Speaker 1: Bloomberg Audio Studios, Podcasts, radio news. This is Masters in
Speaker 1: Business with Barry Ritholts on Bloomberg Radio.
Speaker 2: This week on the podcast, I have an extra special
Speaker 2: guest returning for the first time in a few years,
Speaker 2: John Montgomery. He is the founder of Bridgeway Capital, established
Speaker 2: in nineteen ninety three, and the firm is really a
Speaker 2: very interesting mix of quantitative, value based and factor based investing.
Speaker 2: It's really none and all of the above. It's a
Speaker 2: little more nuanced and sophisticated than that. The firm first
Speaker 2: came to my attention because I was kind of intrigued
Speaker 2: by the idea of donating half their profits to charity.
Speaker 2: That's unusual in the world of finance. In addition, they've
Speaker 2: put up some really impressed of numbers over the past
Speaker 2: thirty years, which has given them the opportunity to donate
Speaker 2: tens of millions of dollars to their favorite organizations. I
Speaker 2: thought this conversation was fascinating and I think you will
Speaker 2: also with no further ado Ridgeway Capitals.
Speaker 3: John Montgomery, Thanks Berry, it's great to be here.
Speaker 2: It's great to see you. Let's for people who may
Speaker 2: not be familiar with the firm, and your background. Let's
Speaker 2: start with how your interesting and unusual career BS and engineering,
Speaker 2: BA in philosophy from Swarthmore. Then you get a graduate
Speaker 2: degree from MIT and you go to Harvard Business School.
Speaker 2: What was the career plan?
Speaker 3: Their career plan originally was urban development and transportation, So
Speaker 3: that was my first career, was working with various bus
Speaker 3: and transportation companies to improve the quality of life in
Speaker 3: the cities. People ask how does that relate to investing,
Speaker 3: and I say, well, they're both service industries. They're both
Speaker 3: people intensive, and those are the elements that I love.
Speaker 2: And I got to imagine there's a ton of data
Speaker 2: analytics and optimization thinking that goes into both.
Speaker 3: That's true. I like the intersection of people and analysis,
Speaker 3: and both industries give a lot of opportunity that I
Speaker 3: love serving people. They're both service industries, so I'm a
Speaker 3: happy camper.
Speaker 2: That makes a lot of sense. You were pretty early
Speaker 2: to computer modeling and statistical methods as a research engineer
Speaker 2: at MCT. This is the late nineteen seventies. That sort
Speaker 2: of data analytics wasn't really well understood back then. How
Speaker 2: did that background help when it comes to modeling portfolios
Speaker 2: or applying those methods of statistical analysis to invest in.
Speaker 3: Well, the statistical side definitely comes from my degree and
Speaker 3: then work as a project manager at MIT, So you're right,
Speaker 3: late seventies till nineteen eighty. The investment piece of that
Speaker 3: didn't come tell business school about three four years later,
Speaker 3: And that was kind of you could say, by chance
Speaker 3: or on a lark. I thought, well, you know, there's
Speaker 3: an opportunity cost of stepping out of your career where
Speaker 3: you have a paycheck to go back to business school
Speaker 3: full time, which I did, and thought, while I'm here,
Speaker 3: I'll take a few investing courses and see if I
Speaker 3: can use those to earn back the opportunity cost of
Speaker 3: going to business school for two years.
Speaker 2: So from transportation to finance. That sounds almost but not
Speaker 2: quite purposeful. Is that Is that a fair description?
Speaker 3: I think that's a very accurate description. So, and actually
Speaker 3: didn't leave the transportation field immediately after business school. I
Speaker 3: was in an investing course and we're doing a case study.
Speaker 3: Professor ends the class and asks the question, who here
Speaker 3: thinks that they'll be able to outperform post leaving Harvard
Speaker 3: Business School this track record? And eighty percent of the
Speaker 3: hands go up in the room. I'm not one of them,
Speaker 3: by the way.
Speaker 2: So the whole class from Lake wobegone everybody's average.
Speaker 3: Yes, yes, exactly, I mean, and I immediately got the
Speaker 3: eighty twenty rules. Wait a minute, this can't be And
Speaker 3: if this is a microcosm and the methods that we
Speaker 3: were using to think about the markets and valuation in
Speaker 3: net present value kind of cfa classic kind of analysis.
Speaker 3: If this is a microcosm of Wall Street in five years,
Speaker 3: which probably it is, then quantitative methods should give you
Speaker 3: a leg up on the competition for a lot lower costs.
Speaker 2: So you've previously discussed the epiphany you had at Harvard
Speaker 2: Business School. Is that the epiphany or was it something.
Speaker 3: Else that was a major piece of it. I would
Speaker 3: say the primary insights were behavioral finance ones we would
Speaker 3: call like I didn't. I'd never heard the word behavioral
Speaker 3: finance at the time.
Speaker 2: At that as a phrase didn't exist for another twenty
Speaker 2: five years.
Speaker 3: Probably not you know, you see you watch. I've once
Speaker 3: had a boss who said, this guy has enough sheep
Speaker 3: skins to skin a sheep. But if I ever did
Speaker 3: go back to school, the next degree I would love
Speaker 3: to have is in psychology, because I really there's so
Speaker 3: much there, and especially the intersection of psychology and money.
Speaker 2: When do you finish up at HBS. What year was that?
Speaker 3: Nineteen eighty five?
Speaker 2: All right, so what do you do between that and
Speaker 2: nineteen ninety three when you launch Bridgeway?
Speaker 3: So the first thing I did was investing as a hobby.
Speaker 3: So that was my advocation for the next six years,
Speaker 3: and my personal track record in investing was about twice
Speaker 3: the market for those periods, right in a good period.
Speaker 2: Scalable or kind of one off, little aberrational.
Speaker 3: No fine, reasonably scalable, reasonably scalable, I would say enough
Speaker 3: that after six years, I had the thought of making
Speaker 3: my avocation my next career and did something that was
Speaker 3: modeled to me by the mayor of Houston, my hometown
Speaker 3: at the time, and that is to take a year
Speaker 3: off between careers. He'd actually had four careers in his
Speaker 3: life in different fields, and every time he switched, he
Speaker 3: took a year off just to study the heck out
Speaker 3: of the next step. So that's when I really studied
Speaker 3: deeply the research why what I'd been doing was working
Speaker 3: more about when it might not and riding a business
Speaker 3: plan for Bridgeway.
Speaker 2: That's pretty fascinating. I took a year off between college
Speaker 2: and grad school, but I had no idea I was
Speaker 2: actually doing what you advocate, or with the Mayor of
Speaker 2: Houston advocates. I just was kind of lost and not
Speaker 2: sure what to do next, and spent a year thinking
Speaker 2: about it before pulling the trigger on law school. But
Speaker 2: your hometown is Houston. The firm is still locating in
Speaker 2: Yuston right since nineteen ninety three, that's when you launched.
Speaker 2: Where you launched. From the very beginning, you said something
Speaker 2: kind of unusual about the firm. We want to donate
Speaker 2: half of our profits to nonprofit organizations. Tell us where
Speaker 2: that idea came from. It's fairly unusual either in finance,
Speaker 2: and I've been to Houston. That's a kind of unusual
Speaker 2: idea in Houston as well.
Speaker 3: That's true. If I gather around, you know, just random
Speaker 3: business people in Houston and say that we donate half
Speaker 3: our profits, I have to say I get some very
Speaker 3: puzzled looks around the room. Not so much from other
Speaker 3: purpose driven people in different fields, though, But yes, it's different.
Speaker 3: Where did that come from? You know, we think things
Speaker 3: come from one place, but usually there are a lot
Speaker 3: of forces at Bay. So I would look back to
Speaker 3: my father, who was a businessman and CEO of an
Speaker 3: oil exploration firm, and believe that business was a way
Speaker 3: to change the world and engage. My mother was what
Speaker 3: I would think of as almost a professional volunteer, so
Speaker 3: giving back to the community. And this was in a
Speaker 3: time when the War on Poverty, you know, was the
Speaker 3: slogan at the time. So I was hugely influenced by
Speaker 3: both of my parents. But I would say also a
Speaker 3: conversation with my wife on the very first conversation of
Speaker 3: starting Bridgeway, and it went something like this, let me
Speaker 3: get this straight, John, You're thinking of leaving the transportation
Speaker 3: industry where you have a lot of experience and a
Speaker 3: w two to start a company in an industry you've
Speaker 3: never worked with, no initial guarantees, no guarantees on the
Speaker 3: money side. And I said, yes, we talked that through.
Speaker 3: I have to say, I'm married to an extraordinary woman.
Speaker 3: I didn't realize at that age of thirty seven how
Speaker 3: extraordinary she was. But she believes in supporting people who
Speaker 3: have a dream and she did that for me in
Speaker 3: for Bridgeway, So she was all in. She had two questions.
Speaker 2: Yeah.
Speaker 3: Question one, can we still send our daughters to college?
Speaker 3: That was like, I should have paid more attention to
Speaker 3: that question because my budget, my business plan was fifty
Speaker 3: percent of our net worth. Before it was all said
Speaker 3: and done, it was one hundred and fifty percent of
Speaker 3: our net worth. Right, so it took three years to
Speaker 3: break even when my business plan had it at one.
Speaker 3: The second question was do I have to go to
Speaker 3: cocktail parties? Why would she not her cup of tea?
Speaker 2: No? But I mean, why would she imagine? Launching of
Speaker 2: funds is going to require your spat Just like.
Speaker 3: She grew up in Washington, DC around academicians and government people,
Speaker 3: and her view of business was you have to go
Speaker 3: to cocktail parties and schmooz with people. Right, that makes sense,
Speaker 3: And having taken a course of negotiation at Harvard Business School,
Speaker 3: I immediately recognized the opportunity and said, dear not if
Speaker 3: you don't want to. So she only comes when she
Speaker 3: when she desires to come wherever I am. But she's
Speaker 3: an amazing soulmate and supporter of everything Bridgeway.
Speaker 2: That's fantastic. So you've been donating half your profits to
Speaker 2: these different organizations over thirty years? Is that right?
Speaker 3: Thirty one years?
Speaker 2: So how much have you guys donated? What are the
Speaker 2: organizations you support? What's been the response in the community
Speaker 2: over the decades.
Speaker 3: We don't give exact numbers. We're privately held firms. Since
Speaker 3: we donate half, we don't report our profits specifically either,
Speaker 3: but I'll just say it's tens of millions. Okay, over
Speaker 3: you know what substantial amount of substantial amount of capital.
Speaker 3: The bullseye of our giving is our own affiliated Bridgeway Foundation.
Speaker 3: This is an extraordinary organization led by a powerhouse of
Speaker 3: a woman, Shannon Davis. Our mission statement focuses on ending
Speaker 3: genocide and prevent any war atrocities, of which there are
Speaker 3: too many opportunities in the world today. So that's the
Speaker 3: crosshairs of our Let me.
Speaker 2: Interrupt you right here. So, so I know you have
Speaker 2: very quantitative leanings. How do you measure how successful you
Speaker 2: are in stopping genocides? Just generally speaking, it's hard to
Speaker 2: measure something that doesn't happen, so you're always engaging in
Speaker 2: counter factuals. But how do you know if you've moved
Speaker 2: the needle?
Speaker 3: It's probably no easier, no more difficult than things that
Speaker 3: we do on the investment side and in the stock market,
Speaker 3: there's time series analysis. We actually hired an outside firm
Speaker 3: to come in and review the record of what we
Speaker 3: had done in our first engagement with an organization called
Speaker 3: the Lord's Resistance Army. And if you want more details,
Speaker 3: there's a book called to Stop a Warlord that Shannon
Speaker 3: Davis wrote. I never thought we'd be able to tell
Speaker 3: the story at that level because you don't want to
Speaker 3: put at risk the people that are on the ground
Speaker 3: doing the real work. However, she found a way to
Speaker 3: do that and protect them, and so there's a book
Speaker 3: that goes into a lot of detail on that. But
Speaker 3: people think there's not a way to measure there is,
Speaker 3: and you're right, being a quantitative statistical guy, you can
Speaker 3: bet that that comes up on the table frequently.
Speaker 2: Huh. Really really fascinating. What's been the response from the community.
Speaker 3: The smallest in community is the Bridgeway community. So that's
Speaker 3: the twenty eight people at Bridgeway we call partners. Right
Speaker 3: they sign on for this work because it's in the
Speaker 3: mission statement. You don't not know about it coming in
Speaker 3: and you don't come if this isn't from day one
Speaker 3: and that's that's everything. The community of Houston, I would
Speaker 3: say less so, but it's kind of it's specific to individuals.
Speaker 3: So every once in a while you get somebody's like unbelievable,
Speaker 3: that's amazing and cannot come huh that level. We have
Speaker 3: partnered with other organizations, one of those being Howard Buffett,
Speaker 3: Warren Buffett's son that does substantial philanthropic work.
Speaker 2: Is he in Texas?
Speaker 3: No, No, he's in Nebraska, But we have partnered with
Speaker 3: him and work in the Ukraine. Worked in the first
Speaker 3: year of getting generators in for obvious reasons and getting
Speaker 3: the grain out for obvious reasons. I tell people at Bridgeway,
Speaker 3: we don't know squat about farming, but Howard Buffett does.
Speaker 3: And the third thing is documenting war crimes, and that's
Speaker 3: actually something that Bridgeway Foundation knows a lot.
Speaker 2: About documenting war crimes. Documenting and what do you do?
Speaker 2: Does this then go to the Hague to the UN
Speaker 2: What do you do with once you've documented and it
Speaker 2: should be fairly substantial in Ukraine, considering the Russians have
Speaker 2: been bombing civilian hospital, schools, infrastructure, apartment buildings, it looks horrific.
Speaker 2: What do you do with all of that information once
Speaker 2: you've documented a warp rhyme in Ukraine.
Speaker 3: So it depends on what national or international jurisdiction engages.
Speaker 3: So optimally you like to keep it at the country
Speaker 3: level if possible. The International Criminal Court is the other
Speaker 3: place that you can take a case that's in the Hague.
Speaker 2: That is in the Okay. So that's what I was
Speaker 2: really thinking about. Do they take these on as individual
Speaker 2: cases or are they kind of you know, it seems
Speaker 2: like the UN is sort of paralyzed because of you
Speaker 2: just have one voting member say no and that that's
Speaker 2: that at the end.
Speaker 3: One of the indicities of the International Criminal Court was
Speaker 3: Dominique Angwin, who was a general in the Lord's Resistance
Speaker 3: Army the first conflict that I mentioned earlier, and we
Speaker 3: played a major role in getting him to the Hague
Speaker 3: to stand trial for justice. So win for justice and
Speaker 3: then and as a deterrent by the way to kind
Speaker 3: of thugs of the world that think they can get
Speaker 3: away with war atrocities.
Speaker 2: What one would hope what happens when you have somebody
Speaker 2: like Putin who's kind of hard to reach and is Wisconsin, Moscow,
Speaker 2: and you know, how many hundreds of thousands of people
Speaker 2: have been killed, civilians, non combatants killed in the Ukraine.
Speaker 2: How do you reach someone?
Speaker 3: I would say one step at a time, and then
Speaker 3: you know, it's a lot of hard work slugging through
Speaker 3: and then occasionally you just need a stroke of good
Speaker 3: luck for something going the right way. Typically it takes
Speaker 3: more time. You know. They say the arc of justice
Speaker 3: gets there, but it's slow. That's not an exact quote,
Speaker 3: but that's my Martin Luther King summary of it.
Speaker 2: Yes, sure, so we'll come back to this because this
Speaker 2: is really fascinating. I had no idea you were so
Speaker 2: international in the philanthropic sphere. But we'll definitely circle back
Speaker 2: to that. Let's start talking a little bit about that
Speaker 2: track record. You have a couple of mutual funds, a
Speaker 2: couple of ETFs. I'm assuming you're running other stuff as
Speaker 2: a either separately managed accounts or a separate what have you.
Speaker 2: I know, one of your funds since inception has outperformed
Speaker 2: the market by about one hundred basis points, and the
Speaker 2: other I don't know if it's still a mutual fund.
Speaker 2: I know it started as a mutual fund is now
Speaker 2: about three hundred basis points over market returns. Tell us
Speaker 2: about the mutual funds and ETFs you run on behalf
Speaker 2: of Bridgeways clients.
Speaker 3: Yes, so let me talk about the strategies. One you
Speaker 3: referred to as aggressive investors, and as the name would indicate,
Speaker 3: it has high beta, very well high beta, but very
Speaker 3: high exposure to the factors that we want that we
Speaker 3: believe in, so.
Speaker 2: High active share. And when you say factors, very high active.
Speaker 2: So you know I should have mentioned this earlier. What
Speaker 2: a lot of people call smart beta, You guys were
Speaker 2: doing long before anyone had a name on it. You've
Speaker 2: been doing smart beta, You've been doing factor investing a
Speaker 2: long time. Tell us a little bit about the sort
Speaker 2: of factor investing that drives Bridgeways returns.
Speaker 3: Well, these are factors that we believe in. First of all,
Speaker 3: some of my co portfolio managers will bristle if you
Speaker 3: refer to us as a factor based firm. I owned
Speaker 3: that a little bit more. But it's a fair point
Speaker 3: in the sense of being systematic, statistically driven over long
Speaker 3: periods of time. But there are human elements, Like if
Speaker 3: there were no human element, everybody would be operating the
Speaker 3: identical strategy out there. So yes, we believe in value.
Speaker 3: We have our own proprietary mix of metrics and we
Speaker 3: can show statistically based on data over decades why we
Speaker 3: do that.
Speaker 2: So let me stop you before you go on to
Speaker 2: the next one. When most people hear value, they immediately think,
Speaker 2: you know, low PE, low price to book ratio. Your
Speaker 2: approach to value, I know, is a little more sophisticated
Speaker 2: than that. Put some flesh on the bones. Tell us
Speaker 2: about Bridgeways value approach.
Speaker 3: So we believe in value, quality, and sentiment, or the
Speaker 3: three primary legs of the stool. Within that, one of
Speaker 3: the things that we've done for a long period of
Speaker 3: time is mix different measures. So and why do we
Speaker 3: do that. It's because it gives you a more stable
Speaker 3: return stream over time. So if it's academically, you know,
Speaker 3: paper when I was in business school came out FAMA
Speaker 3: French and.
Speaker 2: The value factory model factor.
Speaker 3: Yeah, and the three factor then was price to book
Speaker 3: And it's a metric, but we could show statistically that
Speaker 3: if you match it with things like PE, with things
Speaker 3: like price to sales, which has its own part. Think
Speaker 3: through the balance sheet and the income statement, different ways
Speaker 3: to measure value. That putting them together in a efficient
Speaker 3: way gives you a steadier stream of returns into the future.
Speaker 3: So that's why we do that. There's a very interesting
Speaker 3: output of that though, that comes. So I was at
Speaker 3: a conference I don't know, I'm going to say, maybe
Speaker 3: twelve years ago or so, paper presented by NOV marks
Speaker 3: on quality, and he's presently like everybody's excited. I'm excited.
Speaker 3: We go back in. The first thing we all always
Speaker 3: try and to is replicate the work if it's new.
Speaker 3: So we replicated the work we put it into see
Speaker 3: could it help our models, and the answer was no.
Speaker 3: Do you know why the reason was no?
Speaker 2: Because you already had quality.
Speaker 3: And inadvertently we had already included quality in the process.
Speaker 3: Because that doesn't ultimately.
Speaker 2: That doesn't surprise me because you're you're talking about different metrics,
Speaker 2: and when I think about value, and I also think
Speaker 2: about value traps, and I know you cannot generate the
Speaker 2: numbers you have if you're constantly buying stuff that's cheap
Speaker 2: but low quality, high debt, all these other issues that
Speaker 2: come up. Eventually, those things have to underperform. So I
Speaker 2: kind of had the sense that you guys have quality
Speaker 2: exposure just by your long term track record. So you
Speaker 2: reproduce Novi's work. Where do you go from there?
Speaker 3: There's always a next step, Barry. If I take a
Speaker 3: look at just three of our strategies currently, it gives
Speaker 3: you a feel for the breadth of what we do.
Speaker 3: So one would be our small value strategy and you
Speaker 3: might think small value. That seems pretty plain. Vanilla mentioned
Speaker 3: the research on value that we've done. We try and
Speaker 3: incorporate some things and how you incorporate them into the
Speaker 3: portfolio construction where you constrain and where you don't like
Speaker 3: how much are you willing to take on of sector risk?
Speaker 3: But our OMNI small value strategy is a strategy that
Speaker 3: we designed specifically for the purposes of an organization called
Speaker 3: Buckingham or BAM. Then now it's now called Focus Partner's Wealth,
Speaker 3: great friends of ours and our small value OMNIE small
Speaker 3: value fits into their allocation in a way that's efficient
Speaker 3: for their portfolio construction. Now, what's Bridgeways advantage. It's our
Speaker 3: size and this is something that's true across all of
Speaker 3: our strategies currently. We have a huge leg up being
Speaker 3: a smaller organization. Several reasons think of the OMNI small
Speaker 3: value because we're smaller and we don't have hundreds of
Speaker 3: billions under management, we can go deeper on small deeper
Speaker 3: to a degree. Our benchmark is still the Rustle two
Speaker 3: thousand value index, but our strategy is x real estate
Speaker 3: and utilities because our partners focus Wealth Partners has separate
Speaker 3: strategies for that, so we don't duplicate that. And so
Speaker 3: that's an example of the kind of research that we do.
Speaker 3: How does that affect the reterms? Is that a good
Speaker 3: idea to do? But Bridgeway's own small size means that
Speaker 3: we don't have well, it means several things. Really. Number one,
Speaker 3: it means our transaction costs are less, which, based on
Speaker 3: your career, you know exactly the importance of that. So
Speaker 3: if you're a trader and I give you an order
Speaker 3: on a particular stock ticker symbol and say go buy
Speaker 3: me a thousand shares of that, and your job is
Speaker 3: to get this completed at the best price possible. However
Speaker 3: you want to measure it, and I give you one
Speaker 3: ticket for one thousand shares and another ticket for fifty
Speaker 3: thousand shares, but I'm going to hold you accountable to
Speaker 3: the same price. Which one do you want?
Speaker 2: Well? From back in the day, when it was five
Speaker 2: cents a share, you wanted the fifty thousand share order,
Speaker 2: but that's not how you're getting paid. Well, the thousand
Speaker 2: share orders much easier to get done at a good price. Yes,
Speaker 2: fifty thousand shares, especially a small cap, you may move
Speaker 2: the price up. You're certainly not just absolutely lifting the
Speaker 2: offer and walking away with fifty absolute shares.
Speaker 3: So for the investor, you want the smaller one that
Speaker 3: gets done more quickly. If you can get it done
Speaker 3: more quickly, it's more favorable price. You're less likely to
Speaker 3: move the price of the security in an unfavorable way.
Speaker 3: And that same thousand shares will make a more meaningful
Speaker 3: contribution to a smaller shop than to a larger shop.
Speaker 3: Same number of shares is just going to be you know,
Speaker 3: point zero zero one in the portfolio. Why even waste
Speaker 3: your time at Bridgeway. It's more meaningful. That's a big deal.
Speaker 3: And the last part is something that very few people
Speaker 3: I hear talking about, and that's that our effective universe
Speaker 3: is a larger universe. So that gets into our next
Speaker 3: strategy that I'd like to highlight, which is our global opportunities.
Speaker 3: This is a long short strategy. It's glows.
Speaker 2: This is the one that's one hundred percent long one
Speaker 2: hundred percent short. Yes, so less correlation to the market.
Speaker 2: Volatility doesn't matter. If anything, volatility could actually help return
Speaker 2: can So no guarantees, but it could.
Speaker 3: Jacob Pejorni, who who led the research for a two
Speaker 3: year period, resulted in three peer reviewed articles, which for
Speaker 3: firm our size is an astonishing achievement. He likes to say,
Speaker 3: market agnostic. This is long short. The success for us
Speaker 3: is defined as if you know the direction of the
Speaker 3: market tells you nothing about the direction of the returns
Speaker 3: of this strategy.
Speaker 2: Well, if you long short, you should have half the
Speaker 2: volatility of long only.
Speaker 3: Right, that's pretty much right in line with our target. Okay,
Speaker 3: so volatility.
Speaker 2: Is this an absolute return strategy? It is. The assumption
Speaker 2: is you're picking stocks that you think you're going to
Speaker 2: do well, and you're also looking for stocks to short
Speaker 2: that you think you're going to do poorly, and we'll
Speaker 2: do especially poorly. In a draw down, how's that working out?
Speaker 3: It's working out well. This is a big deal in
Speaker 3: terms of the design. A paper that caught my attention
Speaker 3: was following two thousand and eight, and this paper took
Speaker 3: a look at all hedge funds that reported to be
Speaker 3: market neutral, and the bottom line was, most of the
Speaker 3: time they did a pretty good job, but when you
Speaker 3: really needed it, in a downturn of two thousand and eight,
Speaker 3: the beta was zero point four, so about forty percent
Speaker 3: of the downside. Well, it's like, okay, that's cushion, but
Speaker 3: it's not zero. It's not zero, it's not a it's
Speaker 3: neither an anti gravity fund, nor do you expect not
Speaker 3: to be hurt. We've done research on the competition as well,
Speaker 3: and this is fascinating and also just over the last week,
Speaker 3: so we're now, you know, on two days that get
Speaker 3: us close to twenty percent. That's enough to you know,
Speaker 3: run your numbers and see how did they do. Our
Speaker 3: closest competitors to global opportunities have done a much better
Speaker 3: job than quote market neutral funds did back in two
Speaker 3: thousand and eight. All of them within a percent of zero. Well,
Speaker 3: one of them was two percent negative. But out of
Speaker 3: seven strategies that I looked at just earlier today, I
Speaker 3: would say doing a better job.
Speaker 2: I think it was Cliff Astness at AQR had a
Speaker 2: paper out our hedge funds really hedged and Unfortunately, the
Speaker 2: conclusion for a lot of them were not very much.
Speaker 2: And that sounds like it's very consistent with the research
Speaker 2: you guys.
Speaker 3: Well, we specifically designed this not to have the two
Speaker 3: thousand and eight problem identified. But there are a couple
Speaker 3: more areas that we have a huge leg up on
Speaker 3: the competition with a strategy number one. Again, getting back
Speaker 3: to our small size, our universe of stocks is so
Speaker 3: much larger.
Speaker 2: That's both domestic and international.
Speaker 3: Yes, and especially internationally. That's because out of the nine
Speaker 3: thousand or so stocks, significant majority, probably our bigger competitors
Speaker 3: simply can establish a meaningful.
Speaker 2: Position in a competitive advantage.
Speaker 3: Oh it's and it's big.
Speaker 2: Well.
Speaker 3: And by the way, those are the ones that are
Speaker 3: less liquid, less efficient that you are likely to win
Speaker 3: with active management. Huh.
Speaker 2: Really interesting. So we talked earlier about donating tens of
Speaker 2: millions of dollars half of the profits of the firm
Speaker 2: to charity. How does that affect how you recruit employees,
Speaker 2: how you develop a compensation structure. Tell us a little
Speaker 2: bit about the impact of that on running an asset
Speaker 2: management business.
Speaker 3: Sometimes I get into conversation with a prospective client and
Speaker 3: you might hear something like, you know, it sounds like
Speaker 3: you're good guys. You know, you're philanthropically geared and you
Speaker 3: get awards. Is a great place to work. But all
Speaker 3: of that, like, put that aside. I just want to
Speaker 3: talk about the investments. And what I would say is
Speaker 3: culture is everything. It's the housing within which we do
Speaker 3: what we do. So it's very important, and you can
Speaker 3: measure that in some statistical ways like turnover. I would say,
Speaker 3: there are proxies for commitment at Bridgeway and then returns
Speaker 3: of the strategies. Why would you think that's independent of
Speaker 3: the culture that you've built up.
Speaker 2: You also have an internal rule the highest paid employee
Speaker 2: earns no more than seven times the lowest paid employee.
Speaker 2: Is that right?
Speaker 3: So statistically that's probably true. We don't measure it that way.
Speaker 3: There's a new statistic that came out from the sec
Speaker 3: required of public companies and those are some of the
Speaker 3: metrics that we look at currently. Some people think it's like, oh,
Speaker 3: so you underpay. That is absolutely not the intent. It's
Speaker 3: just not to pay outrageous salaries on the top. And
Speaker 3: so you know, if you want to make azill the
Speaker 3: most money that you can make in our industry, you
Speaker 3: probably wouldn't come to Bridgeway if you want to make
Speaker 3: an absolute livable wage and if you invest, save and invest,
Speaker 3: you should do very well over a full career. Then
Speaker 3: then we're purpose driven firm and we ascribe to Daniel
Speaker 3: Pink's what really motivates people is not money, but it's purpose,
Speaker 3: which we have in strong Suit. It's autonomy and it's mastery.
Speaker 3: So we really invest in our people by way of mastery,
Speaker 3: give them opportunities for learning and growth, invest by way
Speaker 3: of mentoring as well, and then the autonomy piece we're
Speaker 3: trying to continually up our game with in a system
Speaker 3: of structure called traction or entrepreneurial operating system.
Speaker 2: And the firm's culture also emphasizes accountability. Tell us about
Speaker 2: the Firewood Group. What does that do?
Speaker 3: Okay? So the Firewood Group is a personal accountability group
Speaker 3: that's not inside Bridgeway. And what happened is in nineteen
Speaker 3: ninety eight a friend of mine came to me and
Speaker 3: he said, so, I want you to be on the
Speaker 3: board of directors. And he worked for a publicly held firm.
Speaker 3: But he was like, Charlie, I like, you're not in
Speaker 3: a position to ask me on that board, and I
Speaker 3: don't know squad about that industry And he said, no, no,
Speaker 3: not the company board, the board of directors of my life.
Speaker 3: And he said, well, what does that look like? You
Speaker 3: never heard of that. Out of that came the following observation.
Speaker 3: We were each members of groups that were great at
Speaker 3: support but lousy it accountability, and we both knew we
Speaker 3: needed accountability. So we formed this group specifically around the
Speaker 3: concept of accountability. And just to give you a very
Speaker 3: specific example, I had a life goal of ending genocide.
Speaker 3: This group starts, and you know, I'm sharing life goals like, well,
Speaker 3: you've made great progress on this one and this one,
Speaker 3: but we don't. We think it's time for you to
Speaker 3: actually turn the ignition on on this one. Out of
Speaker 3: that conversation, we turned the ignition on on our foundation
Speaker 3: and everything that you see that Shannon Davis is doing
Speaker 3: along with our partners.
Speaker 2: That's really fascinating. And I would assume if the founder
Speaker 2: and CEO has that degree of accountability in his personal life,
Speaker 2: how does that then affect the culture of the organization.
Speaker 2: How do you bring your work ethic and your sense
Speaker 2: of accountability into the office.
Speaker 3: Well, I like to think that I modeled it. Number one.
Speaker 3: Number two, we attract people for whom that's an exciting concept.
Speaker 3: And number three, then you've got to actually live it out.
Speaker 3: And that's where aspects of this structure that I call
Speaker 3: traction or some people call entrepreneurial operating system come into play.
Speaker 3: There's an annual goal setting process and most companies have that,
Speaker 3: the ninety day goals that they refer to as rocks.
Speaker 3: There's a very high level of commitment toward It's like
Speaker 3: when you take on that I'm going to do this
Speaker 3: in the next ninety days, everybody is looking at its
Speaker 3: very high profile. It's online. We have to report to
Speaker 3: all of the partners the leadership team's experience, and then
Speaker 3: every partner at Bridgeway, that's every person that has a
Speaker 3: long term commitment to and front Bridgeway, has to do
Speaker 3: the same thing.
Speaker 2: So when I talk about accountability, one of the things
Speaker 2: I was thinking about is the company's annual report where
Speaker 2: you guys kind of own your biggest mistakes, tell us
Speaker 2: about that.
Speaker 3: That's something we started, I don't know, maybe a year
Speaker 3: four or five, and it comes around accountability. The normal
Speaker 3: thing is this in business or in government or academy
Speaker 3: or journalism anywhere. You know you want to learn from
Speaker 3: your mistakes, but you don't want to own them too publicly,
Speaker 3: right it doesn't feel good. People might ask the wrong question.
Speaker 3: We had a lawyer member of our board of directors
Speaker 3: at the time that said, you do realize you're like
Speaker 3: putting on a silver platter something that people could sue
Speaker 3: you over. And my answer to that is like, yeah,
Speaker 3: I get that, that's true, but you can't cut it
Speaker 3: both ways. You either have to own your mistakes, get
Speaker 3: them out in the open, learn from them and make
Speaker 3: sure you don't repeat them, or you sweep them in
Speaker 3: under a rug. And you just can't do both, and
Speaker 3: I choose the former. Our shareholders are investors, our clients
Speaker 3: are our boss. We have a fiduciary duty to them.
Speaker 3: And I had one an early client say, you do realize,
Speaker 3: like I'm your boss and there's accountability there. I should
Speaker 3: know what's really going on. And I'm like, I can't
Speaker 3: argue with that. That is a brilliant statement. This woman,
Speaker 3: by the way, didn't have a high school degree, and
Speaker 3: I learned so much from her.
Speaker 2: Huh, really really fascinating. So let's talk a little bit
Speaker 2: about what's going on in the marketplace. There has been
Speaker 2: a shift over the past twenty thirty years too passive
Speaker 2: from active, especially from expensive underperforming active. I don't put
Speaker 2: you guys in that category. You've done well, your fees
Speaker 2: are are kind of middle of the road. How you
Speaker 2: navigating what's going on in the marketplace?
Speaker 3: A few things that I can point to. Number one
Speaker 3: is you always have to keep working to stay ahead
Speaker 3: of the game and adding value, and that's the research part.
Speaker 3: So we like to say small incremental improvements, but it
Speaker 3: never stops. Number two, we were an early adapter of
Speaker 3: moving some mutual funds converting them into ETFs, so we've
Speaker 3: done that. That was painful because it's costly. Out the
Speaker 3: other side, it's been helpful for the after tax return
Speaker 3: of the shareholders, so big plus there. And those strategies
Speaker 3: are both in positive flows, so good for the advisor
Speaker 3: as well. And the last one is, you know, don't
Speaker 3: make indexing and passive the enemy. What can you learn
Speaker 3: from them? So Bridgeway actually came to market with our
Speaker 3: blue chip strategy. To really be an index fund, you
Speaker 3: have to have somebody else calculating it, and there are
Speaker 3: all rules, and we decided we weren't willing to do that.
Speaker 3: We just wouldn't call it an index fund anymore. But
Speaker 3: it's a megacap strategy that gets off of what I
Speaker 3: think of as the inefficient market cap waiting portfolio construction
Speaker 3: of almost every index fund, not absolutely all of them,
Speaker 3: but we have more than a quarter century real time
Speaker 3: data like this has been a mutual fund. Now it's
Speaker 3: an ETF converted. You can look at that track record
Speaker 3: and draw your own conclusions. But I like to say
Speaker 3: market cap weighting is like a momentum strategy that you
Speaker 3: never rebalance, so you ride the wave up and then
Speaker 3: you write it down, and that's just not very efficient.
Speaker 3: That leads to more volatility. This strategy, on average, has
Speaker 3: different ways to measure it. Beta standard deviation draw down
Speaker 3: of very roughly five percent less than a market cap
Speaker 3: weighted index of a broad index like the S and
Speaker 3: P five hundred, So a little bit less risk, we believe,
Speaker 3: not in every market environment. But you can measure it
Speaker 3: over the long term in last decade for example, and
Speaker 3: then a little bit more return. And why is that
Speaker 3: it's roughly equal weighted, which means you're always investing a
Speaker 3: little bit more in what's done poorly and harvesting a
Speaker 3: little bit from what's done really well. That's bilos sell high.
Speaker 3: Isn't that a basic investing principle?
Speaker 1: That's just.
Speaker 2: That sort of rebalancing is one of the few free
Speaker 2: launches in finance. So if you're not doing market cap waiting,
Speaker 2: and you're talking about blue chip companies, how you're waiting
Speaker 2: the portfolio.
Speaker 3: So we look at the top thirty five thirty six companies,
Speaker 3: We make sure that we've got industry representation at the
Speaker 3: time of recomposition, and then we're rebalancing quarterly and reinvesting
Speaker 3: dividends along the way, and I'll say roughly equal weighting,
Speaker 3: so there's some cushion on harvesting from the top. It
Speaker 3: can go up. Our rule of thumb is about four
Speaker 3: percent is the maximum weight and a strategy. So if
Speaker 3: Apple or Microsoft or somebody else is eight percent of
Speaker 3: an underlying market cap weighted US index, we're going to
Speaker 3: be half of that. But it gives you a more
Speaker 3: diversified fund in me a cap stocks, which gives you
Speaker 3: some of the downside protection and some of the risk characteristic.
Speaker 2: Well, as we've seen in year to date in twenty
Speaker 2: twenty five, the mag seven have become the lag seven. Yes,
Speaker 2: so not being full market cap weight certainly had to
Speaker 2: have a positive impact on returns. What happens when those
Speaker 2: stocks are doing great? How comfortable do you feel if
Speaker 2: you're not full market weight of in Nvidia, Apple, Amazon, Microsoft,
Speaker 2: as as they're going higher and higher.
Speaker 3: That's the discipline of any investment process in the design.
Speaker 3: So know the design of what you're investing in, know
Speaker 3: when it's likely to outperform and when it's not, and
Speaker 3: then you need to be comfortable with those numbers. But
Speaker 3: in that strategy you pointed out exactly when it would
Speaker 3: you know, underperform when the top seven you know, and
Speaker 3: you know there're the nifty fifty back in the well.
Speaker 2: You and I remember the nifty to fifty in the sixties.
Speaker 2: Half our listeners are unfamiliar with them. But people talk
Speaker 2: about out the Magnificent seven like it's something new. Yes,
Speaker 2: it's fifty sixty years old. We have the same sort
Speaker 2: of top heavy market happen when everybody clamoring into the
Speaker 2: same sort of blue chips. Yes, being weighted on a
Speaker 2: non capitalization basis, having other elements drive the waiting, how
Speaker 2: do you manage around that?
Speaker 3: As a disciplined investment shop. We have everything documented in detail.
Speaker 3: So there are four portfolio managers on every strategy at Bridgeway.
Speaker 3: In theory, any one of the four can step in
Speaker 3: and do that job, one because they're trained to do so,
Speaker 3: but two because they have documentation of how to do it.
Speaker 3: In this case blue Chip, I mentioned there's a quarterly
Speaker 3: rebalancing process. There's instructions exactly how you rebalance, how you
Speaker 3: take care of unusual situations, which might be a merger,
Speaker 3: an acquisition, a spin off. Now a company and you
Speaker 3: in the portfolio is no longer one of the top
Speaker 3: thirty five, thirty six by size, so what do you
Speaker 3: do about that? So those are the kinds of exceptions
Speaker 3: that you document, and otherwise it's fairly straightforward.
Speaker 2: What you're describing sounds like a very systematic process to
Speaker 2: evaluate securities and build a portfolio. Tell us a little
Speaker 2: bit about the things that go into that system.
Speaker 3: Let me shift gears back to global opportunities, which is
Speaker 3: which gives you more the full breadth of how we
Speaker 3: do what we do with respect to stock selection and
Speaker 3: portfolio construction. The stock selection side, as I mentioned, you're
Speaker 3: combining factors of value, quality, and sentiment. However, that's within
Speaker 3: a framework of intangible capital intensity. And what that's intangible
Speaker 3: capital intensity? Yes, so are these things like intellectual property,
Speaker 3: patents excesses exactly? Okay, So high intangible capital would be
Speaker 3: exactly the things you mentioned research and development. If you
Speaker 3: rank them by industry, things that flow to the top
Speaker 3: would be the pharmaceuticals, AI software things at the other
Speaker 3: end of the spectrum would be things like manufacturing, transportation utilities.
Speaker 3: So you think of old economy stocks and new economy
Speaker 3: stocks as another way to think about them. But we're
Speaker 3: measuring literally ranking these according to intangible capital intensity. The
Speaker 3: high in tangible capital intensity ones don't work real well
Speaker 3: with the classic measures of value. For example, what we
Speaker 3: found is that sentiment is a stronger predictor of future
Speaker 3: returns for those so we don't only use centiment. We're
Speaker 3: always using the combination, but we're going to overweight the
Speaker 3: sentiment part of that. So we have these three categories
Speaker 3: of factors underneath, which, as I mentioned before, multiple ones
Speaker 3: in the framework of intangible capital intensity, which is original
Speaker 3: research that Bridgeway did over a couple of year period
Speaker 3: and published papers on. That's the overall framework. Then you've
Speaker 3: got in this particular strategy, it's global, and we like
Speaker 3: to be neutral exposure on things that we don't care
Speaker 3: about or aren't in the design, and positive on the
Speaker 3: ones that we do. So what do we not care
Speaker 3: about sectors? So we're always trying to move back to
Speaker 3: it to be sector neutral, which means the same dollars
Speaker 3: on the long side as you have on the short side.
Speaker 3: Similarly with sectors, sectors, countries, certain factors. Book value, for example,
Speaker 3: as a classic one. Don't like that one as much.
Speaker 3: It's problematic for reasons that we relate well.
Speaker 2: Book value doesn't really it tends to measure physical plants exactly,
Speaker 2: and so it much more heavily and IP kind of
Speaker 2: gets the short shrift there.
Speaker 3: Yes, exactly. So what that means is the industries that
Speaker 3: are on the low capital intensative part of the spectrum
Speaker 3: tend to do fine with the classical measures of value.
Speaker 3: So you can see you put all that together, you
Speaker 3: constrain the portfolio according to certain things that you don't
Speaker 3: want it to be exposed to. People come and say, oh,
Speaker 3: global opportunities, that's got China. I don't want any China.
Speaker 3: Well at any one point in time, we might be
Speaker 3: a percent or possibly even too positive exposure to China
Speaker 3: or negative exposure to China. On average, we're targeting that
Speaker 3: zero percent, so you're not going to get any value
Speaker 3: add over the long term. Shouldn't be coming from the
Speaker 3: actual country or the sector. It should be the specific
Speaker 3: factors that we're trying to give exposures to, and that
Speaker 3: leads to a much steadier stream of returns.
Speaker 2: That's really intriguing. So I've always kind of thought of
Speaker 2: you as sort of a factor shop, sort of a
Speaker 2: value shop, sort of a quand shop, a little bit
Speaker 2: of everything. Is that a fair Is that a fair description?
Speaker 2: I don't want to overgeneralize, but you guys do a
Speaker 2: little bit of a lot of things.
Speaker 3: Yes, I would say that that's true. The one thing
Speaker 3: that you left out, which is the hard piece and
Speaker 3: a significant part of our time, is qualifying the data.
Speaker 3: Cleaning the data, especially on the global side. Data is
Speaker 3: cleaner in the large caps on the US side, for sure.
Speaker 3: And also the model assumptions. There's certain assumptions built into
Speaker 3: the model. You get a strong pick. Are the reasons
Speaker 3: that those picks of a model come to the surface,
Speaker 3: ones that really hold true in the marketplace. Is there
Speaker 3: something that you don't know, for example, regulations that have
Speaker 3: just come out in a country that are going to
Speaker 3: change the earnings and financial characteristics that you care about
Speaker 3: with a particular model. So that's part of the work
Speaker 3: and the scrubbing, and you know, that's why we chafe
Speaker 3: a little bit when people say, oh, you're just a
Speaker 3: smart beta shop.
Speaker 2: Clearly there's a lot more going on than just smart beta.
Speaker 2: All right, I only have you for a limited amount
Speaker 2: of time, so let's jump to our favorite questions we
Speaker 2: ask all of our guests, starting with what's been keeping
Speaker 2: you entertained these days? What are you watching or listening to?
Speaker 3: One of my favorite recent ones was actually a South
Speaker 3: Korean series called The Extraordinary Attorney Wu, and it's a
Speaker 3: fascinating study about a woman who's an adult autistic, brilliant
Speaker 3: person in a law firm in South Korea and her
Speaker 3: experiences navigating a non autistic world and the adjustments that
Speaker 3: people do and don't try and make assumptions that people make.
Speaker 3: You know, you might think that has nothing to do
Speaker 3: with investing, But the assumptions side and the statistic side,
Speaker 3: and then the human interaction side, and the behavioral side
Speaker 3: is all right there. That's one of my top recently.
Speaker 2: Really really interesting. Let's talk about mentors who helped to
Speaker 2: shape your career.
Speaker 3: Several had a mentor that passed away last year, Henry
Speaker 3: GROPPI SoundBite from him was respect all people, all the time,
Speaker 3: no exceptions. And it's that last piece that's really challenging.
Speaker 3: So I'm going to put him as a top mentor.
Speaker 3: Had some at MIT advisors there who taught me never
Speaker 3: come to my office just bringing problems. Always try and
Speaker 3: bring solutions when you can. People that have engaged on
Speaker 3: a human level within these that didn't have to. Some
Speaker 3: of the better things that I've learned Jack Bogel, certainly
Speaker 3: on the cost and structure side, a little gritty, which
Speaker 3: is I like, I think that's fun.
Speaker 2: Those are some of momentors really interesting. Let's talk books.
Speaker 2: What are some of your favorites? What are you reading
Speaker 2: right now?
Speaker 3: Right now, I'm reading two books. One is called People
Speaker 3: Dare to Build an Intentional Culture. So you can imagine
Speaker 3: why that would be attracted to me. Chapter two of
Speaker 3: that book is about love. We don't tend to use
Speaker 3: the word love. And workplace they say, well, and more
Speaker 3: accepted word might be genuine caring, and so we think
Speaker 3: a lot about that. We play the Simon Senek game
Speaker 3: of why is why is that important? And underneath that,
Speaker 3: why is that important? If you play that game at
Speaker 3: Bridgeway of why you're doing what you're doing and get
Speaker 3: to a core value, caring frequently comes out among different people,
Speaker 3: board members, partners at Bridgeway. The other book is Jason
Speaker 3: Swig's recent update on The Intelligent Investor. I'm halfway through
Speaker 3: that one. It's it's a thick read because it's really
Speaker 3: two books. It's in Benjamin Graham's book and it's Jason
Speaker 3: Swigg's commentary on it. It's great and not too long ago.
Speaker 2: I saw you mentioned, was it Dan Arawle's The Truth
Speaker 2: About Dishonesty? Yes?
Speaker 3: Right, that's one of my favorite. It might be it
Speaker 3: might be a decade old now, but wonderful book on
Speaker 3: humility in statistics and in non statistics.
Speaker 2: And our final two questions, what sort of advice would
Speaker 2: you give to a recent college grad interested in a
Speaker 2: career in either investing or finance.
Speaker 3: I actually had this opportunity just yesterday. It was somebody.
Speaker 3: I'm going to guess he was about twenty five years
Speaker 3: old and early stage in his career. And my advice is,
Speaker 3: people scare you away when it's a declining industry or
Speaker 3: not declining, but where feet pressure is increasing. So the
Speaker 3: feed pressure has been very strong, different ways to measure it.
Speaker 3: But you know, fees are less than half of what
Speaker 3: they were a dozen years back, and that scares a
Speaker 3: lot of people away. Within that, there's a lot of change,
Speaker 3: and within the change there are strategic opportunities. And because
Speaker 3: it doesn't attract as many people think supply and demand,
Speaker 3: there are great they're kind of even bigger than normal
Speaker 3: mature company opportunities and not as many people coming in.
Speaker 3: You can make a big difference in that environment. I
Speaker 3: think it's fun and fascinating. I would definitely choose this
Speaker 3: as a career if I were doing it all over again.
Speaker 2: And our final question, what do you know about the
Speaker 2: world of investing today that would have been useful back
Speaker 2: in nineteen ninety three when you were first launching the firm.
Speaker 3: Wow, I was a contrarian by nature, but I didn't
Speaker 3: understand the dynamics of chasing hot returns and panicking and downturns.
Speaker 3: Understanding that dynamic better would have helped, not because not
Speaker 3: personally but professionally. It would have given some good insights
Speaker 3: for the individual investor. I would say, build your portfolio
Speaker 3: and learn how to not pay attention in the downturns.
Speaker 3: If it's long term money. And by the way, if
Speaker 3: it's not long term money, you shouldn't have it in
Speaker 3: the stock market. So it's assuming it is long term money.
Speaker 3: The only price you really care about is the last
Speaker 3: price when you want to take the money out, and
Speaker 3: that wasn't last week or this week. Ever, whether it's
Speaker 3: up or down, there's volatility in between. All those numbers
Speaker 3: are irrelevant. All you need to know is the last
Speaker 3: one the first day. You're going to know that number
Speaker 3: his years in the future when you're actually gonna need it.
Speaker 2: Huh, Absolutely fascinating. We have been speaking with John Montgomery,
Speaker 2: founder of Bridgeway Capital. If you enjoy this conversation, well,
Speaker 2: be sure and check out any of the previous five
Speaker 2: hundred or so we've done over the past ten years.
Speaker 2: You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever
Speaker 2: you find your favorite podcast. Check out my new book
Speaker 2: How Not to Invest. The Ideas, numbers and behavior that
Speaker 2: destroys wealth and how to avoid them, how not to
Speaker 2: invest wherever you get your favorite books. I would be
Speaker 2: remiss if I did not thank the correct team that
Speaker 2: helps put these conversations together each week. My audio engineer
Speaker 2: is Sam Danziger. Sean Russo is my researcher. Ana Luke
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Speaker 2: Masters in Business on Bloomberg Radio