WEBVTT - This ETF Is All About Rejection 0:00:05.760 --> 0:00:06.400 Welcome to chains. 0:00:06.440 --> 0:00:15.120 I'm Joel Webber and I'm Eric Balchunis Eric. 0:00:15.160 --> 0:00:17.560 We get to see a lot of ETFs. We talk 0:00:17.600 --> 0:00:19.520 about a lot of new ones, we talk about a 0:00:19.560 --> 0:00:20.239 lot of old ones. 0:00:20.239 --> 0:00:21.840 We talk about the market as a whole. 0:00:22.680 --> 0:00:25.240 I think that when we're going to talk about today 0:00:25.400 --> 0:00:26.239 is pretty cool. 0:00:26.280 --> 0:00:29.080 I haven't ever actually considered this idea before. 0:00:29.280 --> 0:00:31.040 Yeah, it's really interesting. It stuck out to me for 0:00:31.080 --> 0:00:33.360 a few reasons. You know, there's five hundred ETFs that launch, 0:00:33.400 --> 0:00:35.880 and only a couple stick out right off the bat, 0:00:35.920 --> 0:00:39.199 and this one does. It's called the Research Affiliates Deletions ETF. 0:00:39.600 --> 0:00:44.080 The ticker is next, which is pretty apropos and it's 0:00:44.080 --> 0:00:47.800 for research Affiliates. Who is Rob ar Nott's company and 0:00:47.880 --> 0:00:50.040 Rob are not is known as the grandfather of smart beta, 0:00:50.159 --> 0:00:53.559 So the godfather of grandfather one of those two, but 0:00:53.600 --> 0:00:58.240 he's he's he kind of really pioneered that space. And 0:00:58.280 --> 0:01:00.800 for those who don't know, smart beta effect effectively is 0:01:01.800 --> 0:01:04.920 taking an index and tweaking it and designing it with 0:01:04.959 --> 0:01:09.320 some activeness so that it does different things than basically 0:01:09.360 --> 0:01:12.880 just track market beta. Anyway, that's a big category with 0:01:12.920 --> 0:01:15.720 two trillion now and so here's another ETF that is 0:01:15.760 --> 0:01:18.240 sort of from his brain. And this one is also 0:01:18.280 --> 0:01:22.360 interesting because Athanasios on my team just covered the same thing, 0:01:22.440 --> 0:01:24.720 so that they independently found the sort of same data 0:01:24.760 --> 0:01:27.800 that when a stock gets into an index, you think 0:01:27.840 --> 0:01:30.000 that's the time to buy it, but actually when it 0:01:30.000 --> 0:01:33.000 gets kicked out, data shows that has a better performance 0:01:33.040 --> 0:01:35.680 after getting kicked out, which we thought was interesting. And 0:01:35.720 --> 0:01:38.600 obviously this index and ETF is trying to capitalize on 0:01:38.760 --> 0:01:42.600 so just an interesting product, and the fees low has 0:01:42.640 --> 0:01:45.480 a probably a good shot of success. So I just 0:01:45.480 --> 0:01:48.200 think it's also interesting because people do really look at 0:01:48.240 --> 0:01:53.600 how the indexes are impacting stocks and stock prices, and 0:01:53.240 --> 0:01:55.880 here's somebody saying, okay, let's stop talking about it, let's 0:01:55.880 --> 0:01:57.000 try to make some money about it. 0:01:57.400 --> 0:02:00.320 So joining us on this episode, Rob are not the 0:02:00.400 --> 0:02:06.800 founder of research, this time on trillions. Out with the 0:02:06.840 --> 0:02:11.440 New and with the Old, Rob Wilko A trillions, thank 0:02:11.480 --> 0:02:15.120 you so much so. Our colleagues in Bloomberg News wrote 0:02:15.160 --> 0:02:17.880 that lead that headline right there, Out with the new, 0:02:17.919 --> 0:02:20.240 end with the old. That was our colleague of Vildanna 0:02:20.520 --> 0:02:24.680 hi Rich, so fitting, I think, But where where did 0:02:24.680 --> 0:02:27.880 this idea come from? How did you see that there 0:02:27.960 --> 0:02:31.960 was this opportunity and sort of companies that had fallen 0:02:31.960 --> 0:02:34.280 out of the indexes that you know, if you pick 0:02:34.360 --> 0:02:37.920 them all up, might actually be, you know, we're worthy 0:02:38.240 --> 0:02:39.440 of a portfolio of their own. 0:02:40.320 --> 0:02:43.680 Well, we were at a paper back in twenty eighteen 0:02:45.080 --> 0:02:48.320 entitled by High and Sell Low with index funds, and 0:02:48.440 --> 0:02:51.600 the point of the paper was that index funds are 0:02:53.160 --> 0:02:56.240 most people think of them as passive, as representing and 0:02:56.280 --> 0:03:03.440 spanning the whole market, and they approximate do that they're passive, 0:03:03.480 --> 0:03:06.839 except that they do add new stocks and they do 0:03:07.000 --> 0:03:12.200 drop old stocks, hence in with the new and out 0:03:12.200 --> 0:03:15.680 with the old. But that's an active decision. In the 0:03:15.720 --> 0:03:18.520 case of S and P and MSCI, the indexes are 0:03:19.840 --> 0:03:22.919 additions and deletions are sorted through by a committee, and 0:03:22.960 --> 0:03:25.160 in the case of Russell, it's done in a somewhat 0:03:25.200 --> 0:03:29.920 formulaic way. But either way, stocks that get added to 0:03:29.960 --> 0:03:33.679 the index tend to be stocks that have swored, where 0:03:33.720 --> 0:03:36.400 their market value has risen to a point where they're 0:03:36.720 --> 0:03:40.600 big enough to grab a lot of interest and lo 0:03:40.720 --> 0:03:44.040 and behold. Those stocks tend to be trading at frothy multiples. 0:03:44.040 --> 0:03:47.800 On average, about twice the valuation multiples, price earnings or 0:03:47.840 --> 0:03:53.320 price to sales ratios of the broad market, and once 0:03:53.360 --> 0:03:58.280 they're added, the process of adding them pushes them higher. Still. 0:03:59.160 --> 0:04:04.040 In the case of Tesla, just as one example, between 0:04:04.080 --> 0:04:06.680 the announcement date and the effective date of it coming 0:04:06.760 --> 0:04:09.720 into the index, it rose I think over forty percent, 0:04:09.760 --> 0:04:16.080 if memory serves correctly. Now, are the index funds traumatized 0:04:16.120 --> 0:04:20.760 by buying forty percent higher than they could have just 0:04:20.880 --> 0:04:24.520 a few weeks earlier, No, they're not. They're focused on 0:04:24.640 --> 0:04:27.480 tracking here. They want to track perfectly with the index, 0:04:27.920 --> 0:04:31.360 and so they want to buy at exactly the price 0:04:31.400 --> 0:04:36.040 at which the index adds the stock. Now, for every 0:04:36.040 --> 0:04:39.880 stock that's added, something has to go out, and in 0:04:39.920 --> 0:04:43.240 the case sometimes it's a merger or an acquisition or 0:04:43.240 --> 0:04:46.600 a bankruptcy, so there's no decision involved. But if they 0:04:46.640 --> 0:04:49.640 have to make a decision, it's what we would call 0:04:49.680 --> 0:04:53.120 a discretionary deletion. They have to choose a company to 0:04:53.160 --> 0:04:55.120 take out. Well, that's going to be a company that's 0:04:55.160 --> 0:04:57.800 been in free fall for a very long time, a 0:04:57.839 --> 0:05:01.120 company that's trading at a deep discount relative to the market, 0:05:01.680 --> 0:05:05.840 and the process of deleting it pushes it down even further. 0:05:06.680 --> 0:05:10.000 So what did we find. We found that once you 0:05:10.160 --> 0:05:14.000 add a stock on average underperforms for its first couple 0:05:14.040 --> 0:05:16.159 of years by a percent or two a year. The 0:05:16.200 --> 0:05:20.560 stocks that are dropped outperformed by about twenty percent in 0:05:20.600 --> 0:05:23.839 the first year. Now, averaged over time, a lot of 0:05:23.839 --> 0:05:27.640 that's clustered in the aftermath of the dot com bubble, 0:05:27.640 --> 0:05:32.160 in the aftermath of the global financial crisis, but averaged 0:05:32.160 --> 0:05:36.800 over time, the average deletion outperforms by twenty eight percent 0:05:36.880 --> 0:05:40.039 over the next five years. That's a heck of a margin, 0:05:40.279 --> 0:05:41.920 a heck of an incremental return. 0:05:42.000 --> 0:05:44.120 It reminds me of the Fallen Angels bond etf When 0:05:44.120 --> 0:05:47.000 a bond gets kicked out of investment grade and goes 0:05:47.000 --> 0:05:50.480 into high yield, a lot of times it gets over 0:05:50.520 --> 0:05:54.560 sold because so much institutional money tracks that index. 0:05:55.600 --> 0:05:56.440 Is this trying to. 0:05:56.360 --> 0:06:01.359 Exploit a quirk in the fact that indexes have gotten 0:06:01.400 --> 0:06:04.280 so big that when they kick a member out, it 0:06:04.360 --> 0:06:08.960 gets over sold beyond the sentiment. And that's important because 0:06:09.200 --> 0:06:10.919 if a stock gets kicked out of an index, it 0:06:10.960 --> 0:06:13.599 means that active has been selling it and it's in 0:06:13.640 --> 0:06:16.719 free fall. As you say, so, I guess it just 0:06:16.720 --> 0:06:19.320 seems like it could be a tricky business to try 0:06:19.320 --> 0:06:23.120 to capture the over sold part and yet not get 0:06:23.120 --> 0:06:26.080 burned by the fact that the company has been deemed 0:06:26.080 --> 0:06:28.040 to be not worthy by active managers. 0:06:29.279 --> 0:06:31.240 You know, you put your finger on a very very 0:06:31.279 --> 0:06:35.720 interesting and very important point. If active managers don't want it, 0:06:36.160 --> 0:06:40.120 then it falls in price. It's active managers, not the 0:06:40.160 --> 0:06:43.760 index funds that do the price discovery, that set the 0:06:43.839 --> 0:06:46.640 value of a stock. And if it's been in freefall 0:06:46.720 --> 0:06:50.560 for a long time so that it's now worth so 0:06:50.760 --> 0:06:53.160 little that they want to kick it out of the index, 0:06:53.760 --> 0:06:59.000 then who's going to buy it? The index indexes s 0:06:59.080 --> 0:07:02.520 and p indexes span about twenty five percent of the 0:07:02.520 --> 0:07:06.360 market value of every single stock they own. So when 0:07:06.480 --> 0:07:10.760 Tesla came in, twenty five percent of the stock outstanding 0:07:10.800 --> 0:07:13.440 had to be bought by the index funds. And when 0:07:13.480 --> 0:07:17.840 AIV went out, twenty five percent of its outstanding market 0:07:17.920 --> 0:07:21.320 value had to be sold. And it was now a small, 0:07:21.440 --> 0:07:25.760 ill liquid, rather thinly traded stock, So the impact on 0:07:25.800 --> 0:07:29.640 the price is huge. The beauty of a deletion strategy 0:07:29.920 --> 0:07:35.280 is that on average, you get a big rebound. Now 0:07:35.320 --> 0:07:38.040 if you want to time it just perfectly forget it 0:07:39.400 --> 0:07:43.600 active managers don't want it. You're absolutely right. But the 0:07:43.680 --> 0:07:47.000 fact that it's so depressed means that it has to 0:07:47.120 --> 0:07:52.320 only exceed a very low hurdle. It has to exceed 0:07:52.480 --> 0:07:56.960 bleak expectations in order to perform well. Well over half 0:07:57.000 --> 0:08:01.760 of all deletions go on to underperform, continue to underperform, 0:08:02.040 --> 0:08:07.080 but the ones that exceed those bleak expectations rebound in 0:08:07.120 --> 0:08:10.560 some cases so sharply that the overall average is improved 0:08:10.560 --> 0:08:13.840 to a twenty eight percent gain over the market over 0:08:13.880 --> 0:08:14.960 the next five years. 0:08:15.560 --> 0:08:17.680 So Rob, one of the things that's so interesting about 0:08:17.680 --> 0:08:23.000 the strategy is there's this smart beta that we've talked about, 0:08:23.320 --> 0:08:24.840 and it's actually one of the reasons Eric and I 0:08:24.840 --> 0:08:28.120 found each other all those years ago, because I was like, 0:08:28.160 --> 0:08:31.280 this is really interesting. It's like it's sort of got 0:08:31.720 --> 0:08:35.360 a part of passive and a part of active, and 0:08:35.400 --> 0:08:39.760 you come together because the strategy is basically rules, right, 0:08:39.840 --> 0:08:43.040 so it's not just active picking kind of whatever they 0:08:43.160 --> 0:08:47.480 feel like is could have outperformance. It's like you look 0:08:47.480 --> 0:08:49.559 at passive, you take some of the rules of passive 0:08:49.559 --> 0:08:51.559 and you and some rules of the active, and you 0:08:51.679 --> 0:08:55.560 kind of find a place, a heartless place in the middle. 0:08:56.040 --> 0:08:59.800 And I'm curious when you think about this, how how 0:09:00.040 --> 0:09:00.800 heartless is it? 0:09:01.120 --> 0:09:01.320 Right? 0:09:01.360 --> 0:09:03.840 Because I'm just drawn to like wanting to know what 0:09:03.840 --> 0:09:06.680 the companies are that sort of exemplify the strategy. And 0:09:06.760 --> 0:09:08.520 yet you, on the other hand, it's like you don't 0:09:08.559 --> 0:09:11.160 really care about the companies so much as the strategy. 0:09:11.160 --> 0:09:12.160 That's exactly the rules. 0:09:12.480 --> 0:09:15.880 Yeah, Well, the whole essence of smart beta originally was 0:09:16.720 --> 0:09:19.000 strategies that break the link between the price of a 0:09:19.040 --> 0:09:22.239 stock and its weight in the portfolio. With conventional indexes, 0:09:22.280 --> 0:09:25.400 the higher the price, the higher the valuation multiples, the 0:09:25.440 --> 0:09:30.239 bigger your weight in that portfolio, and so you're assuredly 0:09:30.320 --> 0:09:35.439 overweighting the overvalued and underweighting the undervalued. Well, deletions kind 0:09:35.480 --> 0:09:38.480 of tick that to a new level. There they fall 0:09:38.520 --> 0:09:42.520 in value so much that the index kicks them out 0:09:42.559 --> 0:09:45.680 and gives them zero weight altogether. So one way to 0:09:45.720 --> 0:09:48.920 think about this is it's a completion strategy. If you 0:09:48.960 --> 0:09:52.160 want to own the market and you own an index fund, 0:09:52.360 --> 0:09:55.000 you don't own the stocks that aren't in the index. Well, 0:09:55.000 --> 0:09:58.679 that includes tiny companies that may or may not make it, 0:09:59.200 --> 0:10:05.000 and size past successes that have fallen deeply out of 0:10:05.000 --> 0:10:07.720 favor and I think that's why you get the snap back. 0:10:07.880 --> 0:10:14.959 Your starting point is deep discount valuations, long term under performance. 0:10:15.600 --> 0:10:18.040 That sort of thing can lay a foundation for long 0:10:18.040 --> 0:10:20.760 horizon mean reversion for the bounce back that we're seeking 0:10:20.800 --> 0:10:21.320 to catch. 0:10:29.160 --> 0:10:31.720 Let's talk about this lack of you called it heartless, 0:10:31.800 --> 0:10:34.679 lack of emotion, because a lot of ETFs coming on 0:10:34.800 --> 0:10:37.600 hour active like active. I think last time I checked 0:10:37.640 --> 0:10:39.720 about it, three quarters of all the launches are active, 0:10:40.360 --> 0:10:42.400 and that's because the ETF rule has made it easier 0:10:42.400 --> 0:10:44.200 to do active and I won't get in details, but 0:10:44.280 --> 0:10:47.440 also active having a little bit of a renaissance anyway. 0:10:48.360 --> 0:10:51.960 Smart Beta is active but using an index. So once 0:10:52.000 --> 0:10:56.199 you set the index, you the human who manage the fund, 0:10:56.280 --> 0:11:00.400 you can't do a thing about it. And that lack 0:11:00.440 --> 0:11:04.720 of emotion, you know, is interesting because when you have 0:11:04.760 --> 0:11:06.760 an active ETF at the end of the day, a 0:11:06.880 --> 0:11:10.160 human can do a thing about it. And so I guess, 0:11:10.600 --> 0:11:13.160 can you talk a little bit about how the lack 0:11:13.200 --> 0:11:19.120 of emotion is you know, one of one of the features, 0:11:19.160 --> 0:11:22.040 not bugs, I guess, of the smart Beta ETFs, which 0:11:22.080 --> 0:11:24.640 by the way, now have two trillion in assets, that's 0:11:24.640 --> 0:11:27.880 about twenty two twenty three percent of all etfsts. 0:11:28.440 --> 0:11:31.840 Yeah, that's we crossed the two trillion threshold just this year. 0:11:31.880 --> 0:11:40.000 That's kind of an exciting transition. Emotions are our enemy, 0:11:40.000 --> 0:11:44.120 and investing emotions condition us to well, think about it 0:11:44.120 --> 0:11:48.160 this way. Whatever has caused us has given us profit 0:11:48.720 --> 0:11:52.720 and joy. We want more of that, even though past 0:11:52.760 --> 0:11:56.560 profits don't mean future profits. Whatever has given us pain 0:11:56.640 --> 0:12:00.240 and losses. Human nature says, get me out of here, 0:12:01.360 --> 0:12:06.160 even though past disappointment doesn't mean future disappointment. In fact, 0:12:06.160 --> 0:12:12.040 there's a market anomaly called long horizon meaner version, where 0:12:12.440 --> 0:12:15.520 assets that have performed badly for a very long time 0:12:15.720 --> 0:12:20.280 tend to outperform. That's one of the key drivers here. Well, 0:12:20.360 --> 0:12:23.360 human emotion will tell us not to buy those stocks. 0:12:24.040 --> 0:12:27.680 And so I love stripping emotion out of the decision 0:12:27.720 --> 0:12:30.760 process because emotion steers us to do the wrong thing 0:12:30.800 --> 0:12:33.400 at the wrong time all the time in investing. 0:12:33.640 --> 0:12:36.640 You know, this idea of no emotion. One of the 0:12:36.640 --> 0:12:38.400 best examples, and I cite it in my first book. 0:12:38.480 --> 0:12:42.680 Droll was something that a CTF nerds you included called 0:12:42.720 --> 0:12:46.760 the immaculate rebalance, And it was a time when one 0:12:46.760 --> 0:12:50.160 of Rob's indexes, which was linked to the ETF called PRF. 0:12:50.880 --> 0:12:54.120 It's a fundamentally weighted index. It had to do a 0:12:54.160 --> 0:12:56.720 rebalance in two thousand and eight, two thousand and nine, 0:12:57.760 --> 0:13:00.600 and because it had a certain program in it to 0:13:00.679 --> 0:13:04.720 look for deeply you know, troubled deep value and whatnot, 0:13:05.559 --> 0:13:08.440 it went and did a bout. It bought so many 0:13:08.480 --> 0:13:11.120 bank stocks that the financial allocation went up to fifty 0:13:11.120 --> 0:13:14.960 percent because no human on earth, no human manager, could 0:13:15.040 --> 0:13:18.240 stomach buying those banks. After what happened in two thousand 0:13:18.280 --> 0:13:19.760 and eight, I think I think you just got it 0:13:19.760 --> 0:13:22.000 to me once. Like it was like a portfolio manager 0:13:22.080 --> 0:13:23.600 running into a burning building and like. 0:13:23.600 --> 0:13:25.280 I'll buy it, I'll buy it all. Yeah. 0:13:25.360 --> 0:13:28.400 Yeah, it's like literally running into fire. But the index 0:13:28.440 --> 0:13:31.960 doesn't care. It's like a terminator. It runs into the fire. 0:13:32.040 --> 0:13:33.520 It doesn't it doesn't do anything. 0:13:33.960 --> 0:13:34.440 Right? Is that? 0:13:34.760 --> 0:13:38.640 And tell us about the index, the ETF versus the 0:13:38.679 --> 0:13:40.160 separate account you have with that index. 0:13:41.640 --> 0:13:49.080 Sure, well, the ETF you're referring to PRF is Investigo 0:13:49.200 --> 0:13:56.360 Power Shares RAFFI one thousand, RAFI being Research affiliates Fundamental Index. 0:13:57.160 --> 0:14:00.959 Fundamental index basically has a premise that we don't want 0:14:00.960 --> 0:14:03.720 to weight stocks according to how expensive they are. We 0:14:03.800 --> 0:14:06.640 want to wait them according to how big their business is. 0:14:07.600 --> 0:14:14.680 So when you had a situation where very large businesses autos, banks, 0:14:14.720 --> 0:14:22.040 and so forth were priced for oblivion, then Fundamental Index said, okay, 0:14:22.080 --> 0:14:25.720 it's time to rebalance. Let's find out how big these 0:14:25.720 --> 0:14:27.920 businesses are. Oh, they're still just as big as they 0:14:27.920 --> 0:14:30.840 were a year ago. Okay, so let's top them up 0:14:31.480 --> 0:14:34.280 to the weight that they had a year ago. And 0:14:34.560 --> 0:14:39.240 the result was massive buying of deeply out of favor 0:14:39.320 --> 0:14:45.920 financial services companies and autos and other consumer durables. One 0:14:45.960 --> 0:14:49.880 of the autos, GM went bankrupt sixty days later, so 0:14:49.960 --> 0:14:52.880 you bought into it and it went to zero. But 0:14:53.160 --> 0:14:56.280 on the other hand, you bought into City and b 0:14:56.440 --> 0:15:00.120 of A and other banks. City and b of A 0:15:00.320 --> 0:15:03.200 were two percent of the US economy each, so you 0:15:03.480 --> 0:15:06.240 bought back to two percent weight, and they went on 0:15:06.280 --> 0:15:11.680 to triple in the next six months. So those stocks 0:15:11.720 --> 0:15:18.040 were bought because waiting companies according to their economic footprint 0:15:18.120 --> 0:15:22.320 means if the price tumbles and the underlying fundamentals don't, 0:15:22.480 --> 0:15:25.280 you're going to top it up. And if the price 0:15:25.320 --> 0:15:27.560 soars and the fundamentals don't, you're going to trim it, 0:15:28.320 --> 0:15:33.440 so you wind up contratrating against the market's most extravagant bets. Well, 0:15:33.480 --> 0:15:36.280 those were big bets in the global financial crisis. And yeah, 0:15:37.360 --> 0:15:41.200 the best of my recollection, that particular index beat the 0:15:41.320 --> 0:15:45.240 S and P by fifteen hundred basis points that year. Well, 0:15:45.320 --> 0:15:47.640 let's bring this back was with a broadly diversified thousand 0:15:47.680 --> 0:15:48.640 stock portfolio. 0:15:49.240 --> 0:15:51.880 So let's bring this back to next because I'm curious 0:15:51.920 --> 0:15:54.800 about you know a thing that we haven't talked about yet, waitings. 0:15:54.920 --> 0:15:58.320 How do you decide what to what waitings to give 0:15:58.600 --> 0:15:59.920 the holdings in the portfolio. 0:16:01.080 --> 0:16:04.080 Well, firstly, we're not going to capitalization weight it because 0:16:04.080 --> 0:16:07.160 that just puts all of your money in the least 0:16:07.240 --> 0:16:12.520 unloved names on the list. And so we equally wait 0:16:12.960 --> 0:16:16.120 the stocks. Basically, any stock that falls out of the 0:16:16.160 --> 0:16:18.800 top five hundred or out of the top thousand in 0:16:18.840 --> 0:16:22.480 the US stock market, roughly corresponding to S and P 0:16:22.600 --> 0:16:25.600 five hundred and Russell one thousand. But stocks that fall 0:16:25.640 --> 0:16:29.200 out of those top tier lists and have done so 0:16:29.320 --> 0:16:32.400 anytime in the last five years become members of the 0:16:32.600 --> 0:16:36.280 next index. And so this consists of all of the 0:16:36.320 --> 0:16:39.480 stocks that have been deleted from top five hundred to 0:16:39.480 --> 0:16:42.600 top one thousand anytime in the last five years. Now, 0:16:42.840 --> 0:16:44.680 how big is that? Un that's a lot of stocks. 0:16:45.400 --> 0:16:47.680 That turns out to be about one hundred and fifty 0:16:47.720 --> 0:16:50.840 to two hundred stocks. We then take out the twenty 0:16:50.880 --> 0:16:55.120 percent worst quality of these stocks, the ones that have 0:16:55.320 --> 0:16:59.960 debt equity ratios or debt coverage ratios that are terrible, 0:17:00.040 --> 0:17:03.320 the ones that don't have any profits at all. So 0:17:03.360 --> 0:17:07.720 the bottom twenty percent are dropped for quality reasons. We 0:17:07.760 --> 0:17:10.800 don't we want cheap stocks, we don't want value traps. 0:17:11.520 --> 0:17:13.960 And the result is that that takes the total list 0:17:14.040 --> 0:17:16.720 down to on average, one hundred and twenty two hundred 0:17:16.760 --> 0:17:19.680 eighty names. Right now, it's got I think one hundred 0:17:19.680 --> 0:17:25.200 and forty seven names equally weight them and no disaster 0:17:25.359 --> 0:17:29.480 stock is going to hurt you too badly. And if 0:17:29.800 --> 0:17:31.840 you have a half dozen or a dozen of them 0:17:31.880 --> 0:17:35.960 that triple, well, that boosts your aggregate return rather nicely. 0:17:37.520 --> 0:17:40.359 Okay, let me ask you a question, why not just 0:17:40.480 --> 0:17:45.439 buy a small cap value ETF. There's a couple ones 0:17:45.440 --> 0:17:49.199 that have taken off recently in that category. What's the 0:17:49.240 --> 0:17:49.920 difference here? 0:17:51.560 --> 0:17:54.440 Well, a couple of things though, small cap value The 0:17:55.520 --> 0:17:58.320 biggest name in small cap value I think is IWN, 0:17:59.600 --> 0:18:04.920 which is the Russell two thousand value ETF by I Shares. Firstly, 0:18:05.000 --> 0:18:10.280 that's capitalization weighted, so most of your money will be 0:18:10.520 --> 0:18:15.960 in the least inexpensive of the small cap value names, 0:18:16.400 --> 0:18:24.080 so the capitalization waiting reduces your opportunity. Secondly, it includes 0:18:24.280 --> 0:18:29.320 all of the Russell two thousand value stocks, including all 0:18:29.320 --> 0:18:31.800 the value traps. We try to filter those out with 0:18:31.840 --> 0:18:36.840 a quality filter. Thirdly, it includes a lot of little 0:18:36.880 --> 0:18:40.560 companies that may or may not turn out to be successful. 0:18:41.200 --> 0:18:46.000 The NIXT index owns companies that were successful that fell 0:18:46.040 --> 0:18:50.719 out of favor. Fallen angels is a perfectly legitimate label 0:18:50.760 --> 0:18:54.359 for it. So these fallen angels, some of them regain 0:18:54.400 --> 0:18:56.480 their footing, and you don't need a lot of them 0:18:56.520 --> 0:18:59.320 to regain their footing for the average return to be brilliant. 0:19:00.640 --> 0:19:03.439 Rob, I'm curious, you've been doing this for a while. 0:19:04.040 --> 0:19:08.639 Research affiliates been around creating indexes and whatnot, But this 0:19:08.720 --> 0:19:12.679 is actually the first time you had an ETF to 0:19:12.760 --> 0:19:17.639 your name, and I'm curious why this one, and what 0:19:17.720 --> 0:19:20.480 have you learned about the industry that you didn't know before. 0:19:21.640 --> 0:19:26.320 Well, a few things. Firstly, we've been associated with lots 0:19:26.359 --> 0:19:29.720 of ETFs. PRF that we were just talking about was 0:19:29.800 --> 0:19:34.320 launched based on our fundamental index concept. PRF was launched 0:19:34.800 --> 0:19:38.280 with power Shares before. It was part of Invesco reaching 0:19:38.320 --> 0:19:40.320 out to us and saying, we love your concept, can 0:19:40.320 --> 0:19:43.159 we launch an ETF. This was a little bit the 0:19:43.240 --> 0:19:47.359 other way around. ETF Architects is a one stop shop 0:19:47.920 --> 0:19:52.400 for turnkey launch of ETFs. We reached out to them 0:19:53.160 --> 0:19:54.960 to say would you like to launch this? And of 0:19:55.000 --> 0:19:59.560 course the difference is with a turnkey platform for launching 0:19:59.600 --> 0:20:04.199 an et most of the revenues come to us, where 0:20:05.800 --> 0:20:08.400 with power Shares most of the revenues would go to them. 0:20:08.480 --> 0:20:13.679 So it's just a different business model. What made it 0:20:14.000 --> 0:20:18.479 our first case where we initiated the launch of an 0:20:18.480 --> 0:20:24.920 ETF strategy was firstly, this is a niche strategy. It's 0:20:24.960 --> 0:20:28.040 a really cool, interesting strategy, but it's not a big 0:20:28.119 --> 0:20:33.600 market strategy that an organization like Invesco or I Shares 0:20:33.680 --> 0:20:39.480 is likely to want to launch. Secondly, the one stop shop, 0:20:39.560 --> 0:20:44.000 the turnkey system for launching ets didn't exist until the 0:20:44.080 --> 0:20:47.080 last few years and so it wasn't an option for us. 0:20:47.119 --> 0:20:52.600 We don't have ETF infrastructure. We don't have a trading desk. 0:20:53.119 --> 0:20:56.240 We specialize in product innovation, which is why our business 0:20:56.240 --> 0:20:58.280 model is to partner with others for distribution. 0:21:06.440 --> 0:21:08.600 Let me ask you something. You're a veteran of the 0:21:08.600 --> 0:21:11.840 ETF space. When I bumped into a couple veterans over 0:21:11.880 --> 0:21:15.600 the past year, and they are getting a little old 0:21:15.640 --> 0:21:21.600 man on launish about all of the new launches, you know, 0:21:21.640 --> 0:21:26.440 the single stock leverage ETFs, the buffer ETFs. It's sort 0:21:26.440 --> 0:21:31.320 of like what happened to my beloved ETF industry. It's 0:21:31.359 --> 0:21:35.720 gone crazy. Are you Are you part of that kind 0:21:35.720 --> 0:21:38.280 of mindset or are you a little more libertarian? 0:21:38.359 --> 0:21:39.359 You know, go crazy? 0:21:39.400 --> 0:21:42.280 You know, I am a libertarian with both in my 0:21:42.400 --> 0:21:46.200 politics and in my approach to business. I love exploring 0:21:46.240 --> 0:21:49.280 new ideas, and if somebody wants to launch a three 0:21:49.520 --> 0:21:54.760 x leveraged in Vidia single stock ETF, more power to them. 0:21:54.800 --> 0:22:00.800 I'm not going to be a buyer, but the marketplace 0:22:00.880 --> 0:22:03.479 sort out the good ideas from the bad. I'm a 0:22:03.720 --> 0:22:07.080 huge proponent of free market. 0:22:08.000 --> 0:22:10.600 Well, I guess that's a pretty interesting way to bring 0:22:10.640 --> 0:22:16.080 it back to next. So when do you decide that 0:22:16.600 --> 0:22:19.880 it's your any of these holdings are no longer worthy. 0:22:19.880 --> 0:22:22.960 Of being in your in your team. It's the exit strategy. 0:22:24.400 --> 0:22:27.480 The exit strategy is very simple. If it's been readded 0:22:27.720 --> 0:22:31.280 to the top five hundred to the top thousand, then 0:22:32.000 --> 0:22:35.679 it's no longer a reject, so it comes out of 0:22:35.720 --> 0:22:40.840 our portfolio. So it's as you said in the opening tagline, 0:22:41.840 --> 0:22:44.920 out with the new and in with the old. So 0:22:48.320 --> 0:22:51.360 the second way you get kicked out of our index 0:22:51.600 --> 0:22:54.920 is after five years, because there's this window of time 0:22:55.320 --> 0:22:59.960 of five years in which you get twenty eight percent 0:23:00.000 --> 0:23:05.120 average incremental return over the next five years. That's five 0:23:05.160 --> 0:23:09.000 percent compounded per annum. It dissipates after the first five years. 0:23:09.040 --> 0:23:11.719 It's still positive, but it's not as interesting. 0:23:11.640 --> 0:23:15.120 On the five years. Is that because once it gets 0:23:15.200 --> 0:23:18.840 kicked out, you need active managers to have some time 0:23:19.440 --> 0:23:21.040 to sort of sort through and go, wait a second, 0:23:21.480 --> 0:23:23.920 this is undervalue. But if it lasts five years as 0:23:23.960 --> 0:23:25.639 a dog, it's just bad. 0:23:27.119 --> 0:23:30.320 I think there's truth in that. Although a beautiful counter example. 0:23:31.440 --> 0:23:35.000 Dillard's is a small department store that I believe has 0:23:35.040 --> 0:23:38.840 been in the Russell one thousand, four separate times in 0:23:38.880 --> 0:23:41.560 the last thirty years. It's been kicked out four times 0:23:41.920 --> 0:23:44.000 the last time it was kicked out was two thousand 0:23:44.000 --> 0:23:44.320 and seven. 0:23:45.160 --> 0:23:48.160 That is a great We do trivia shows on here. 0:23:49.200 --> 0:23:52.960 That is a killer Jeopardy one thousand level question right there. 0:23:53.560 --> 0:23:54.240 Four times. 0:23:54.320 --> 0:23:58.840 Huh yeah, And the last time was twenty seventeen, and 0:23:58.920 --> 0:24:01.440 it's up something like five hundred and fifty percent since then. 0:24:01.520 --> 0:24:03.119 Most of that was in the first five years that 0:24:04.200 --> 0:24:08.439 I'm guessing that next year they'll probably be readmitted for 0:24:08.480 --> 0:24:16.280 a fifth time. So if index funds buy high and 0:24:16.320 --> 0:24:20.720 sell low, buy high multiple stocks when they're added, sell 0:24:20.760 --> 0:24:23.679 low multiple stocks when they're kicked out. We try to 0:24:23.680 --> 0:24:26.520 buy low and sell high by buying deeply out of 0:24:26.560 --> 0:24:29.080 favor and selling when they come back into favor. Now 0:24:29.080 --> 0:24:31.320 some of them, roughly half of them never do come 0:24:31.359 --> 0:24:35.880 back into favor. But if the ones that underperform underperform modestly, 0:24:35.920 --> 0:24:38.439 and the ones that outperform underperformed by a big margin, 0:24:38.720 --> 0:24:41.399 you've got a winning strategy. So I think it's a 0:24:41.440 --> 0:24:43.919 lot of fun. I think it's a cool idea. I 0:24:43.960 --> 0:24:48.280