker 2: So that's a pretty significant increase if we think about that,
Speaker 2: kind of contextualize it with some netflows since twenty twenty,
Speaker 2: I think around two and a half trillion dollars out
Speaker 2: of mutual funds and four point eight trillion dollars into ETFs,
Speaker 2: just a massive amount of money. So I think the
Speaker 2: concept of what vehicles are people choosing and then what
Speaker 2: is the kind of the strategy of those underlying vehicles
Speaker 2: is something that's pretty important to start with.
Speaker 1: You.
Speaker 2: Once you get into ETF specifically and you look at
Speaker 2: the share of passive relative to active flows, that dynamic
Speaker 2: is shifting as well. To your point, So if we
Speaker 2: go back to twenty nineteen, I think it was less
Speaker 2: than ten percent of flows, we're going into two active.
Speaker 2: If you look at twenty twenty five, you're over thirty percent.
Speaker 2: So that's materially different and there I think that there
Speaker 2: is more options for investors, for sure, but I think
Speaker 2: it has to be still contextualized. Of it's a big
Speaker 2: choice of the ETF vehicle over the mutual fun vehicle,
Speaker 2: and I really don't see that reversing. So I mean
Speaker 2: market leadership.
Speaker 1: If we just think about the market right now, it's
Speaker 1: still pretty concentrated, you know, handful or so megacap names
Speaker 1: in this type of environment, you know, most people think
Speaker 1: that passive tends to work. Well, why do you think
Speaker 1: we're really seeing this push towards active right now?
Speaker 2: I think there's a few different things. Because I think
Speaker 2: with passive, so I think about passive and active as
Speaker 2: being way more of a spectrum than like take a
Speaker 2: company like Meta, for example, is it a value stock
Speaker 2: or is it a growth stock? According to MSCI right now,
Speaker 2: it's a value stock. According to Russell, right now, it's
Speaker 2: a growth stock. So is that a passive decision or
Speaker 2: is that an active decision? Right there? These they're even
Speaker 2: among indexes. If it's a non total market index, I
Speaker 2: contend that there's still some form of security selection that
Speaker 2: is going on. Right you have to determine how is
Speaker 2: it how are we constituting it as a value stock?
Speaker 2: What's our ceiling for a small cap portfolio or a
Speaker 2: floor for a mid or large cap portfolio. These are
Speaker 2: active decisions. And so if we look at the growth
Speaker 2: in indexing and where it's come from, I really don't
Speaker 2: think a lot of it has come from people stepping
Speaker 2: back and just buying the total market. That's happening, but
Speaker 2: not nearly to the same level as people are buying
Speaker 2: components of the market that can be sectors, that can
Speaker 2: be styles, that can be market cap segments, it can
Speaker 2: be factors as well. Right, different sort of slices of
Speaker 2: the market that technically track an index. There's a set
Speaker 2: of rules, there's a methodology that you can go and read,
Speaker 2: and so the funds are tracking that index. But is
Speaker 2: that really passive. No, I don't really think that it is.
Speaker 2: I think that it might be passive at implementation, but
Speaker 2: there's still some active security selection that's going on. It's
Speaker 2: just a matter of who's doing it. So has it
Speaker 2: been concentrated at the top? Yes? What's really led to
Speaker 2: that two things. There's been really tremendous earnings growth at
Speaker 2: the top end of the market, and there's also been
Speaker 2: some pretty significant multiple expansion, Right, so as fast as
Speaker 2: the earnings have come out, the prices have extended further
Speaker 2: beyond that, they've risen even faster. I think it's still
Speaker 2: a time where folks should not be overlooking the rest
Speaker 2: of the market. I would contend there's still plenty of
Speaker 2: really really good opportunities that are out there where you
Speaker 2: can get a lot of the same characteristics that you
Speaker 2: might appreciate in a total market kind of passive strategy.
Speaker 2: You can get things like broad diversification, low turnover, low fees.
Speaker 2: Those options exist, but you can still pay attention to valuations, right,
Speaker 2: That's really one thing we try to center ourselves on
Speaker 2: at Avontics is paying attention to valuations, and so I
Speaker 2: think there's still an element of just not paying attention
Speaker 2: to price and isolation, not paying attention to fundamentals and
Speaker 2: isolation thinking about those in concert. There's always a place
Speaker 2: for that in the portfolio. So the further I.
Speaker 1: Mean Evantis is kind of known for its systematic equity approach.
Speaker 1: How does that approach kind of change the way you
Speaker 1: think about where active you know, adds value. I know
Speaker 1: you mentioned valuations, but if you go a little deeper.
Speaker 2: Yeah, so the systematic piece of it, right, we get
Speaker 2: a lot of questions around well what does that mean?
Speaker 2: Does it just mean you're a quant right? And I
Speaker 2: think I think even with some of these labels, and
Speaker 2: I'm going to stay it sound maybe like a curmudgeon
Speaker 2: as it comes to all these labels. So I don't
Speaker 2: mean to, but I think sometimes you get categorized as
Speaker 2: a manager by things that you don't do relative to
Speaker 2: things that you do. So the fact that we are
Speaker 2: going down going and sitting across the table from you know,
Speaker 2: CEOs and CFOs of portfolio companies and listening to them
Speaker 2: about their outlook for their respective businesses and it's like, oh, well,
Speaker 2: you must not be a fundamental manager. We care about
Speaker 2: fundamentals as much as anybody out there. I would contend
Speaker 2: as much as or more than anybody out there. What
Speaker 2: the strength the underlying fundamentals of businesses are relative to
Speaker 2: their prices, if they're going to have a spot in
Speaker 2: our portfolio or not. But we're trying to do it
Speaker 2: in a really objective way. And so when I think
Speaker 2: about systematization, that's existed for a long time, right, it's
Speaker 2: existed ever since computers have been around, is to varying
Speaker 2: degrees and forms. If we think about kind of the
Speaker 2: market and options for people to invest, and how that's
Speaker 2: evolved over time, it used to be everybody was just
Speaker 2: out picking stocks, right there. There were stock pickers, and
Speaker 2: maybe some things started to get systematized a little bit
Speaker 2: within there. But I would argue the systematization really started
Speaker 2: with indexing of people started to build indexes of you know,
Speaker 2: large cap indexes or small cap indexes, but really just
Speaker 2: just looking at how big is the company in the market.
Speaker 2: That's the share it makes up of the index, and
Speaker 2: that's the share it makes up of your portfolio, and
Speaker 2: that's really it that's now advanced a fair bit more
Speaker 2: right over a long period of time of different styles
Speaker 2: of indexes and different factors and things. So at avontis
Speaker 2: what we think about in terms of the systematization is
Speaker 2: there's parts of our process that if you can systematize it,
Speaker 2: you can do it faster, you can do it less expensively, right,
Speaker 2: you can do it more more efficiently, and potentially even
Speaker 2: at higher quality and better quality control checks than those things.
Speaker 2: So anything that we're doing in a very repetitive, repeative,
Speaker 2: repeated frequency, we try to make sure we have good
Speaker 2: systems in place to help us do that, to help
Speaker 2: us do it really consistently, really cost efficiently, because going
Speaker 2: back to the days of just the pure stock picking,
Speaker 2: you know that that's a pretty labor intensive and costly
Speaker 2: kind of an exercise to go and do this really
Speaker 2: deep due diligence on individual portfolio companies. So if I
Speaker 2: can systematize aspects of that and deliver a portfolio that's
Speaker 2: significantly lower fee but still has that end that sort
Speaker 2: of bend toward valuations and having good risk management and
Speaker 2: everything else, we think that that can be a really
Speaker 2: great deal for investors.
Speaker 1: You know, you mentioned you know kind of a spectrum
Speaker 1: of you know, between active and passive and you know,
Speaker 1: what do you think you know? And we also talked
Speaker 1: about the different things that are labeled as active today
Speaker 1: and you know that could that can mean quite of
Speaker 1: different things. What do you think you know of what's
Speaker 1: actually labeled active today? What's genuinely differentiated versus just you know,
Speaker 1: repackage factors, you know, exposure, you know, I know there's
Speaker 1: a lot of smart beta that you know, some consider active,
Speaker 1: some don't.
Speaker 2: I think about this question in various forms a lot
Speaker 2: because I talk to a lot of allocators who are
Speaker 2: building portfolios, and they're building portfolios using all of these
Speaker 2: different types of tools and approaches together in a strategy. Right,
Speaker 2: So they're using things that are index cores or index lead,
Speaker 2: they're using smart beta factor base, they're using what would
Speaker 2: be considered maybe a more concentrated active strategy. They're using
Speaker 2: all these different things inside of a portfolio. And so
Speaker 2: where I come back to is that idea of so
Speaker 2: around active, right if we because I think there's a
Speaker 2: there's a really big piece as we think about around
Speaker 2: active is unless you are holding every stock in the
Speaker 2: market at its market cap weight, there is some level
Speaker 2: of active in your portfolio, and so you get into
Speaker 2: a matter of well who is making those decisions? Are
Speaker 2: you making them as an allocator? Is there an index
Speaker 2: house or another asset manager who's making them on your behalf?
Speaker 2: And as you think about the idea of well what
Speaker 2: am I trying to achieve with that allocation? What kind
Speaker 2: of risk am I setting myself up for as I'm
Speaker 2: taking that? Am I doing it in the most cost
Speaker 2: effective way possible? Those start to become really important questions
Speaker 2: to answer because the concept of like repackaged factor exposure
Speaker 2: being passive, right, I think the idea is like, well,
Speaker 2: if it's if it's just factor exposure, that's kind of
Speaker 2: a passive exposure. I say, that's really still quite active.
Speaker 2: All of those things are really active decisions. It's a
Speaker 2: matter of who's making them and then how cost effectively
Speaker 2: are they able to do it? So where I come
Speaker 2: back to you know, I think if you think about
Speaker 2: from an attribution framework, right, you can always do an
Speaker 2: attribution on a portfolio and see how much of it
Speaker 2: was an allocation effect versus a selection effect. But even
Speaker 2: once you're into that kind of attribution world, well, the
Speaker 2: attribution lens that I'm looking at it through. If I'm
Speaker 2: looking at it through a sector or through a specific
Speaker 2: set of factors or whatever else, I'm going to have
Speaker 2: different betas in different kind of alpha terms. Right, So,
Speaker 2: even all the models have their own biases that can
Speaker 2: be built into them. What I think about I think
Speaker 2: about the allocator, who is really on the hook for
Speaker 2: this decision at the end of the day. They have
Speaker 2: to think about, well, do I have a goal? Do
Speaker 2: I have a goal that I'm trying to outperform my
Speaker 2: benchmark by? And we could have probably an hour long
Speaker 2: conversation just on benchmarking, David. So I'm not going to
Speaker 2: subject everybody to that today. But if I have a
Speaker 2: policy benchmark that we agree is reasonable, and then it's
Speaker 2: what's my goal in outperforming that portfolio benchmark and how
Speaker 2: am I going to get there? I can do it
Speaker 2: by me the allocator, trying to tactically overweight and underweight
Speaker 2: regions or sectors or styles or market cap segments that
Speaker 2: I think are more attractive or less attractive at different
Speaker 2: points in time. That's one option. I can put factors
Speaker 2: on top of it, right, I can lean towards value.
Speaker 2: I can lean towards quality or profitability if you have
Speaker 2: folks who do it that way, or I can outsource
Speaker 2: a lot of the stock selection to folks who are
Speaker 2: going and trying to find what they believe are the
Speaker 2: best companies. So build a portfolio of many concentrated active
Speaker 2: strategies and then look at my factor exposure and maybe
Speaker 2: try to offset some of if I don't like it. Right,
Speaker 2: there's so many different choices, But if you don't have
Speaker 2: a goal for what you're trying to achieve above and
Speaker 2: beyond that benchmark, then it's really hard to talk about
Speaker 2: what risk is and what risk looks like because that
Speaker 2: concept of it. If I want to outperform by a
Speaker 2: percent and a half, well, how much active risk do
Speaker 2: I have to take to make that a reasonable achievable goal?
Speaker 2: And how much of that am I outsourcing the decision
Speaker 2: versus I'm keeping it I have control. The more you
Speaker 2: have active managers in that camp, the more you're outsourcing it,
Speaker 2: and they may decide to do something differently right. They
Speaker 2: may change the stocks versus what they add last quarter,
Speaker 2: last year, and that might change the way they look
Speaker 2: in the portfolio relative to what else you have. So
Speaker 2: at avontis. One thing that's really important for us is
Speaker 2: we know anytime we're being hired, there's this trade off
Speaker 2: between we're being hired to deliver that underlying asset class,
Speaker 2: but they're choosing us because they think we can do
Speaker 2: better than just market cap weighting within that universe. So
Speaker 2: we have to think about managing that trade off effectively,
Speaker 2: and I would argue that we're as good as anybody
Speaker 2: out there doing that of making sure that sort of
Speaker 2: jobs one and two are designed. The portfolio is what
Speaker 2: does a good job of delivering that underlying intended asset class,
Speaker 2: and we do our job. We'd play that role in
Speaker 2: the allocation, but we have more information about differences than
Speaker 2: expector returns across stocks, and we can use that to
Speaker 2: not really meaningfully change the risk profile of the strategy.
Speaker 2: We might have some tracking her to a small value
Speaker 2: benchmark and our small value strategy, but it's not going
Speaker 2: to meaningfully contribute to an active risk or tracking error
Speaker 2: to the overall market level versus just using a small
Speaker 2: value index fund. So we think it can be a
Speaker 2: really effective tool for folks to use in those allocations,
Speaker 2: But the differentiation has to come through in that net
Speaker 2: a fee result at the end of the day.
Speaker 1: So, you know, if we think about what has to
Speaker 1: be true for an active strategy to have some sort
Speaker 1: of durable edge after costs. You know, you mentioned, you know,
Speaker 1: having a research process, and you know, is there things
Speaker 1: that you know just have you know, they kind of
Speaker 1: contribute to being able to outperform over a longer period
Speaker 1: of time. You know, I know that some managers might
Speaker 1: get lucky in some periods, but you know, like.
Speaker 2: To have that durable edge. What else do you think
Speaker 2: goes into it? I think I think there's two elements
Speaker 2: to it. I would say, there's let's let's talk about
Speaker 2: process and then let's talk about costs. So on the
Speaker 2: process side, this probably isn't so well defined. So I'm
Speaker 2: gonna I'm gonna do my best to define it, and
Speaker 2: you'll have to judge, or I guess the audience will
Speaker 2: judge while I define it. So I tend to differentiate
Speaker 2: between a manager or a process that's really focusing on
Speaker 2: signals versus one that's that's focused on valuations. So if
Speaker 2: one is really really focused on signals, of I've identified
Speaker 2: something that I think the market is is mispricing and
Speaker 2: there's a there's the signal that gives me that information,
Speaker 2: and so I'm gonna hammer that and and extract a
Speaker 2: premium because of it. Right, And they're constantly having to
Speaker 2: sort of rotate through what those signals are because they're
Speaker 2: being arbitrage away because other people are identifying those same
Speaker 2: signals and kind of crowding into those traits. That requires
Speaker 2: a lot of signals, and it requires a pretty high
Speaker 2: rate of frequency in terms of the turnover among those signals.
Speaker 2: So that process is one that I would say as
Speaker 2: a really high bar in terms of constantly having to
Speaker 2: refresh and find those new sort of areas of mispricing.
Speaker 2: What we do is much more grounded in valuations, and
Speaker 2: I would argue that that's a lot more stable and persistent. Right,
Speaker 2: The chances of a relationship between a lower price company
Speaker 2: relative to fundamentals and a higher price company relative to
Speaker 2: fundamentals of that premium over time flipping and going negative
Speaker 2: for long periods is not something that makes a lot
Speaker 2: of sense to me. Right. The magnitude of those premiums
Speaker 2: may change, but the concept of if I'm paying a
Speaker 2: lower price to get the same level of equity and
Speaker 2: profits in a business, and over time, I expect that
Speaker 2: to compound at a higher rate I get better returns.
Speaker 2: I don't, you know, I'm very comfortable with the long
Speaker 2: term nature of that and conviction that. So that's really
Speaker 2: the process piece. On the cost piece, there's a large
Speaker 2: asset consultant that throughout sort of a two thirds one
Speaker 2: third they believe that a manager should eat no more
Speaker 2: than a third of their excess return. So I don't
Speaker 2: think that's an unreasonable kind of a bogie if you
Speaker 2: think about a two thirds one third split of the
Speaker 2: client keeps two thirds and the manager keeps a third.
Speaker 2: At Avontas, So we've had strategies up since since September
Speaker 2: twenty nineteen. If I look at the strategies that have
Speaker 2: been around, you know since that time, the split that
Speaker 2: we've given to investors is closer to ninety ten, right,
Speaker 2: as far as ninety percent of the access return going
Speaker 2: the investors ten percent for Avantas. So I feel like
Speaker 2: we've done a really good job for investors or investors
Speaker 2: have gotten some really good value add from our strategies.
Speaker 1: Do you think I kind of want to just talk
Speaker 1: on the process a little bit more, you know, if
Speaker 1: we talk about the edge is do you see that
Speaker 1: coming from a different place in twenty nineteen versus today
Speaker 1: or is it kind of still just valuations kind of
Speaker 1: driving that.
Speaker 2: Yeah, Son, running these portfolios right this, there's a lot
Speaker 2: that goes into it. So you know, you think about
Speaker 2: the way we look at equity markets and you know
Speaker 2: we've got I think about it. There's different ways to
Speaker 2: describe it, but it's really a singular kind of foundation
Speaker 2: or view of being able to map or differentiate expector
Speaker 2: returns across stocks. We point that capability at different areas
Speaker 2: of the market. We've got large cap only portfolios, mid
Speaker 2: cap only portfolios, small cap only portfolios. We've got portfolios
Speaker 2: that just do it in the US or do it
Speaker 2: in non yes developed markets or emerging markets. So there's
Speaker 2: a lot of different sort of fishing ponds right where
Speaker 2: we're applying this, but we have one way of fishing.
Speaker 2: DA said, we're doing this across more than fourteen thousand
Speaker 2: companies across more fifty some odd countries every single day, right,
Speaker 2: So that's a lot of data that requires some really
Speaker 2: really good systems and checks in place to make sure
Speaker 2: you've got clean data that you're organizing it effectively, and
Speaker 2: that you're serving it up to really informed portfolio managers
Speaker 2: investment people who can interpret the outputs of that and
Speaker 2: use it to make good decisions. Right, So I would
Speaker 2: contend that you need to have expertise in all those areas.
Speaker 2: I would contend that you need to be paying attention
Speaker 2: to all those areas because you don't know where the
Speaker 2: next edge is actually going to come from. It can
Speaker 2: come from many different aspects within that, but it takes
Speaker 2: all of it together working in concert to create a
Speaker 2: good portfolio. Right. If we said, well we've got really
Speaker 2: strong portfolio managers, but our systems are crap, that's not
Speaker 2: going to lead to a good outcome. Right, You need
Speaker 2: all of it together. Sometimes people ask us that of
Speaker 2: what's more important is that the systems of the portfolio managers,
Speaker 2: And tongue in cheek, I say, well, what do you
Speaker 2: like most about pizza? Right? Do you like the sauce?
Speaker 2: Do you like the cheat? It tastes good because it
Speaker 2: all works together. And our portfolios we think they work
Speaker 2: well because everything works well together.
Speaker 1: So would you say, I mean, is there anything you
Speaker 1: think that investors underestimate about how these portfolios are implemented,
Speaker 1: you know, like whether it's trading rebalancing our costs.
Speaker 2: It probably depends on the lens at which they're viewing
Speaker 2: it through, because I think they could underestimate a lot.
Speaker 2: I think the biggest one, back to the earlier comment,
Speaker 2: is it's not a self driving process, right. These portfolios
Speaker 2: aren't way most so we've got somebody who's at the
Speaker 2: helm who is making sure like it's never going to
Speaker 2: be a computer model that's sending orders to market. It's
Speaker 2: a portfolio manager who's looking at things and saying, is
Speaker 2: this reasonable? Does this make sense? Right? We talked about
Speaker 2: wanting to systematize anything that we're doing with a very
Speaker 2: high rate of frequency so that you can do it
Speaker 2: more efficiently and do it more cost effectively. But there
Speaker 2: will be exceptions. There will be new things that pop up,
Speaker 2: and you need portfolio managers to be able to interpret
Speaker 2: those and make decisions and surface them to the team.
Speaker 2: So I feel like that's one piece for sure. You
Speaker 2: can't just set it and forget it. Not not even close.
Speaker 2: But the other thing that I think is it relates
Speaker 2: to systematic strategies and maybe even more broadly, the communication
Speaker 2: around them, I think is really really important setting and
Speaker 2: managing expectations effectively for investors, because it doesn't matter what
Speaker 2: kind of strategy you manage. If you're active, there's going
Speaker 2: to be a time when you underperform. And if you
Speaker 2: have taken a lot of shortcuts in how you explain
Speaker 2: the strategy, and you've just said, look, look at our
Speaker 2: sharp ratios, look at our information ratios, and just kind
Speaker 2: of smile and say, like, we've got good number. If
Speaker 2: folks are surprised by the results that have come out,
Speaker 2: then they might not stick around in the strategy. And
Speaker 2: in my mind, that's the worst outcome for everybody, because
Speaker 2: you know, they're hiring you when you got good returns,
Speaker 2: they're firing you you got bad returns, and what did
Speaker 2: they get out of it?
Speaker 1: Right?
Speaker 2: Maybe maybe not so much. We want people to hold
Speaker 2: these things for the long term, be aable enjoy you know,
Speaker 2: the express returns that we plan to offer that these
Speaker 2: are designed to offer. So how we communicate around the
Speaker 2: strategies being really clear about this is how we take
Speaker 2: active risk. This is how much active risk we take.
Speaker 2: These are the environments where we're not going to do
Speaker 2: so well. Twenty twenty five actually provides A great example
Speaker 2: of that. You look at small cap stocks in the US,
Speaker 2: is profitability quality, something was rewarded noll R right, not
Speaker 2: at all. Our small value strategy did not farewell in
Speaker 2: that environment. But as I was doing client reviews, we're
Speaker 2: sitting down with the of walking them through. Here's what
Speaker 2: you hired us to do. These are the types of
Speaker 2: companies we focus on. This is what happened in the
Speaker 2: market or over this time period. They're okay, right. It
Speaker 2: doesn't mean we like underperforming ever, but it's reasonable and
Speaker 2: it makes sense given the broader market environment. Are not
Speaker 2: going to change our stripes because of a six month
Speaker 2: or twelve month period. So I think that communication is
Speaker 2: really really important.
Speaker 1: You know, there's been some talk about systematic equity becoming
Speaker 1: more and more crowded. How do you avoid you know,
Speaker 1: these signals getting arbitraged away.
Speaker 2: We talked about a little bit before around the signal.
Speaker 2: So do I do different differentiator distinguish between the signals
Speaker 2: piece versus the valuations piece? Right? So on the on
Speaker 2: the valuations piece, the idea that look a company with
Speaker 2: you know, a better price relative to its profits and
Speaker 2: its equity. You know, do you expect those fundamentals to
Speaker 2: be rewarded over long periods. I am very very comfortable
Speaker 2: with that, right. And the beauty of our process is
Speaker 2: if I'm holding a bunch of companies that have those
Speaker 2: attractive prices to underlying fundamentals, if a whole bunch of
Speaker 2: other investors show up and bid up those companies, the
Speaker 2: prices of those companies and the fundamentals don't change. Guess
Speaker 2: what happens. We sell them. We sell those companies, and
Speaker 2: we're going on reinvesting the proceeds into more attractive opportunities.
Speaker 2: So this this daily process, right, the keeping our eye
Speaker 2: on the ball there is something definitely makes a lot
Speaker 2: of sense. But also we are not chasing these really
Speaker 2: really kind of fast moving signals, you know, trying to
Speaker 2: find a lot of elements of mispricing is trying to
Speaker 2: identify that value that is reflected in those prices and fundamentals.
Speaker 2: So I think there's some more staying power there. And
Speaker 2: you know, you know, every market where there's success, there's
Speaker 2: the potential risk of things being crowded by like a
Speaker 2: me too product or those kind kinds of things. We
Speaker 2: try to make sure we're restaurant orwers of look this
Speaker 2: is what we focus on. This is what we're signing
Speaker 2: you up for, and then just doing our job, you know,
Speaker 2: just making sure that you can count on us to
Speaker 2: do what we said we would do, because I think
Speaker 2: in the investment world that goes a long long way
Speaker 2: if folks know they are going to be surprised by
Speaker 2: your results.
Speaker 1: So the valuations in a sense, you know, kind of
Speaker 1: make sure that you know, as more and more assets
Speaker 1: get put in, you know, the returns aren't getting competed away. Correct, Okay,
Speaker 1: And so if we switch gears a little bit, you know,
Speaker 1: just talk about the ETF rapper. You know, we all
Speaker 1: know about the benefits you know, cost, tax efficiency, things
Speaker 1: like that. How much do you think the growth in
Speaker 1: active ETF reflects kind of really genuine improvements in outcomes
Speaker 1: versus just rapper.
Speaker 2: It's a it's an important question, you know. You look
Speaker 2: at twenty twenty five as an example, a thousand active
Speaker 2: ETFs listed right new ones that brings us I think
Speaker 2: to around twenty eight hundred according to a morning Star
Speaker 2: report that I was looking at. So that's a number,
Speaker 2: that's a number of options to contextualize the thousand, I
Speaker 2: think somewhere in the neighborhood of like one hundred passive
Speaker 2: ETFs and or index based ttfs and one hundred and
Speaker 2: fifty mutual funds that were launched over that same timeframe.
Speaker 2: So clearly there's a lot that's going on in the
Speaker 2: active space.
Speaker 1: Now.
Speaker 2: You know, your colleague garrettles to talk about hot sauce.
Speaker 2: I think a fair number of those ETFs might might
Speaker 2: fall under that hot sauce kind of label if they
Speaker 2: got a lot of leverage, if maybe you know, inverse
Speaker 2: or single stock, you know. So, I think probably at
Speaker 2: least a third of the ETFs would absolutely fall within
Speaker 2: that category of those that were listed in twenty twenty five.
Speaker 2: And me personally, I do question if that's it's providing
Speaker 2: more choice. That's for sure. Investors have never had more
Speaker 2: you know, active ETF options than they've had today. And
Speaker 2: choice is not necessarily a bad thing. But is it
Speaker 2: choices that can really drive meaningfully good kind of outcomes
Speaker 2: for those long term oriented investors. I'm probably a little
Speaker 2: bit more skeptical of that. I think you have to
Speaker 2: would have to dig deeper into the underlying piesis of
Speaker 2: each of those portfolios, you know, with the with the commoditization.
Speaker 2: You know, you see it in fees, right, fees have
Speaker 2: come down significantly. If you look at where the money
Speaker 2: is going among active etf it's not really going to
Speaker 2: high cost active ETFs, it's going to lower cost activettfs.
Speaker 2: So that shift from mutual funds to ETFs that I
Speaker 2: would contend is absolutely about tax efficiency and things like
Speaker 2: the rapper provides, but was also just an emphasis on costs,
Speaker 2: lower costs ways of achieving the same exposure in a portfolio.
Speaker 2: So costs are still going to matter. I think they
Speaker 2: still should absolutely matter for investors who are evaluating these things.
Speaker 2: But I think you gotta with whether it's active, whether
Speaker 2: it's index based. I don't know if allocators of like
Speaker 2: hearing this answer or not, probably depends on your role.
Speaker 2: I think you gotta you know, you got to open
Speaker 2: the hood, you got to kick the tires. You got
Speaker 2: to understand how does the stock get into the portfolio,
Speaker 2: how is it weighted, and then when might it leave
Speaker 2: right and why would it leave. You have to understand
Speaker 2: that to understand the role it's going to play in
Speaker 2: your portfolio. The other thing I would say is you
Speaker 2: look at kind of ETF sponsors as a somebody's doing
Speaker 2: due diligence. I think it's a great question to ask
Speaker 2: people if how do you think about product development rights?
Speaker 2: What's causing you to bring new strategies to market? Or
Speaker 2: why did you launch these strategies?
Speaker 1: Are?
Speaker 2: How do you think about it? You'll learn a lot
Speaker 2: about how they think about supporting investors as they think
Speaker 2: about developing strategies. So, uh, those are those are really
Speaker 2: important questions to be asking a sponsorle so you had
Speaker 2: made you reference the small value you as one example,
Speaker 2: how do how should it investors kind of set expectations
Speaker 2: for different market environments, you know, specifically for these type
Speaker 2: of strategies. I love the question, uh, and I think
Speaker 2: it's really important. So the way that I think about it,
Speaker 2: if you're evaluating a manager, I think that there's there's
Speaker 2: three questions that you really need to be asking and
Speaker 2: before you start looking at any sort of you know,
Speaker 2: MPT stats or a lot of data or anything else.
Speaker 2: So one is you know, so explain to me how
Speaker 2: you take active risk? Right? How do you put names
Speaker 2: into a portfolio? Why do they make it in there?
Speaker 2: So you get an understanding of that process us, Right,
Speaker 2: how are you and then how does that translate to
Speaker 2: adding value above and beyond the benchmark? So that's sort
Speaker 2: of component one, Component two. Okay, what are you expecting
Speaker 2: to generate above and beyond that? Right? So that gives
Speaker 2: them a sense of if they got an access return target,
Speaker 2: and what's the what's the tracking error that's going to
Speaker 2: come with that? Right, what's the active risk that they're taking. See,
Speaker 2: you have some semblance of that, and they should be
Speaker 2: able to show you, you know, why is that a
Speaker 2: reasonable number or not? Right? So does it make sense
Speaker 2: relative to to to what they're doing, what kind of
Speaker 2: kind of peers are they going to underperform it? And
Speaker 2: then finally, what's the fee you're going to charge me?
Speaker 2: Right for that endeavor? So if you have those three
Speaker 2: things lined up, and do you think that that cost
Speaker 2: is reasonable? If you have your head around that as
Speaker 2: an allocator, then starting to use attributions or MPT stats
Speaker 2: or whatever else can start to help you check and
Speaker 2: analyze and and really see if it matches up relative
Speaker 2: to what the manager is telling you they do, and
Speaker 2: you can get a lot more comfort. Right, But you
Speaker 2: have something like downside capture gets thrown around a lot, right,
Speaker 2: It's a, Oh, we got really good downside capture. I
Speaker 2: want to manage it. As a good downside capture I
Speaker 2: can show you, Or I can look at a downside
Speaker 2: capture number of a portfolio and it might tell me
Speaker 2: a lot about the way that the manager is managing
Speaker 2: the strategy, or it might tell me absolutely nothing at all, right,
Speaker 2: depending on how exactly they manage the strategy. Because think
Speaker 2: about twenty twenty two. If you had a portfolio that
Speaker 2: favored value at all in the US, it was going
Speaker 2: to look like you had great downside protection why or
Speaker 2: downside capture? Why growth stocks? Growth stocks were really what
Speaker 2: came down right, They were falling down in price in
Speaker 2: twenty twenty two. So if somebody looks at that and said,
Speaker 2: I want this manager because they have good downside protection, well,
Speaker 2: if I'm not managing it for downside risk, if it
Speaker 2: just was episodic based on that market environment, that number
Speaker 2: is pretty meaningless in that context, right, I shouldn't expect
Speaker 2: it the next time. So I think it's really you
Speaker 2: have to answer those core questions so that you can
Speaker 2: start to form your own expectations of what should I
Speaker 2: expect this strategy to do well or not do? So well,
Speaker 2: and am I comfortable with that? You know, sort of
Speaker 2: range of outcomes. Those are the really important things to
Speaker 2: get across versus sort of coming with the objective first
Speaker 2: of I want this, and then I'm going to screen
Speaker 2: on those measures and I'm going to get to a
Speaker 2: universe of strategies that provide that, and then I'll figure
Speaker 2: out which one is the best one. I'd always start
Speaker 2: back at the the thesis first, right, how do how
Speaker 2: do these managers work? First? And then see if it
Speaker 2: matches up with what you're what you're looking for. Okay,
Speaker 2: so my last question for you is, you know, I
Speaker 2: know we covered us a little bit. We talked about
Speaker 2: how you know, a lot of launches recently. You know,
Speaker 2: a lot of that is you know, leverage, single stock.
Speaker 2: You know, you get to find out CUB as well.
Speaker 1: And I guess it can be debatable if you know,
Speaker 1: if it's true active or you know, I like to
Speaker 1: separate in between you know, traditional active and new active.
Speaker 1: If we you know, think about the future and you know,
Speaker 1: five years from now, what would convince you that this
Speaker 1: was a you know, a true shift back to active,
Speaker 1: you know that the narrative was real and it wasn't
Speaker 1: just mostly noise.
Speaker 2: So I I have I have three three components to
Speaker 2: an answer and hopefully it's a satisfying answer. So the
Speaker 2: first one back to kind of mutual funds and anytfs, right,
Speaker 2: So move away from mutual funds to ETFs. I would
Speaker 2: I would put a big stamp on that as validated,
Speaker 2: right like that. I don't think that's going back in
Speaker 2: the other direction. And so there there is the component
Speaker 2: of you know, well, how are you defining active, right
Speaker 2: is it? Is it non index? The non total market index?
Speaker 2: Because I still put all those within the realm of
Speaker 2: active in some fashion. Uh. And so there, if you're
Speaker 2: you know, whether at ANYTF that is labeled active or
Speaker 2: ANYTF that is labeled index, I think we got to
Speaker 2: dig a little bit deeper to be able to say
Speaker 2: which is the better way of doing it. With with Avantis,
Speaker 2: we you know, we would argue. So if you look
Speaker 2: at costs, if you look at the level of diversification
Speaker 2: that's available in a portfolio, if you look at the
Speaker 2: turnover levels of a portfolio, we had a lot of
Speaker 2: portfolios that are pretty darn low feet low turnover, pretty
Speaker 2: broadly diversified, really tax efficient with the ETF rapper that
Speaker 2: again i'd put a stamp on that and say validated,
Speaker 2: Like if I can check off those things, I think
Speaker 2: a lot of allocareas are very happy to have those
Speaker 2: as tools in a portfolio, regardless of what the label is.
Speaker 2: So you know, we've we started in twenty nineteen, we
Speaker 2: had five ETFs at that point. We've launched a lot more.
Speaker 2: But I said earlier about you know, talking to a
Speaker 2: manager how they think about product development. We don't on
Speaker 2: strategies and helps that people show up. We go and
Speaker 2: talk to people as to what else they might need
Speaker 2: and how we can help. And that's what's going to
Speaker 2: lead us as far as what you know, what's sort
Speaker 2: of next out there. So that I think is a
Speaker 2: much more sustainable way of growing a franchise of strategies
Speaker 2: that are available, solutions are available to investors, and it's
Speaker 2: as well sort of our clients. Well, we're around one
Speaker 2: hundred and thirty billion in total assets under management now,
Speaker 2: you know six and a half years later. That doesn't
Speaker 2: come from you know, I would say being lucky. It
Speaker 2: comes from hopefully, you know, doing what you say you
Speaker 2: would and having things that really embody all the characteristics
Speaker 2: of things that people want in a strategy. So I'm
Speaker 2: maybe cheating a little bit here in terms of that validation,
Speaker 2: but I like to borrow from both disciplines. I think
Speaker 2: there's disciplines of active management that make a lot of
Speaker 2: sense in a portfolio. Daily oversight, have a sun, valuations
Speaker 2: and things. There's also elements that may be more often
Speaker 2: associated with passive back to the broad versification, low fees
Speaker 2: and things that I also think are good components of
Speaker 2: a strategy. So we're going to have those embedded. If
Speaker 2: we can blend those effectively together, we think it can
Speaker 2: translate to really good outcomes for clients. And you know,
Speaker 2: those those five strategies that I was talking about, if
Speaker 2: you look at their average net access return versus their benchmark,
Speaker 2: you know, with over three hundred basis points annualized of fees.
Speaker 2: So we again feel like that's a pretty good deal
Speaker 2: that investors have gotten and we're happy to keep doing
Speaker 2: it for them. Great.
Speaker 1: Great, Well, unfortunately we need to end here, but this
Speaker 1: is a lot of fun. I really enjoyed this conversation.
Speaker 2: Phil. Likewise, thank you, David, I really appreciate it.
Speaker 1: Thank you for coming on. I also want to thank
Speaker 1: our listeners. If you like the episode, please share it,
Speaker 1: subscribe and leave a review. And if you'd like to
Speaker 1: see more of our research on the terminal, go to
Speaker 1: bifund Go for Fund and Active Research Until our next episode.
Speaker 1: This is David Code with Inside Active