Speaker 1: M. This is Mesters in Business with very Renaults on
Speaker 1: Bluebird Radio. This week on the podcast, I have an
Speaker 1: extra special guest. His name is Rob or Not and
Speaker 1: he is the chairman and founder of Research Affiliates, a
Speaker 1: firm who essentially patented the concept of fundamental index thing
Speaker 1: pretty much they invented it. And uh, I know Rob
Speaker 1: for a good couple of years. He was on the
Speaker 1: show in and his office just cranks out so many
Speaker 1: fascinating research pieces, hence the name Research Affiliates. That you know,
Speaker 1: after you read the third or fourth thing from somebody
Speaker 1: in a couple of months, it's like, damn, I gotta
Speaker 1: get robbed back on. This is some really interesting things.
Speaker 1: We went deep into the woods on electric vehicles in
Speaker 1: Tesla and we talked about what makes a big market
Speaker 1: delusion when an entire sector, not just a company, a
Speaker 1: whole sector runs amuck. We talked about everything really, from
Speaker 1: E s G to bitcoin to value. I thought it
Speaker 1: was really intriguing if you're at all interested in fundamental
Speaker 1: indexing or smart beta, if you're interested in where alpha
Speaker 1: comes from and what the sources of various value and
Speaker 1: other types of factor premiums are, then you're going to
Speaker 1: find this to be absolutely fascinating. So, with no further ado,
Speaker 1: my conversation with Research Affiliates Rob are Not. This is
Speaker 1: mesters in Business with very renaults on Bluebird Radio. My
Speaker 1: special guest this week is Rob are Not. He is
Speaker 1: the founder and chairman of Research Affiliates, a firm that
Speaker 1: has created and patented a methodology for creating indexes based
Speaker 1: on fundamental metrics instead of the traditional market cap waiting.
Speaker 1: Various asset managers are unning over a hundred and sixty
Speaker 1: billion dollars using strategies developed by Research Affiliates. Rob is
Speaker 1: the author of over a hundred academic papers, seven of
Speaker 1: which one Graham and Dodge Scrolls and Awards. He is
Speaker 1: the co author of the book The Fundamental Index A
Speaker 1: Better Way to Invest. Rob are Not, welcome to Bloomberg.
Speaker 1: Thank you so much. It's a privilege. Well, it's pleasure
Speaker 1: to have you back. There's so much to go over
Speaker 1: since the last time we had you on the show
Speaker 1: about three years ago. Let's just start out with Research
Speaker 1: Affiliates or or Raphaels as I know it. Um, you
Speaker 1: guys don't manage assets directly, but advise on over a
Speaker 1: hundred and sixty billion dollars in assets, explained to the
Speaker 1: listeners how that process works well. We want to focus
Speaker 1: on our area of competitive advantage, and that is in
Speaker 1: doing research and develop investment strategies, in carrying out um
Speaker 1: UH and exploring potentially disruptive ideas for the investment management community.
Speaker 1: UM to run an asset management firm also typically means
Speaker 1: UM call center, means portfolio accounting, it means UM trading desk,
Speaker 1: trade reconciliation departments, and the list goes on and on
Speaker 1: and on. So the last time I ran an asset
Speaker 1: management firm first quadrant back in two thousand four, we
Speaker 1: had about twenty people and a roughly twelve were in research.
Speaker 1: Here we've got about eighty people and roughly half of
Speaker 1: them are in research. So we're able to concentrate our
Speaker 1: attention on our area of competitive advantage while at the
Speaker 1: same time using affiliates external distribution partners to handle distribution
Speaker 1: and quiet relationships. And so basically they view us as
Speaker 1: an extension of their R and D capabilities. UH. Certainly,
Speaker 1: they're not going to replace their R and D efforts,
Speaker 1: but if our ideas are complementary, then we're an extension
Speaker 1: of that and we view them as our distribution channel.
Speaker 1: Let's talk about one of the strongest research ideas and
Speaker 1: strategies that you and your farm are behind. And and
Speaker 1: that's the basic concept that hey, we're doing this index
Speaker 1: waiting thing all wrong. Instead of doing it based on
Speaker 1: market cap or the size of the company, it's instead
Speaker 1: it should be based on fundamental metrics like revenues or profits.
Speaker 1: Explain why that's a better approach. Thank you for asking that.
Speaker 1: A lot of the attention in the world of so
Speaker 1: called smart beta is on formula based techniques for investing,
Speaker 1: and the umbrella terms smart beta began as a focus
Speaker 1: on strategies that no longer weight companies in direct proportion
Speaker 1: to their price, which is what cap Waiting does, and
Speaker 1: it's cap Waiting's heel Achilles heel um uh. If you
Speaker 1: wait companies in proportion to the their price, than any
Speaker 1: company that's above its eventual fair value and destined to
Speaker 1: underperform will have a current weight that's too high, and
Speaker 1: any company that's cheap and destined to outperform will have
Speaker 1: a current weight in the portfolio that's too low. So
Speaker 1: you're gonna be overweight the overvalued and underweight the undervalue
Speaker 1: even though you don't know which ones are which, which
Speaker 1: is an interesting nuance UM. But the term smart beta
Speaker 1: has since been broadened to embrace factor investing, and basically
Speaker 1: anything that uses a formula, even momentum investing, is called
Speaker 1: smart beta, although it's the antithesis of the original definition.
Speaker 1: UH Fundamental Index was an idea that we came up
Speaker 1: within two thousand three in the aftermath of the bursting
Speaker 1: of the tech bubble. A dear friend of mine who
Speaker 1: was on the board of the New York State Pension
Speaker 1: and was founding president of Common Fund, which manages commit
Speaker 1: Um university endowments. He was horrified at the amount of
Speaker 1: money that was lost by major pension funds by investing
Speaker 1: in cap weighted indexes. As the tech bubble burst. Four
Speaker 1: percent of the portfolio UM invested UH in the largest
Speaker 1: market cap company at the time UM Cisco, and Cisco
Speaker 1: subsequently went down. Something like so there went if you
Speaker 1: had four percent in it, there went three point six
Speaker 1: percent of your money and one single stock, okay, UH.
Speaker 1: He challenged us to think about better ways to invest,
Speaker 1: and we came up with the idea, an idea I
Speaker 1: had been playing around with for a few years. Why
Speaker 1: on earth do you want to invest in proportion to
Speaker 1: market capitalization, which means that the more expensive the company is,
Speaker 1: the more heaviest weight in the portfolio. Why not wait
Speaker 1: companies in accordance with sales, or with profits, or with
Speaker 1: book value, or or even with a number of employees.
Speaker 1: So UM, we went back and tested the idea first,
Speaker 1: starting with sales and book value and going back thirty
Speaker 1: plus years. We found that if you chose the thousand
Speaker 1: largest businesses in the US based on their sales and
Speaker 1: wasted them by their sales, that you wound up two
Speaker 1: and a half percent a year better off than with
Speaker 1: cap weighted indexing. And we tested it with book value,
Speaker 1: We tested it with offits, with cash flow, with EBA, duh,
Speaker 1: with number of employees. UM, and everything we tested had
Speaker 1: one and a half to two and a half percent
Speaker 1: access return. So that was our first a ha moment
Speaker 1: that oh, it doesn't matter what measure you're using. What
Speaker 1: matters is whether the measure incorporates price, because if the
Speaker 1: price is too high, then any any waiting scheme will
Speaker 1: do better. You could use darts, or you could base
Speaker 1: it on the number of executives who like to have
Speaker 1: a mustache or whatever. Um and you're still breaking the
Speaker 1: link with price, and you're still going to add one
Speaker 1: and a half to two and a half percent a year. Cool.
Speaker 1: And so we developed the idea of Fundamental Index, which
Speaker 1: has become a very important part of our business. It's
Speaker 1: over a hundred forty billion in assets now and it's
Speaker 1: under licensed to other distribution partners Pimco, Schwab, investc Amura,
Speaker 1: and the list goes on and on. We have at
Speaker 1: least eight part distribution partners with at least ten billion
Speaker 1: each managed using our ideas. So what is cool about
Speaker 1: Fundamental Index is that you're earning a profit based on
Speaker 1: two things. First, the obvious one a value tilt. If
Speaker 1: growth stock is priced at lofty multiples to fundamentals, then
Speaker 1: you're rewaiting those stocks down to their economic footprint, the
Speaker 1: size of the business. And if a stock is trading
Speaker 1: at deep discounts, you're rewaiting it up. So you have
Speaker 1: a stark value tilt all the time, and value investing
Speaker 1: usually wins. But it turns out that's not the dominant
Speaker 1: source of incremental return. It turns out that the dominant
Speaker 1: source of access return is a rebalancing discipline. If a
Speaker 1: stock soars and the fundamentals don't, then RAFI. The fundamental
Speaker 1: index will say, thank you for those lovely games. Let's
Speaker 1: rewait this investment down to its economic footprint. And if
Speaker 1: it's company tumbles and its fundamentals don't, rathey will say, oh,
Speaker 1: thanks for the lovely discount. Let's rewait you back up
Speaker 1: to your economic footprint. So, since the market is constantly
Speaker 1: changing its mind as to how much a company is worth,
Speaker 1: you're constantly rebalancing contratrating against the market's most extravagant bets,
Speaker 1: and your biggest bets will be on the companies where
Speaker 1: the market is making the biggest bet. In the opposite direction,
Speaker 1: the companies that have soared the most. Game Stop swared
Speaker 1: tremendously this quarter on top of an already stupendous rise
Speaker 1: in two thousand twenty. So you'd look at that and say,
Speaker 1: if you owned it, which we did, we owned it
Speaker 1: as a value investment with a cost bay syst of
Speaker 1: around a little under four bucks share. If you owned it,
Speaker 1: you'd say, thanks for this great gain. The underlying fundamentals
Speaker 1: haven't changed. Let's take some profits and rebalance that rebalancing
Speaker 1: alpha is the dominant engine for incremental return, and that
Speaker 1: is not true of most of the strategies that currently
Speaker 1: carry the smart beta label. That's interesting that the pushback
Speaker 1: I've heard from the traditional market cap weighted index ers
Speaker 1: are on the on the one hand, you're selling stocks
Speaker 1: that have rallied and very well may continue to rally.
Speaker 1: If if you're rebalancing away from Amazon or Apple anytime
Speaker 1: over the past I don't know, twelve years, you know
Speaker 1: you saw the stock go higher. And on the other hands,
Speaker 1: on the cheap ends, you have a tendency to buy
Speaker 1: into the value traps, things that look cheap because they're
Speaker 1: in a spensive and still have revenues but aren't. What's
Speaker 1: the counter to that critique? That critique is absolutely correct.
Speaker 1: M Here's the deal, though, for every Amazon, there is UM,
Speaker 1: a company that is perceived as a disruptor that subsequently
Speaker 1: gets disrupted UM. Apple has been hugely successful in contratrating
Speaker 1: out of Apple has not been a good thing. But
Speaker 1: who came before Apple? UM? BlackBerry Palm. Palm was dominating
Speaker 1: the world of handheld communication devices back in the year
Speaker 1: two thousand when it was spun off from three com
Speaker 1: it's spun off at evaluation briefly greater than General Motors
Speaker 1: at the time of the spinoff. It was spun off
Speaker 1: from three com at a total market value larger than
Speaker 1: three comes market value before of the spinoff. Isn't that interesting?
Speaker 1: And um, of course it went to zero and BlackBerry
Speaker 1: disrupted Palms business. And then no sooner was BlackBerry dominance
Speaker 1: and world straddling on handheld communication devices than Apple came
Speaker 1: along with the iPhone and said hey, hey, this is
Speaker 1: a whole lot better, and so did the marketplace. So
Speaker 1: disruptors do get disrupted. And yes, we missed the boat
Speaker 1: on highly successful companies that go from strength to strength
Speaker 1: to strength until they don't. And on the down side,
Speaker 1: you do have value traps, you'll rebalance into them in
Speaker 1: theory all the way to zero, which is one reason
Speaker 1: you absolutely do not want to rebalance a fundamental index
Speaker 1: strategy daily, because then you'll just buy into the value
Speaker 1: traps all the way to zero. So there's two broad
Speaker 1: flavors of fundamental index. One rebalances annually, the other does
Speaker 1: what's called quarterly staggered rebalancing, which means every quarter you
Speaker 1: move one fourth of the way to your target weight.
Speaker 1: That way, you're going to be hurt by value traps
Speaker 1: only modestly, only occasionally. And for every value trap there
Speaker 1: are several companies that look cheap and in fact are
Speaker 1: so case in point two thousand nine trough of the
Speaker 1: financial crisis that the March two thousand nine rebalancing that
Speaker 1: took place in Fundamental Index um UH. We rebalanced to
Speaker 1: the economic footprint of businesses b of A and City.
Speaker 1: We're both um priced at a fraction of a percent
Speaker 1: of the market, and yet both of them were about
Speaker 1: two of the US economy measured in terms of of revenues, profits,
Speaker 1: book value, dividends and so forth. General Motors was about
Speaker 1: one percent of the economy and a tenth percent of
Speaker 1: the market. So we rebalanced into all three. We rebalanced
Speaker 1: back up to a one percent WAIT and GM and
Speaker 1: two percent each for the A in City and GM
Speaker 1: went to zero. In the next quarter went bust value trap.
Speaker 1: There went one percent of our portfolio. The two percent
Speaker 1: each in the of A in City tripled, so you
Speaker 1: wound up going from two to six in two stocks
Speaker 1: and from one to zero in a third stock. So
Speaker 1: the beauty of Fundamental Index is not that it has
Speaker 1: any special insights into what the fair value of a
Speaker 1: company is, but that it contra trades against the market's
Speaker 1: most extravagant bets, which often in the long run turn
Speaker 1: out to be wrong. People love to buy growth stocks
Speaker 1: because they've got a great, great story, But the right
Speaker 1: question to ask is not is this company a great company?
Speaker 1: If it's a growth stock, of course it's a great company.
Speaker 1: The question is how much good news is there in
Speaker 1: the future for this business that isn't already in the
Speaker 1: consensus opinion and already in the current price. Is there
Speaker 1: more likely to be downside surprise growth that is less
Speaker 1: extravagant than expected um, or upside surprise where lofty expectations
Speaker 1: are actually exceeded. Amazon is a beautiful example of a
Speaker 1: case where lofty expectations have been exceeded again and again
Speaker 1: and again, and at some point they won't be But
Speaker 1: who knows when it's a brilliantly run company with a
Speaker 1: brilliant product that is disrupting vast squaws of industry um.
Speaker 1: Kudos to Bezos and his team, But the price of
Speaker 1: the stock reflects an expectation that the growth of the
Speaker 1: last decade will persist in the next decade and that's
Speaker 1: a little dangerous. So you guys actually received a patent
Speaker 1: for this methodology of selecting securities and creating indexes. Um.
Speaker 1: Why a patent? What does that do for the firm?
Speaker 1: It's really kind of fascinating to see a financial methodology
Speaker 1: actually awarded a patent. Well, method patents are not new.
Speaker 1: They've been around for decades. UM. Uh early days of patents,
Speaker 1: it had to be something you could hold in your
Speaker 1: hand to be patented. UM. But over time, with the
Speaker 1: advent of computers and so forth. UM, the notion of
Speaker 1: method patents applied to UH, software methods, computer software methods, UH,
Speaker 1: even business methods if they were truly unique, truly different,
Speaker 1: and truly disruptive to an industry. Um, why shouldn't it
Speaker 1: be patent to Now? The issue that I think bears
Speaker 1: mentioned is we could be in the business of product
Speaker 1: innovation or in the business of patent litigation. UH which
Speaker 1: expertise do we have? The former not the latter. So
Speaker 1: I view the patents really as a stake in the
Speaker 1: ground to say to the financial services community, Hey, this
Speaker 1: is our idea, please respect it. Please UM license from
Speaker 1: us at modest fees if you want to use this idea,
Speaker 1: work around the patent if you want to explore something
Speaker 1: similar but different. Competition is a great thing, UM, And
Speaker 1: what we've found is the financial services community as a
Speaker 1: whole lot more um, honest, and has more integrity than
Speaker 1: its reputation. A few bad eggs in the financial services
Speaker 1: community tarnish the reputation of the whole community. So what
Speaker 1: we found is that there have been a handful of
Speaker 1: cases where somebody just took the idea and ran with it,
Speaker 1: and the vast majority of folks in the financial services community,
Speaker 1: if they liked the idea, they'll come to us and
Speaker 1: say we'd like to license it. And if they don't
Speaker 1: like the idea, they don't have to use it. So
Speaker 1: the patent is not so much a basis for going
Speaker 1: after people. It is a basis for saying, hey, please
Speaker 1: respect our space. Speaking for credit for respecting intellectual property.
Speaker 1: For a long time, I've heard you credited with creating
Speaker 1: the phrase smart data, UM, but you've described that as
Speaker 1: more something you've popularized and created. Give us a quick
Speaker 1: explanation of that. Sure, there's a consulting firm that works
Speaker 1: with some of the largest pension funds in the world
Speaker 1: called Towers Watson their London an office. UM coined the
Speaker 1: expression smart beta, and the idea was not that cap
Speaker 1: weighted index funds were stupid beta. The idea was that, um,
Speaker 1: the cap weighted index funds were a neutral form of beta.
Speaker 1: They called it bulk beta um UM. And the stupid
Speaker 1: beta is those who chase fads and load up just
Speaker 1: on whatever's gone up the most. And the phrase smart
Speaker 1: beta was attached initially just as strategies that broke the
Speaker 1: link with price, that would trim a stock if it's
Speaker 1: price went up and all else remained unchanged UM and
Speaker 1: so that included equal weighting equal waiting. Is about as
Speaker 1: simple as strategy as you can imagine. How could it
Speaker 1: be smart? Well, it's smart because it has embedded rebalancing,
Speaker 1: although it does have a profound small cap tilt that
Speaker 1: makes it less liquid and more expensive to trade. Fundamental
Speaker 1: index was the inspiration for the term smart beta, but
Speaker 1: I never invented the term. I liked it. I thought
Speaker 1: that's a clever way to label it. And then pretty
Speaker 1: soon everybody under the sun was saying, oh, we do
Speaker 1: smart beta. You had index calculators saying, hey, our growth
Speaker 1: and value indexes are both smart beta. No, they're both
Speaker 1: tied to the price of the stock. They're still cap weighted. Um.
Speaker 1: You had factor investors saying our value factor is smart beta. Well,
Speaker 1: that's true because it does contratrade. Our momentum factor is
Speaker 1: smart beta. No, that chases whatever has gone up the most.
Speaker 1: Our quality factor is smart data. No, that's going to
Speaker 1: load up on whatever is expensive. Also, so you had
Speaker 1: lots of organizations embrace the phrase because the phrase itself sells.
Speaker 1: It helps selling product. So I like the expression smart data,
Speaker 1: but I like its original definition. And if smart beta
Speaker 1: is applied to everything under the sun, smart ideas and
Speaker 1: stupid ideas, then the term ceases to mean anything. And
Speaker 1: I think that's where we are now. Rob you wrote
Speaker 1: a really fascinating peace with your team titled Big Market
Speaker 1: Delusions Electric Vehicles. I want to start with your definition
Speaker 1: of quote big market delusion. That's when all the firms
Speaker 1: in an evolving industry rise together even though their competitors,
Speaker 1: and ultimately some will win and some will lose. Why
Speaker 1: does it not make sense for investors to just own
Speaker 1: all of the basket of everybody in that space and
Speaker 1: eventually the market will self correct. The winners and the
Speaker 1: all outweigh the losers. Well, that is the basic definition
Speaker 1: of diversification. And it makes sense unless all of the
Speaker 1: firms in the industry are priced as if they will
Speaker 1: be outlier winners, because they won't. Um If if a
Speaker 1: company is priced as if it will achieve stupendous success,
Speaker 1: and it achieves its stupendous success, wonderful you did find
Speaker 1: you didn't get hurt by that. If five companies are
Speaker 1: all priced as if they're going to be stupendous successes
Speaker 1: and you know that only one or two of them will,
Speaker 1: then you've just bought a basket that collectively is destined
Speaker 1: to perform badly. The guy who coined the term big
Speaker 1: market delusion is Brad Cornell, past professor at U C
Speaker 1: l A and at cal Tech, and uh, it's an
Speaker 1: idea that's been around, but it's a great term to
Speaker 1: capture the concept. Back at the peak of the tech bubble,
Speaker 1: there were several of us, me Cliff Fastness, and probably
Speaker 1: dozens of others who pointed out that not all the
Speaker 1: tech companies will win, and they're all priced as if
Speaker 1: they will all win, so as a segment, they were
Speaker 1: collectively extravagantly overpriced. You can even have it on the
Speaker 1: other side and anti bubble like at the trough of
Speaker 1: the financial crisis, financial services companies were all priced based
Speaker 1: on the perceived risk of bankruptcy, and so they were
Speaker 1: priced as a call option on future survival. And yet
Speaker 1: with each company that failed that went out of business,
Speaker 1: the landscape was now cleared for the others to earn
Speaker 1: outsize profits in the subsequent economic rebounds. So big market
Speaker 1: delusion can play out in both directions. We singled out
Speaker 1: electric vehicles because at their peak during this last quarter,
Speaker 1: Tesla was priced at thirty four times its annual run
Speaker 1: rate sales UM. Now there's eight companies around the world
Speaker 1: that specialized in electric vehicles. Tesla was the second cheapest
Speaker 1: of the eight in terms of measured market value to
Speaker 1: prior year revenues. Thirty four times sales was second cheapest
Speaker 1: on the list. The others were ranged from uh The
Speaker 1: others ranged from about twenty times sales to literally ten
Speaker 1: thousand times sales. So when you have those kinds of valuations,
Speaker 1: the winners might might be worth their valuations, but the
Speaker 1: losers most assuredly won't. And that's the nature of big
Speaker 1: market delusion. I have no idea if Tesla will be
Speaker 1: worth its current price. I very much doubt it. But
Speaker 1: I have absolute confidence that the collective e V market
Speaker 1: is not worth its current price. Well, I know they've
Speaker 1: had offense pastic run ending um the in the research piece,
Speaker 1: you use January thirty one of this year to show
Speaker 1: how far all of these companies have have come. Um,
Speaker 1: are they remotely like? I'm thinking of the old days
Speaker 1: of biotech, where it was impossible to come up with
Speaker 1: evaluation because it was so binary. You would end up with, Hey,
Speaker 1: either this company develops a molecule that does what it's
Speaker 1: supposed to and then becomes a stupendent success, or it
Speaker 1: doesn't and it's a zero. Or should we be looking
Speaker 1: at these e V companies the same way. Either they're
Speaker 1: gonna put out a successful car and that's what jump
Speaker 1: starts them, or they're just expensive R and D shops
Speaker 1: for now and perhaps might be worth nothing. Well, the
Speaker 1: correct way to do the kind of analysis you're talking
Speaker 1: about is, if this company produces a disruptive product that
Speaker 1: massively changes the industry, what's it going to be worth
Speaker 1: and what are the odds that this will happen with
Speaker 1: this company as the dominant winner. The missing piece in
Speaker 1: a market. Big market delusion is that latter piece. If
Speaker 1: all of them are priced as if they have the
Speaker 1: potential to be massive successes, then you have a problem.
Speaker 1: And that's that's the issue we're dealing with Tesla. Is
Speaker 1: it is its current valuation too high or is it
Speaker 1: in bubble territory. One of the things that I think
Speaker 1: is interesting is everyone band these around the word bubble
Speaker 1: as if it has some clear meaning, and it doesn't.
Speaker 1: Usually it's used in retrospect after a bubble has burst.
Speaker 1: So we came up with a definition back in two
Speaker 1: thousand eighteen we that we think can be used in
Speaker 1: real time. And that definition is very simple. Um, if
Speaker 1: you're using a discounted cash flow model, you would have
Speaker 1: to make implausible assumptions about future growth to justify the
Speaker 1: current price. And second part of the definition just as important, Um,
Speaker 1: the marginal buyer has no interest in valuation models. Let's
Speaker 1: take Tesla as an example. We UH did a piece
Speaker 1: on Tesla last December as it was on its way
Speaker 1: into the SMP, and we had done an analysis where
Speaker 1: we assumed, let's let's say Tesla's book of business at
Speaker 1: sales grow fifty percent a year for the next ten years. Now,
Speaker 1: how plausible is that. Well, Amazon, the big winner of
Speaker 1: the two thousand tens, grew six percent a year over
Speaker 1: the decade ended two thousand twenty a year. That's enough
Speaker 1: to make a company eleven times as large in just
Speaker 1: ten years. Fifty sent a year makes a company fifty
Speaker 1: five times as large. So tacitly, we were assuming that
Speaker 1: Tesla would be five times as successful as Amazon over
Speaker 1: the coming decade versus Amazon over the last decade. All right,
Speaker 1: that's a pretty darned extravagant assumption. We then said, let's
Speaker 1: us further assume that Tesla is has a an after
Speaker 1: tax profit margin ten years from now. That is, that
Speaker 1: matches the highest after tax profit margin of any automaker
Speaker 1: in the world in the last decade. Well, there was
Speaker 1: one year when Toyota hit a ten after tax profit margin.
Speaker 1: So let's assume gross profit margin. Um well, that's pretty
Speaker 1: good profits. If you discounted that back to current prices,
Speaker 1: you could justify a price of fos tequ was twice that.
Speaker 1: So that's an example of um uh using a definition
Speaker 1: of bubble to test it in real time. Now, con
Speaker 1: Tesla wind up using other markets to justify the current price. Perhaps,
Speaker 1: but you're really dealing with some pretty extravagant assumptions. And
Speaker 1: the point of big market delusion wasn't that Tesla is
Speaker 1: a bubble poised to crash. I do think Tesla is
Speaker 1: an extravagantly overpriced company that will investors will be very
Speaker 1: lucky to have positive return over the next ten to
Speaker 1: twenty years, very lucky indeed. But the point of big
Speaker 1: market delusion is um if you look at the electric
Speaker 1: vehicle industry in aggregate, it's worth about eight percent as
Speaker 1: much as all other vehicle makers combined. And oh, by
Speaker 1: the way, over half of all electric vehicles are made
Speaker 1: by those other existing players who make conventional cars and
Speaker 1: electric cars. So the e V specialists comprise less than
Speaker 1: half of the EV market and have total valuation very
Speaker 1: nearly that of companies that collectively produced nearly a hundred
Speaker 1: times as many vehicles, a hundred times as many vehicles.
Speaker 1: You know what's so fascinating about that is how, after
Speaker 1: really taking their time, the traditional internal combustion engine car
Speaker 1: manufacturers have really ramped up their e V game. I
Speaker 1: had Afford Mustang for a week. I got to play
Speaker 1: with really a very nice, very well made car, good looking,
Speaker 1: very high quality, surprisingly high quality UM and in many
Speaker 1: ways way superior to not the software of Tesla, just
Speaker 1: the physical vehicle. The new Volkswagen I D four is
Speaker 1: getting really good reviews were and that's before we start
Speaker 1: talking about what's coming out of Mercedes and an Audi.
Speaker 1: Audi has a run of um RS cars that are
Speaker 1: very competitive, the same with the Porsche take in turbo
Speaker 1: as fast as cars that cost ten times as much.
Speaker 1: So I know the e V manufacturers are all battling
Speaker 1: amongst themselves, but there's a really strong case to be
Speaker 1: made that the future of electric vehicles is coming from
Speaker 1: the internal combustion group. I think that's exactly right UM
Speaker 1: when Volkswagen our Toyota decide, well, Toyota has been a
Speaker 1: pioneer UM in hybrid technology, which by definition means they've
Speaker 1: been a pioneer in electric vehicle technology UM for longer
Speaker 1: than Tesla has been in existence. So nobody's gonna deny
Speaker 1: that Tesla has been a massive disruptor, that Tesla has
Speaker 1: a big head start, and that Tesla has a surprisingly
Speaker 1: good product for a newbie automaker. But when Toyota decides
Speaker 1: to spend more on electric vehicle um uh innovation, then
Speaker 1: Tesla could plausibly take in as gross revenues over the
Speaker 1: coming three to five years and to do that every year.
Speaker 1: Um okay, Tesla is going to have some serious competition.
Speaker 1: So um. The whole notion of big market delusion is
Speaker 1: that people look at disruptors and say, these disruptors have
Speaker 1: the future in their sights, they know what's coming, their
Speaker 1: position for it beautifully, and they overlook the fact that
Speaker 1: disruptors get disrupted. It happens again and again and again.
Speaker 1: There's no doubt Tesla has a lead in things like
Speaker 1: over the air updates and autonomous driving and the supercharging network.
Speaker 1: But you already see companies like Lucid, which their new vehicle,
Speaker 1: the Air is coming out later this year, much longer range,
Speaker 1: much smaller electric motor. It's a midsize car on the outside,
Speaker 1: and the inside it's a full sized vehicle. Because they
Speaker 1: were able to miniaturize so many components. They really brought
Speaker 1: um a lot of impressive technology to the game, disrupting
Speaker 1: the disruptors. What does history tell us that's like? So
Speaker 1: you mentioned phones. What about other things like PCs or
Speaker 1: televisions or railroads? Is that historically consistent? The disruptive technologies
Speaker 1: themselves eventually gets disrupted. Oh, that happens again and again
Speaker 1: in industry after industry. It's hard to It's hard to
Speaker 1: come up with any industry where the disruptors weren't ultimately
Speaker 1: displaced by new disruptors. I mean, how many search engines
Speaker 1: did Google displace UM in its rise to to dominance
Speaker 1: of the search engine space? I read one study that
Speaker 1: said there were twenty six search engines that came and
Speaker 1: went with Google as the ultimate survivor. Will somebody disrupt Google?
Speaker 1: Who knows? UM? Is it priced to allow for the
Speaker 1: possibility that a disruptor will knock them from their perch. No,
Speaker 1: it's priced for the um expectation that that can't possibly happen,
Speaker 1: and and it could happen. UM. This is this is
Speaker 1: the achilles heel of growth and momentum investing that UH
Speaker 1: disruptors do get disrupted. I recall a couple of years
Speaker 1: ago you had done a study about the additions and
Speaker 1: deletions to various indexes, And it turns out, especially with
Speaker 1: the SMP five hundred. The companies that get added underperformed
Speaker 1: the companies they replace, and in Tesla's case, that would
Speaker 1: be Apartment Investment and Management. Uh, you guys are forecasting
Speaker 1: that this is going to outperform Tesla over the next one, five,
Speaker 1: ten years. What what do those numbers look like historically
Speaker 1: for additions and deletions. Well, just to be clear, we
Speaker 1: aren't forecasting that um uh that uh Tesla will underperform
Speaker 1: a I VUM by two thousand basis points. Were observing
Speaker 1: that historically that's been the norm, and so that's a
Speaker 1: little bit different. But um, the norm is that the
Speaker 1: companies that are added to the S and P five
Speaker 1: hundred underperformed by about two in the subsequent twelve months
Speaker 1: after they're added. Companies that are added and are already
Speaker 1: in the top one hundred by the time they're added
Speaker 1: underperformed by about seven over the coming year. Now, no
Speaker 1: company other than Tesla has ever been added which ranked
Speaker 1: in the top ten the day it was added. Um,
Speaker 1: and so one would assume, extrapolating from history, that its
Speaker 1: performance in the first year would be expected to be
Speaker 1: negative to an extent that's larger than those historic norms.
Speaker 1: The Companies that are dropped, on the other hand, usually
Speaker 1: are small, thinly traded, ill liquid, and they just get
Speaker 1: clawbered as they get removed. But they're underlying fundamentals usually
Speaker 1: are mediocre. That's why they're dropped, fully reflected in the
Speaker 1: price before they're dropped, and bludging down to unreasonable levels
Speaker 1: on the way out. And the result is the companies
Speaker 1: that are dropped from the SMP UH. And here we're
Speaker 1: excluding corporate actions. A company that's dropped from the SMP
Speaker 1: because it doesn't exist anymore doesn't count. But discretionary deletions
Speaker 1: like apartment investment in Management on average historically beat the
Speaker 1: SMP by over two thousand basis points UH in the
Speaker 1: first year after they're deleted. So that would suggest to
Speaker 1: us that based on history, Apartment Investment and Management would
Speaker 1: be expected to beat Tesla by maybe thirty percentage points
Speaker 1: in the first year after the change was made. Tesla's
Speaker 1: kind of a special case because everyone knew that SMP
Speaker 1: was going to have to add Tesla, and the Investment
Speaker 1: Committee of SMP just basically said, hey, we've got a rule.
Speaker 1: If you don't have profits for the last four quarters,
Speaker 1: we're not going to add you. And so in March
Speaker 1: of two thousand and twenty, I remember seeing speculation in
Speaker 1: the media that if the first quarter was profitable, Tesla
Speaker 1: would finally have four consecutive positive quarters UM and the
Speaker 1: S and P would have no choice but to add them,
Speaker 1: and that set Tesla off on a on a tear.
Speaker 1: So Tesla was up I think the number was six
Speaker 1: or seven hundred from its March lows until the decision
Speaker 1: was announced in November to add them uh and then
Speaker 1: up another or more from the announcement date to the
Speaker 1: actual inclusion in the index. Just astounding numbers because Tesla
Speaker 1: was a big company, big market cap company, and so
Speaker 1: the addition to the SMP meant that the market the
Speaker 1: index funds would have to buy upwards of two hundred
Speaker 1: billion dollars worth of the stock on that same day.
Speaker 1: And of course it's not that anyone didn't anticipate that
Speaker 1: hedge funds would load up on it in anticipation of
Speaker 1: flipping it to the index funds, and of course they did. UM.
Speaker 1: So additions and deletions to indexes have their own special
Speaker 1: characteristics and are very much disrupted. Continue to be amazed
Speaker 1: that academia hues to the notion that markets are efficient.
Speaker 1: Has anyone thought to put a long short fund together
Speaker 1: of these additions and deletions. It sounds like that's a
Speaker 1: potential alpha generator. I think it's a potential alpha generator.
Speaker 1: It's going to be a very niche oriented strategy because
Speaker 1: let's say there's let's say there's twenty changes in the
Speaker 1: index in a given year, You're gonna go long twenty
Speaker 1: very illiquid stocks just before they're dropped UM and short
Speaker 1: twenty very liquid, very popular stocks, uh, just as they
Speaker 1: get at it. So you're gonna wind up UM having
Speaker 1: a big short on large cap stocks and a big
Speaker 1: long on small cap stocks, a big short on growth stocks,
Speaker 1: a big long on value stocks, and a big short
Speaker 1: on highly liquid stocks, and big long on highly illiquid
Speaker 1: stocks in a lumpy, concentrated portfolio. So I think as
Speaker 1: part of a broad strategy it would be a fun
Speaker 1: thing to put together. As a standalone strategy, I think
Speaker 1: it would have a little too much risk for the
Speaker 1: tastes of most investors, to say the least. So let's
Speaker 1: talk a little bit about value. You wrote an interesting
Speaker 1: piece with your team titled Reports of Values. Death may
Speaker 1: be greatly exaggerated tell us about why value ain't dead yet. Well,
Speaker 1: whenever anything in the finance world is called dead, chances
Speaker 1: are it's it's about to come back to life. However,
Speaker 1: I would say that we've been hearing reports of values
Speaker 1: death for three or four years now, and so it
Speaker 1: sure took a long time to begin its recovery. UM.
Speaker 1: The narrative is growth stocks are better. Growth have better
Speaker 1: growth and better profit margins than they used to. Value
Speaker 1: stocks are more disrupted, and disruptors are getting better and
Speaker 1: faster at disrupting and just demolishing vast slaws of business UM,
Speaker 1: and so values really had its day and is not
Speaker 1: coming back. Well, why would value fail again? The narrative
Speaker 1: fills in the details. One of the core engines for
Speaker 1: the value factor is migration. A company that's in the
Speaker 1: growth segment falls out of favor, tumbles invaluation multiples, pulling
Speaker 1: down the performance of the growth portfolio, and then it's
Speaker 1: kicked out and replaced with a new high flyer. UM.
Speaker 1: A company is um on the values side turns out
Speaker 1: not to be facing as severe headwinds as people feared,
Speaker 1: so it's valuation multiple sore, and then it's replaced with
Speaker 1: a new, deeply unloved value company. So you get this
Speaker 1: constant rotation for growth, underperforming out for value, outperform, and out,
Speaker 1: and that's the dominant engine for the value factor. It's
Speaker 1: largely offset but not entirely offset by the main profit
Speaker 1: engine for growth, which is the companies are growing faster,
Speaker 1: they're more profitable, they're better companies. Of course they are.
Speaker 1: That's why they have the higher multiples. And so if
Speaker 1: in an efficient market, the benefit of growth should pretty
Speaker 1: much exactly offset the benefits for value from its migration
Speaker 1: from its rotation. Now the narrative is um that that
Speaker 1: rotation is slowing and the difference in quality between growth
Speaker 1: and value stocks has widened. There's truth in that narrative.
Speaker 1: There's truth and most narratives. The migration has been slowing,
Speaker 1: but not by much. The differential in profit margins for
Speaker 1: growth versus value has widened, but not by much. And
Speaker 1: so one of the shocking findings was that during the
Speaker 1: worst period for value investing in history, a period of
Speaker 1: time when if you're using price to book to define value,
Speaker 1: value underperformed growth by fifty nine percentage points over a
Speaker 1: thirteen year span, just horrific underperformance. How much of that
Speaker 1: came from value falling out of favor and becoming cheaper
Speaker 1: relative to growth. Well, it turns out well over the
Speaker 1: under performance was value getting cheaper, not value companies under performing.
Speaker 1: So what we found was that the relative cheapness of
Speaker 1: value went from being one fourth as expensive as value
Speaker 1: as growth to one twelfth is expensive in that thirteen
Speaker 1: year span. That means that value cheapness fell by sixty
Speaker 1: seven percent while its performance fell by Okay, that sounds
Speaker 1: like a subtle nuance, but what it means is that
Speaker 1: if the relative valuation hadn't moved, value would have beak
Speaker 1: growth again in the last thirteen years and again in
Speaker 1: the last three years during the really dreadful meltdown for value.
Speaker 1: If you've got a stock that has fallen by sixty
Speaker 1: or fifty or six, but it's pe ratio has fallen
Speaker 1: by sixty or sevent do you look at that and say,
Speaker 1: get me out of here, I can't stand the pain.
Speaker 1: Or do you look at that and say, I can't
Speaker 1: believe it's this cheap, Let me buy it. I leaned
Speaker 1: towards the latter interpretation. Now, the second nuance in the
Speaker 1: paper that I think is very important is that price
Speaker 1: to book is the worst measure for defining value. If
Speaker 1: you use price earnings ratios, the peak wasn't back in
Speaker 1: two thousand seven. The peak was in two thousand fourteen.
Speaker 1: If you use price to sales, it was two thousand seventeen.
Speaker 1: If you use fundamental index to cap weight our strategy,
Speaker 1: it was two thousand seventeen. It makes a big difference
Speaker 1: between whether you've got a thirteen and a half year
Speaker 1: dry spell where values underperforming and a three and a
Speaker 1: half year dry spell. The former is really hard to
Speaker 1: stay the course. The latter is less. So so I
Speaker 1: look at UH price to book as a terrible measure,
Speaker 1: and we, in fact, in that same paper dive into
Speaker 1: that and show that price to book that book value
Speaker 1: itself misses all the intangibles we've heard. We've all heard
Speaker 1: the cliche that our assets go up and down in
Speaker 1: the elevator every day. Well, that is true of bigger
Speaker 1: and bigger swaws of the US economy or the world economy.
Speaker 1: Then used to be the case. So we found that intangibles, Uh,
Speaker 1: we're about as large as tangible book value fifty years ago,
Speaker 1: and now it's as large. Means book value would double,
Speaker 1: literally double, if you include intangibles. We also did a
Speaker 1: test and found that if you use price to book
Speaker 1: value where you adjust the book value for intangibles, Firstly,
Speaker 1: the performance of the price to book value factor is
Speaker 1: twice as good over that last fifty seven years as
Speaker 1: it was without um adjusting for intangibles UM. And again
Speaker 1: the peak was two thousand and fourteen, not two thousand seven.
Speaker 1: So it works much better if you take account of intangibles.
Speaker 1: But price to book is not the only measure. It's
Speaker 1: not even by a long shot, the best measure, huh
Speaker 1: and Rob. When we're talking about things like intangibles, we're
Speaker 1: referring to things like patents, copyrights, processes, methodologies, things that
Speaker 1: just don't show up in the traditional Hey, here's our factories,
Speaker 1: here's our headquarters, those sort of measures of book value.
Speaker 1: That's exactly right, quite interesting. So for value to start
Speaker 1: generatinging that value premium again, what has to happen? Do
Speaker 1: we need to see mean reversion against growth? Do rates
Speaker 1: have to tick up, or do we need to see
Speaker 1: a recession? What's going to be the the thing that
Speaker 1: could kick off value reclaiming it's premium. Well, We've already
Speaker 1: had that recession last year, and it was a doozy um.
Speaker 1: The narrative was, and again, narratives are always based on
Speaker 1: some measure of fact. The problem with narratives and investing
Speaker 1: is that they move prices much too far. The narrative
Speaker 1: was that the growth companies are beautifully positioned for a
Speaker 1: COVID world and a post COVID world. True. The narrative was,
Speaker 1: value stocks have much higher risk of bankruptcy, and in
Speaker 1: the face of the COVID crisis, especially the business lockdowns,
Speaker 1: is going to be sweeping bankruptcies. True. Now, what was
Speaker 1: overlooked was almost all of those bankruptcy we're in companies
Speaker 1: that were too small to be publicly traded. So there
Speaker 1: were literally millions of companies that went out of business
Speaker 1: last year, but shockingly few of the thirty million businesses
Speaker 1: in the US, only thirty five hundred are publicly traded.
Speaker 1: And of those thirty five hundred, let's say twenty or
Speaker 1: value stocks, shockingly few went out of business as a
Speaker 1: consequence of the lockdowns. So all you needed was for
Speaker 1: people to realize ge uh, these value companies didn't fail.
Speaker 1: Maybe I should now start pricing it not based on
Speaker 1: bankruptcy risk, but based on its likely future P and L,
Speaker 1: and all of a sudden, the turn happened at the
Speaker 1: beginning of September, just when people were starting to realize, hey,
Speaker 1: vaccines are about to be rolled out. Uh, this is
Speaker 1: looking promising as an end to the crisis. And a
Speaker 1: lot of these value companies are just not going to
Speaker 1: go bust, so maybe I should reprice them for their
Speaker 1: future success. And we've seen that in in energy stocks
Speaker 1: and cyclicals, in bank stocks that rotation away from growth,
Speaker 1: a lot of which were worked from home stocks and
Speaker 1: towards traditional economic early cycle recovery stocks. That seems to
Speaker 1: be really moving along unless I'm I'm seeing it wrong.
Speaker 1: What what are your thoughts on that? I think that's
Speaker 1: exactly right. Um. We did a test looking at draw
Speaker 1: downs um when value underperformance growth, and it ranges from
Speaker 1: you know what, one month value underperforms growth by half
Speaker 1: a percent, so that's a half percent draw down from
Speaker 1: the last peak and thirteen years underperformance by fifty nine
Speaker 1: percentage points. We asked the question, historically, is there a
Speaker 1: link between the magnitude of the draw down and the
Speaker 1: magnitude of values out performance? In the subsequent two years,
Speaker 1: and we found that when when value has underperformed by
Speaker 1: more than three thousand basis points, it has no examples
Speaker 1: historically of sailing to outperform over the next two years,
Speaker 1: with an average outcome between four and five thousand basis
Speaker 1: points about performance. So, when you see the nature of
Speaker 1: that particular relationship, extrapolating to the current size of the
Speaker 1: draw down um uh. And extrapolating is always dangerous. But
Speaker 1: if past is prologue, and if extrapolating that relationship to
Speaker 1: today's unprecedented draw down works, then value would be expected
Speaker 1: to outperform growth by over one hundred percentage points over
Speaker 1: the next two years. You know, if it's a third
Speaker 1: of that, I'll be thrilled, to say the very least.
Speaker 1: Let's talk a little it about yields and inflation. We've
Speaker 1: been hearing a lot of chatter about yield starting to
Speaker 1: tick up higher from admittedly low historical levels. Does this
Speaker 1: have any meaning for value, stocks or the market as
Speaker 1: a whole? What what should we take away about rising yields? Well, firstly,
Speaker 1: it bears mentioned that yields are not well correlated with
Speaker 1: the stock market. The stock market um has stocks and
Speaker 1: bonds tend to have a negative correlation except during inflationary
Speaker 1: times when inflation is rising or is materially elevated. And
Speaker 1: so what we find is that it's a poor linkage.
Speaker 1: But but um, again, the narrative is low rates justify
Speaker 1: high valuation multiples and justify a bigger spread between orowth
Speaker 1: and value than historic norms because growth stocks are going
Speaker 1: to grow for a long time, and if you're discounting
Speaker 1: at a very low rate, that future growth is more
Speaker 1: valuable than it was at a high rate. Okay, it
Speaker 1: makes intuitive sense. Going back over long periods of time
Speaker 1: in history, you still you find lots of anomalies. Okay,
Speaker 1: in the early fifties when interest rates were not too
Speaker 1: much above current levels, um, what was the average valuation
Speaker 1: multiple for the market, It was a third what it
Speaker 1: is today. What was the average spread between growth and value?
Speaker 1: It was a fraction of what it is today. So
Speaker 1: and when you look at um non US markets, European
Speaker 1: and Japanese markets in particular, where rates are zero, you
Speaker 1: find valuations are not as elevated as in the US.
Speaker 1: If the rates are even lower, why not that the
Speaker 1: spread between growth and value is not as wide? As
Speaker 1: the U. If the rates are lower, why not. But
Speaker 1: a narrative can drive markets, and so the rising interest
Speaker 1: rates I think has a lot to do with the
Speaker 1: recent underperformance of fang stocks and the recent performance of
Speaker 1: value stocks. UH. Basically, the rumor that this might happen
Speaker 1: becomes a self fulfilling prophecy on a short term basis.
Speaker 1: On a long term basis, I don't think the linkage
Speaker 1: is all that useful or interesting. And I assume the
Speaker 1: same goes for inflation and inflation expectations or or does
Speaker 1: that result in a different outcome that's a little bit different.
Speaker 1: Rising inflation UH clearly does horrible things for bonds and
Speaker 1: also UM increases investors risk aversion inequities, so when stocks
Speaker 1: are expensive, rising inflation has a nasty impact. So the
Speaker 1: real question is UH, is the current increasing rate of
Speaker 1: inflation a temporary consequence of deflationary pressures twelve months ago
Speaker 1: and a snap back in pricing over the last twelve months,
Speaker 1: or is it a sustained consequence of UM Today's central
Speaker 1: bank and fiscal policies around the world which looked to
Speaker 1: all the world to me like a full wholehearted embrace
Speaker 1: of modern monetary theory, So let me ask that question. Now, deficits,
Speaker 1: as far as the eye can see, it doesn't matter
Speaker 1: if it's a Democrat or Republican in the White House.
Speaker 1: Either it's tax cut and spend or tax I can spend.
Speaker 1: But we've seen nothing but deficits were my entire at
Speaker 1: out life with a couple of I think in or
Speaker 1: we had a balanced budget for a year or so.
Speaker 1: What is What is the rise of modern monetary theory
Speaker 1: mean for markets? Well, modern monetary theory is a little
Speaker 1: bit like Caynesianism on steroids. Canes basically said, Hey, you
Speaker 1: can spend more money than you're taking in in taxes,
Speaker 1: and you need to during an economic downturn. Then you
Speaker 1: cut your deficit spending when the economy recovers because the
Speaker 1: money the spending isn't as needed and you can run
Speaker 1: a surplus to pay back the increase in the debt. Well,
Speaker 1: that's gone right out of the window. I think Canes
Speaker 1: would be horrified at current economic theory and practice. Modern
Speaker 1: monetary theory takes it another step, basically saying, um, central
Speaker 1: bank can print whatever money the policy elite wants to spend,
Speaker 1: as long as that spending goes to increase employment and
Speaker 1: therefore to increase future revenues to pay this act. Um. Okay,
Speaker 1: as you said, it's it's um um not sensitive to
Speaker 1: who's in the White House. Uh. I joked last year
Speaker 1: in the run up to the election, when people would
Speaker 1: ask about the election, I said, Look, we have an
Speaker 1: incredibly important choice ahead of us. We have a choice
Speaker 1: between somebody who will run two trillion dollar deficits as
Speaker 1: far as the eye can see in somebody who will
Speaker 1: run three trillion dollar deficits as far as the eye
Speaker 1: can see. I may have heard on the downside on
Speaker 1: that latter one, but to say any of the least. Yeah.
Speaker 1: In any event, the usual immediate question was yes, but
Speaker 1: who is who, to which I would reply exactly. So
Speaker 1: let's both both parties have embraced MMT. Yeah, it certainly
Speaker 1: seems that way. Let's let's stick with the topic of
Speaker 1: recessions and recoveries. I am a big fan of Campbell Harvey,
Speaker 1: an academic who is now a part of the team
Speaker 1: at Research Affiliates. When when did Campbell Harvey join Raffie
Speaker 1: and what does he do? I'm a huge fan of
Speaker 1: his work. Um, I'm a huge fan too. We we
Speaker 1: kept inviting him to join our advisory panel, which used
Speaker 1: to meet once a year UM, where we would gather
Speaker 1: notable academics, usually including a couple of Nobel laureates together
Speaker 1: to pose big picture questions. Not where should people invest
Speaker 1: today or what strategies and products should we look at
Speaker 1: developing tomorrow? UM, but how is the world going to
Speaker 1: change in the coming ten years? And uh uh he
Speaker 1: joined our advisory panel two or three times, but he
Speaker 1: was always committed to work for the folks at Man Group.
Speaker 1: And as soon as Pimco UM recruited Manny Roman to
Speaker 1: become their new CEO. Turns out Manny had not only
Speaker 1: hired Cam Harvey also went to university with Cam Harvey
Speaker 1: and uh they were very good friends. So UM uh
Speaker 1: with UM, with the help of Manny, we went to
Speaker 1: Cam and said, hey, why don't you UM join us
Speaker 1: in a more formal relationship. And so we're his dominant
Speaker 1: consulting relationship. We have access to a certain uh portion
Speaker 1: of his time. Uh. He is the guiding light for
Speaker 1: our R and D. He's already led some half breaking
Speaker 1: work in UM what's called pears trading. And when you
Speaker 1: mentioned that you're a big fan of his work. One
Speaker 1: of the things I find fascinating is, unlike most academics,
Speaker 1: his work is squarely focused on what's practical, what's useful,
Speaker 1: and in modern academic finance, practical and useful are two
Speaker 1: of the most damning things you can say about somebody's work.
Speaker 1: If it's practical, oh my goodness, what use are they
Speaker 1: in academia? Uh? Well, I love that about camp. He's
Speaker 1: um uh tremendous innovator, deep thinker, and has been an
Speaker 1: enormously important addition to our team. Let me ask about
Speaker 1: another one of your team members, your colleague Alex Picard,
Speaker 1: who wrote a fascinating piece um about bitcoin. And I
Speaker 1: thought this was really intriguing. So many people are sort
Speaker 1: of dancing around bitcoin given the run up they're they're
Speaker 1: afraid to get in the way of it. Picard road quote,
Speaker 1: Bitcoin is not a capital asset or a store of value.
Speaker 1: The price of BTC is nearly certainly a bubble and
Speaker 1: likely manipulated. What are your thoughts on that? Well, firstly,
Speaker 1: you're asking the wrong guy, um um bitcoin. How do
Speaker 1: you value using discounted cash flow? How do you value
Speaker 1: something that has no cash flow and never will um.
Speaker 1: In that sense, it's no about no different from a
Speaker 1: dollar bill. A dollar bill has has a value, but
Speaker 1: discount of cash flow it doesn't have any. So the
Speaker 1: price of bitcoin and the price of the US dollar
Speaker 1: is exactly what the consensus in the marketplace thinks it
Speaker 1: ought to be worth. In the case of the dollar,
Speaker 1: that moves slowly and sadly inexorably in the direction of
Speaker 1: worth less and less. Uh, it's worth on the order
Speaker 1: of one d when it was worse worse worth a
Speaker 1: century ago. In terms of purchasing power, UM. Bitcoin seems
Speaker 1: to move the opposite direction. But in both cases there
Speaker 1: is no There is no measurable value. There is no
Speaker 1: way to say this is worth that amount. UM. So
Speaker 1: when Alex says bitcoin is near certainly a bubble and
Speaker 1: likely manipulated, my response to that is yeah, I agree.
Speaker 1: But the reason I say I'm the wrong person to
Speaker 1: ask is that, unlike Alex, Uh, I never bought much
Speaker 1: in the way of bitcoin. I think it was back
Speaker 1: in two thousand fifteen, I bought one bitcoin just as
Speaker 1: an item of curiosity to watch it, and um, I
Speaker 1: missed that entire boat. UM. I do think bitcoin is
Speaker 1: a speculative asset. People talk about it as a replacement
Speaker 1: for fiad currency because the supply is strictly limited and
Speaker 1: is capped at a level that is not that much
Speaker 1: larger than today's out standing float. And they're right, but
Speaker 1: occurrence a fiat currency is used as a mechanism for
Speaker 1: exchange of goods and services and a store of value
Speaker 1: across time too, and it can't be a store of
Speaker 1: value if it's price PO goes around. That's a problem
Speaker 1: with bitcoin. It can't be a means of transacting UM
Speaker 1: buying and selling goods and services because transacting in bitcoin
Speaker 1: has very large transaction costs, so it can't be a
Speaker 1: replacement for fiat currency. And as as such UM I
Speaker 1: wouldn't own it. But hey, my son a year and
Speaker 1: a half ago bought a UM, put his money half
Speaker 1: in Tesla and half in bitcoin, and at the end
Speaker 1: of last year sent me his statement which was up,
Speaker 1: and asked me, how do you do Dad? So I
Speaker 1: have to addend to being having been dead wrong on
Speaker 1: both for a while. Now that's pretty funny. Let's talk
Speaker 1: about e s G for a moment. Some people have
Speaker 1: been making the case e s G environmental, social, and
Speaker 1: governmental styles of investing are a factor. You make the
Speaker 1: case that it's more of a theme ben a factor.
Speaker 1: Please explain that what's the difference? Sure? Sure? Um? A
Speaker 1: theme A factor is something that can be clearly defined
Speaker 1: where the stocks um on the one side of the
Speaker 1: factor uh and the stocks on the other side of
Speaker 1: the factor strongly correlate with members of that same cohort,
Speaker 1: So growth versus value. Growth stocks correlate with one another.
Speaker 1: Value stocks correlate with one another, and the difference in
Speaker 1: performance has historically favored value and does so for a
Speaker 1: reason that you can reasonably explain. E S g um.
Speaker 1: One of my colleagues did a test where he looked
Speaker 1: at a half dozen different vendors of E s G
Speaker 1: product at their definitions of what is an E s
Speaker 1: g um, how an E s G score is calculated
Speaker 1: for each company, and found that the correlation between s
Speaker 1: G definitions is shockingly not low, not that much above zero.
Speaker 1: So my E s G and R s G are
Speaker 1: likely to be very, very different. It's hard to create
Speaker 1: a factor when that's the case. I think is also
Speaker 1: interesting and a little disturbing. Is it used to be
Speaker 1: called s R I UH Socially response investing. And back
Speaker 1: then the narrative was you want to invest in ways
Speaker 1: that align with your values, with your principles UM, and
Speaker 1: you can do so with a portfolio that's going to
Speaker 1: perform reasonably in line with the broad market. UM. Don't
Speaker 1: expect to win with SRI investing, but don't expect to
Speaker 1: give up much either. That narrative has shifted now. It
Speaker 1: is with the s G investing. You can invest in
Speaker 1: line with your principles, and as more and more people
Speaker 1: shift over to E s G investing, you get a
Speaker 1: tail wind and you will outperform as well as UM.
Speaker 1: Aligning your investments with your principles, you you do well
Speaker 1: by doing good. In fact, you do better than the market. UM. Well,
Speaker 1: that narrative offends me because any time you you narrow
Speaker 1: your opportunity set UM in theory, you shouldn't be boosting
Speaker 1: your performance. You should be degrading it. And you'd be
Speaker 1: boosting your performance only if E s G stocks were
Speaker 1: inherently superior. I have no problem with the s G.
Speaker 1: I have a problem with marketing it as a superior
Speaker 1: source of higher investment performance UM, and so I look
Speaker 1: at E s G as a major trend in the marketplace,
Speaker 1: one that must not be ignored. One that indeed, we
Speaker 1: have offered product to help people invest in E s
Speaker 1: G in a fundamental index fashion that can beat the
Speaker 1: market because of fundamental index, not because of E s G,
Speaker 1: and we're pretty proud of that. But E s G
Speaker 1: stocks are trading at a large premium. That raises a
Speaker 1: really interesting question. And you've touched on this in three
Speaker 1: separate groups of assets. One was domestically higher price. US
Speaker 1: stocks are trading pretty well, especially compared to Europe and Japan.
Speaker 1: Bitcoin there remains a firm bid beneath that that's doing well.
Speaker 1: And now E s G as a potential telwin was
Speaker 1: the phrase you used, which really raises the question for
Speaker 1: all of these tradeable assets. Is it simply a function
Speaker 1: of demand and supply if enough people want to buy something,
Speaker 1: regardless evaluation. Arguably, we've seen elevated pe multiples in the
Speaker 1: United States, especially if we use the Schiller Cape index
Speaker 1: since the early nineties. At what what point is it
Speaker 1: strictly more dollars chasing fewer shares or coins, and that
Speaker 1: relative imbalance causes prices to go higher and higher. Well,
Speaker 1: what you've described as the nature of a bubble. Bubbles
Speaker 1: persist longer and can go further than anyone could possibly imagine.
Speaker 1: My favorite example is Zimbabwe stocks, which during the summer
Speaker 1: of two thousand eight, when the currency was first going
Speaker 1: into free fall. Let's split the summer into first half
Speaker 1: and second half of the summer. First half of the
Speaker 1: summer the currency fell um Uh fell tenfold in purchasing
Speaker 1: power in just six weeks, and Uh the Zimbabwe stock
Speaker 1: market rose five hundred fold, not five five hundred fold,
Speaker 1: five hundred times the price adjusted for the currency, it
Speaker 1: rose fiftyfold, meaning that if you thought this market's over
Speaker 1: priced and the currency has headed for a cliff, and
Speaker 1: get me the heck out of there. Um. In fact,
Speaker 1: I'm going to make a modest short position at two
Speaker 1: short position, those six weeks would have wiped you out.
Speaker 1: You would be bankrupt, um because they two short position
Speaker 1: went up fifty fold. Okay, well that's daunting. What happened
Speaker 1: in the next eight weeks the currency fell another hundredfold
Speaker 1: in the stock market basically went to zero. So you
Speaker 1: were right over the next quarter, but bankrupt. So be
Speaker 1: very careful when dealing with bubble assets. Do not bet
Speaker 1: against them. In any material way, but that doesn't mean
Speaker 1: you necessarily want to hold them. Very interesting. I know
Speaker 1: that you're a fan of motorcycles, and a couple of
Speaker 1: years ago they were described as underpowered toys. But there
Speaker 1: was a really interesting Hannah Elliott column and Bloomberg about
Speaker 1: the e V market for motorcycles is surging with exciting
Speaker 1: new possibilities, including some powerful bikes. What are you driving
Speaker 1: these days? What are you riding these days? And would
Speaker 1: you ever consider an electric bike? Well? I absolutely would
Speaker 1: consider an electric bike. The problem with electric bikes today,
Speaker 1: and this isn't a problem with cars, UM, is weight.
Speaker 1: I mean, if you if you have a thousand pounds
Speaker 1: battery in a car, um, so what if you have
Speaker 1: a hundred pound battery on a motorcycle? That's a big deal.
Speaker 1: And uh so it disrupts the handling and the range
Speaker 1: is problematic. Um. In other words, I think electric cars
Speaker 1: are already at a point where they are practicable and
Speaker 1: useful for anyone other than long distance driving. UM. And
Speaker 1: with motorcycles that's just not true. UM. I'm old enough
Speaker 1: at this stage that I don't really ride that much.
Speaker 1: I've been in Florida, um all of this year to date.
Speaker 1: Last time I was out of Florida was last October UM,
Speaker 1: and I won't ride in Florida, so I haven't written
Speaker 1: this year yet. Um. But bottom line is, electric vehicles
Speaker 1: are here to stay. Electric motorcycles are coming. It's just
Speaker 1: that the technology isn't there yet. Uh Uh. That said,
Speaker 1: they are blindingly fast. I was looking at the arc
Speaker 1: vector and that thing is a bolt of lightning. Literally,
Speaker 1: it's quite fascinating. So let me ask you a different
Speaker 1: automobile question. I'm not a car collector. I'm a driver.
Speaker 1: I don't understand people who buy sneakers and don't wear them.
Speaker 1: Sneakers are for wearing cars for driving. That said, I'm
Speaker 1: kind of fascinated with the thought of all of these
Speaker 1: collectible internal combustion engine vehicles. What happens to that market
Speaker 1: in thirty or fifty years. Will there still be people
Speaker 1: who can repair them, rebuild them, renovate them, or is
Speaker 1: this market, you know, on a on a short timeline. Well,
Speaker 1: short answer would be, of course there will be people
Speaker 1: who can repair them. Um. There's there's a market for
Speaker 1: anything that any that has enough customers that are interested.
Speaker 1: And uh, I do you think twenty years from now,
Speaker 1: electric vehicles will utterly dominate the roads, and that self
Speaker 1: driven cars, cars that a human being drives, will probably
Speaker 1: be illegal because we'd be we'd be a threat. Um. Um,
Speaker 1: autonomous cars are going to be electric. Um. Can you
Speaker 1: imagine an autonomous car going to a gas station and
Speaker 1: saying fill her up versus just going to a recharging
Speaker 1: station and plugging itself in the ladder is very easy.
Speaker 1: Uh So with autonomous cars, you're going to have electric
Speaker 1: vehicles utterly dominant. That means that today's collectible cars, almost
Speaker 1: all of them conventionally and powered, are going to be
Speaker 1: an anachronism and have no practical value. They'll have collector value,
Speaker 1: and there will be races where people take Ferraris and whatnot.
Speaker 1: Whether I think that means is, if you've got a
Speaker 1: Chevy um, it's going to be uh pretty pretty much
Speaker 1: worthless in ten to twenty years. If you've got a Ferrari,
Speaker 1: it'll have collector value. And um, okay, that's the nature
Speaker 1: of a changing marketplace. Huh. Quite quite interesting. What are
Speaker 1: you streaming these days? Tell us your favorite Netflix or
Speaker 1: Amazon Prime show or whatever podcast you might be enjoying. Sure,
Speaker 1: my wife is Russian and so one of the things
Speaker 1: we love to do is is find an obscure Russian
Speaker 1: film or an obscure UH Russian TV series where she
Speaker 1: watches in the original language and I read the subtitles.
Speaker 1: Um Uh. There's a UM Russian crime series from two
Speaker 1: thousand fifteen called The Method, which is about a fellow
Speaker 1: who solves crimes using all kinds of illegal methods to
Speaker 1: find and take take down the bad guys and a
Speaker 1: woman who um becomes more or less his apprentice, and
Speaker 1: ultimately his health is not very good. Um, so she
Speaker 1: really is his prospective replacement. And uh it ran for
Speaker 1: I think two seasons, and it was great fun to
Speaker 1: binge watch. It's called The Method. Uh. Fantastic actress. She
Speaker 1: also appeared in a later UH TV series called Better
Speaker 1: than Us, in which she placed played the role of
Speaker 1: a robot that was able to have emotions and able
Speaker 1: to think and feel and um, therefore better than us.
Speaker 1: So anyway, too, wonderful Russian series. Very interesting. Tell us
Speaker 1: about your mentors who helped to shape your career. Oh gosh,
Speaker 1: there were so many of them. Um um um. Jack
Speaker 1: Bogel was a mentor. UM. Harry mark Owitz was and
Speaker 1: still is a mentor. Um. Peter Bernstein was a giant
Speaker 1: in shaping who I am and how I think about investing.
Speaker 1: Bill Sharp. The list goes on and on. Um. Basically,
Speaker 1: I look to anyone, uh uh. And I still do this.
Speaker 1: I mean, I think it's fair to say I still
Speaker 1: have mentors, but I look to anyone who has insights
Speaker 1: that are interesting that I can learn from, and who
Speaker 1: has ways of approaching the business that I can emulate
Speaker 1: and seek to build. Very interesting. Let's talk about books.
Speaker 1: What are some of your favorites and what are you
Speaker 1: reading right now? Oh, there's a fun book that I
Speaker 1: had last week called ten ten Trends that every smart
Speaker 1: person should know. It's an extremely fast read. Uh. It's
Speaker 1: extremely simple, and basically it looks at you know, the
Speaker 1: narrative is, look how many things are going wrong with
Speaker 1: the world, And this one just turns that on its
Speaker 1: head and says, look at how many things are going
Speaker 1: right with the world. Life expectancy up um, the subsistence
Speaker 1: poverty was something like the world population uh thirty years ago,
Speaker 1: and it's dropped from eight um. And so it goes
Speaker 1: through a whole series of trends and basically poses the question, Hey,
Speaker 1: why why is everybody um so quick to criticize how
Speaker 1: the world is? The world has its flaws, but it's
Speaker 1: way better than it has ever been in human history,
Speaker 1: and I thought it was just a marvelous piece. Another
Speaker 1: that I I love that I finished about six or
Speaker 1: eight months ago was four and four Two Big Tones,
Speaker 1: detailing how the Western world looked before Columbus and how
Speaker 1: the advent of global trade um U in the aftermath
Speaker 1: of Columbus has reshaped the world and reshaped opportunities the
Speaker 1: world over. Those are three really cool books that I
Speaker 1: would heartily recommend. Very interesting. Let's talk about some advice
Speaker 1: for a recent college grad if they were interested in
Speaker 1: a career in finance. What sort of advice would you
Speaker 1: give them? Oh, my advice would be very very simple.
Speaker 1: Whatever you're taught from whoever teaches it to you, ask
Speaker 1: the question, um, is this true? Have people tested it?
Speaker 1: And um um? I think I could credit my career
Speaker 1: too the notion that uh. Basically I always asked the question,
Speaker 1: has somebody tested this? If there's a bit of conventional
Speaker 1: wisdom floating around, I love to test it, and half
Speaker 1: the time I find it's absolutely correct, and half the
Speaker 1: time I find that it's absolutely false. And it's in
Speaker 1: that latter category where something is widely believed but false,
Speaker 1: that profit opportunities can be found. So be skeptical. These
Speaker 1: skeptical ask, and if you have access to the data,
Speaker 1: test it very interesting. And our final question, what do
Speaker 1: you know about the world of investing today that you
Speaker 1: wish you knew thirty or forty years ago when you
Speaker 1: were first getting started. Yeah? Um uh, that's that's an
Speaker 1: easy one. Thirty or forty years ago, I was doing
Speaker 1: that stuff, testing conventional wisdom, often finding it to be wrong,
Speaker 1: and then publishing my results and having expecting people to say, Wow,
Speaker 1: this is cool, and instead the reaction was very, very often,
Speaker 1: how dare you? How dare you challenge? Um? What we
Speaker 1: know to be true? Um? And uh. I wrote a
Speaker 1: piece in two thousand entitled Death of the Risk Premium,
Speaker 1: and about five years later met a guy at a
Speaker 1: conference and asked him how things were going, and he said,
Speaker 1: all things are going finally. Oh, by the way, I
Speaker 1: no longer hate you. And I said what you said?
Speaker 1: You wrote Death of the Risk Premium. You challenged everything
Speaker 1: I believed in investing, and I hated you for that.
Speaker 1: I now realize you were right. Um, So thirty years ago,
Speaker 1: I used to be really disappointed when my work angered people.
Speaker 1: Now I just shrug it off. It's it's a given.
Speaker 1: If you up end somebody's worldview, they're going to be
Speaker 1: angry because they've built their career on the basis of
Speaker 1: a premise that you just demonstrated was wrong. Of course
Speaker 1: they're going to be angry, and so I roll with criticism.
Speaker 1: I'm almost amused by criticism these days, where thirty years
Speaker 1: ago it just um, I was things skin and it
Speaker 1: really hurt. Well, Rob, thank you for being so generous
Speaker 1: with your time. This has been really fascinating. We have
Speaker 1: been speaking with Rob are Not. He is the founder
Speaker 1: and chairman of Research Affiliates. If you enjoy this conversation,
Speaker 1: be sure and check out any of our previous four
Speaker 1: hundred interviews. You can find those at iTunes, Spotify, wherever
Speaker 1: you feed your podcast fix. We love your comments, feedback
Speaker 1: and suggestions right to us at m IB podcast at
Speaker 1: Bloomberg dot net. Sign up from my daily reads at
Speaker 1: Rid Halts dot com. You can check out my weekly
Speaker 1: column on Bloomberg dot com slash Opinion. Follow me on
Speaker 1: Twitter at rit Halts. I would be remiss if I
Speaker 1: did not thank the crack staff that helps put these
Speaker 1: conversations together each week. Maroufle is my audio engineer ATKO.
Speaker 1: Val Bron is our project manager. Michael Batnick is my
Speaker 1: head of research. Michael Boyle is my producer. I'm Barry Ridholts.
Speaker 1: You've been listening to Master's in Business on Bloomberg Radio