Speaker 1: Hello, and welcome to another edition of The Bots Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe. Joe. Do you remember
Speaker 1: what was happening in nineteen sixty two? I mean from
Speaker 1: a financial markets perspective. I thought I thought you were
Speaker 1: asking me, like what my personal recollection was from nineteen
Speaker 1: But no, not only do I not personally remember what
Speaker 1: happened in nineteen sixty two, probably couldn't actually tell you
Speaker 1: anything that I know about financial markets in nine sixty two.
Speaker 1: So I'm I'm drawing a blank here. Okay, well you're
Speaker 1: going to enjoy this, then I find this really interesting.
Speaker 1: I think you will too. But in nineteen sixty two,
Speaker 1: there was a little stock market crash and it became
Speaker 1: known as the Kennedy Slide. Not many people remember it now,
Speaker 1: but it was really interesting because it was basically the
Speaker 1: first crash that happened in a stock market that had
Speaker 1: mutual funds in it, because mutual funds hadn't really been
Speaker 1: around in nine or in the Great Depression, So it's interesting.
Speaker 1: So it was the crash associated with something mechanically with
Speaker 1: the funds or is it was it just sort of
Speaker 1: like a coincidence that there are these new vehicles at
Speaker 1: the time. Ah okay, So this is where it gets
Speaker 1: really interesting because as stocks started to fall on this
Speaker 1: one particular week in nineteen sixty two, there was this
Speaker 1: real concern that all these new fangled mutual funds we're
Speaker 1: going to end up making the crash worse. Basically, people
Speaker 1: thought that investors would be able to sell their holdings
Speaker 1: much more easily because they were in they were wrapped
Speaker 1: up in these mutual funds. Now, in the end that
Speaker 1: didn't actually happen. The mutual funds actually came in and
Speaker 1: bought a bunch of stocks, so they ended up supporting
Speaker 1: the market and everyone was kind of saved thanks to
Speaker 1: mutual funds. But it's clearly interesting because it gets to
Speaker 1: this big question of how open ended funds behave when
Speaker 1: there's trouble. And you and I both like to talk
Speaker 1: about market structure. We talk a lot about the rise
Speaker 1: of passive investing, but we also talk about e t
Speaker 1: f s and sometimes mutual funds, right exactly, and you
Speaker 1: hear it a lot these days, people warning about e
Speaker 1: t f s are getting so big and so enormous,
Speaker 1: and there's so many, they're so liquid, and people are
Speaker 1: concerned about the underlying assets in them, and we haven't
Speaker 1: really seen any big structural systematic problems yet. But if
Speaker 1: you ask people like, oh, what are you most worried
Speaker 1: about or what could bring on another financial crisis, even
Speaker 1: if people are sort of vague and hazy about how
Speaker 1: it would work, there's like this suspicion that modern rappers
Speaker 1: of assets or modern vehicles are somehow going to be involved. Right,
Speaker 1: that's exactly right. And of course there's an overwriting discussion
Speaker 1: as well about how mutual funds are constructed and how
Speaker 1: the benchmarks that they follow are actually defined and constructed.
Speaker 1: And that's something that we've spoken about before in terms
Speaker 1: of these worries over mutual funds or e t F
Speaker 1: basically open ended vehicles wrapped around certain assets. There was
Speaker 1: one moment in time that happened relatively recently, certainly much
Speaker 1: more recently than in nineteen sixty two. Do you remember
Speaker 1: that one, Joe, Yeah, I think it was was that
Speaker 1: late and everyone started reading white papers about the connection
Speaker 1: between junk bond ETFs and junk bonds and whether that
Speaker 1: was going to create a problem. Yeah, that's exactly right.
Speaker 1: And we also had a credit fund. Uh, you know.
Speaker 1: I think at one point this credit fund was worth
Speaker 1: about three point five billion dollars, the Third Avenue Credit Fund,
Speaker 1: and it experienced about of redemptions that base sickly spooked
Speaker 1: the entire market. Yeah, I remember that. And in the end,
Speaker 1: the market overall was fine and we didn't have many
Speaker 1: sort of big systemic problems. But people sort of thought
Speaker 1: it was like, Okay, this could be like a harbinger.
Speaker 1: I mean, hey, I think people were relieved that it didn't,
Speaker 1: but it seemed like the type of thing that spoke
Speaker 1: to a lot of these anxieties which we've been talking
Speaker 1: about for a while. Yeah, exactly. So today I'm I'm
Speaker 1: quite excited about our guest because our guest is actually
Speaker 1: the former CEO of Third Avenue. It's David Bars and
Speaker 1: he's not only going to be talking about his experience
Speaker 1: at the fund and his opinions about general liquidity and
Speaker 1: mutual funds and e t f s, but we're also
Speaker 1: going to go into a really interesting discussion about indexes specifically,
Speaker 1: and also his new venture, which is kind of an
Speaker 1: interesting tweak on existing index investing. I can't wait. Alright, So,
Speaker 1: without further ado, David Clarks welcome to the show. So
Speaker 1: it's great to be here. I thought when you mentioned
Speaker 1: nineteen sixty two you were going to talk about that
Speaker 1: was the year I was born, and this was the
Speaker 1: significance of that, And you came up with this very
Speaker 1: interesting story that I didn't know about myself. So so
Speaker 1: you as your your barn you like me, You don't
Speaker 1: have any recognition now I do not, but I do
Speaker 1: have a pretty good recollection of what happened in two
Speaker 1: thousand fifteen. Shall we start with that then, um, and
Speaker 1: I wish that I could claim the nineteen sixty two
Speaker 1: thing is the result of my um deep research ahead
Speaker 1: of this podcast, but unfortunately it's just a happy coincidence.
Speaker 1: Let's start with late two thousand fifteen. David, do you
Speaker 1: want to maybe just explain what was going on at
Speaker 1: that time? Yeah, I mean, look, the name of the
Speaker 1: fund was the third Avenue Focused Credit Fund. Focused being
Speaker 1: emphasized here for making the point that we were a
Speaker 1: concentrated portfolio of highled and distressed securities that you could
Speaker 1: not get in that format in a liquid mutual fund
Speaker 1: format pretty much anywhere else. We were unique in what
Speaker 1: we had created for the marketplace. But the The fact
Speaker 1: that people thought of that fund as some representation for
Speaker 1: an overall market is sort of a misnomer because if
Speaker 1: you think back to the financial crisis, where you had
Speaker 1: many many funds git themselves in effect right put up
Speaker 1: the gates which there were permitted to do, you really
Speaker 1: didn't have much of a different story here. This was
Speaker 1: a fund that was the focused credit fund was set
Speaker 1: up to offer investors really an alternative to to a
Speaker 1: hedge fund, to a private vehicle. Uh and we were
Speaker 1: doing it in a in a public format. So what
Speaker 1: happened with that one fund really was not representative representative
Speaker 1: what was going on the markets. That weren't any other
Speaker 1: funds like that fund. So how did you have the
Speaker 1: idea originally before we get to even the events of
Speaker 1: late tell us a little bit about the evolution of
Speaker 1: the fund itself and how you saw an opportunity to
Speaker 1: offer access to a concentrated portfolio of these assets in
Speaker 1: that liquid vehicle. Okay, so two thousand eight, the financial
Speaker 1: crisis is is coming upon us. We were deep value investors.
Speaker 1: Pretty much most of our assets under management were in
Speaker 1: publicly listed equity securities. We had had a historical participation
Speaker 1: in debt and distress debt, both in public and private vehicles,
Speaker 1: but had really not had much exposure to that asset
Speaker 1: class leading up until the financial crisis. But as the
Speaker 1: financial crisis came upon us, obviously being higher up in
Speaker 1: the capital structure of a business is a safer way
Speaker 1: to invest. And our idea was to try and gather
Speaker 1: assets into that wave, if you will, and and do
Speaker 1: that in a in a way in which we can participate,
Speaker 1: cause we were like any other opportunistic value investor. That's
Speaker 1: where we saw the value really and really were excited
Speaker 1: about the opportunity. The problem is, how do you raise
Speaker 1: money going into a financial crisis when most people are
Speaker 1: taking money off the table, and we were experiencing that
Speaker 1: with our open and mutual funds, the equity funds. So
Speaker 1: the only solution that I could come up with at
Speaker 1: the time, because I was out pitching investors literally the
Speaker 1: week before and after Lehman Brothers went into bankruptcy, was
Speaker 1: to launch an open and mutual fund because that's what
Speaker 1: we had successfully done historically. And it took about nine
Speaker 1: months to get that done. So it's August two thousand
Speaker 1: nine and we read we file our third Avenue focused
Speaker 1: credit fund, and the opportunity was pretty clear, right. You
Speaker 1: had high yield trading at twelve hundred over as a spread,
Speaker 1: and and so you could pretty much pick your litter.
Speaker 1: It was like shooting fish in a barrel, quite frankly,
Speaker 1: because you could buy very plentiful supply of securities out
Speaker 1: there that you could buy and diversify the portfolio even
Speaker 1: though it's a focus fund, but diverse by the portfolio
Speaker 1: across industry, and that was an easy opportunity for us.
Speaker 1: The challenge was there weren't many funds being launched in
Speaker 1: that format. In fact, I believe we were the only one,
Speaker 1: and most people, if they were trying to access these securities,
Speaker 1: were doing it in private funds and hedge funds, So
Speaker 1: we were very unique. And in fact, I remember going
Speaker 1: on CNBC to announce the launch of the fund and
Speaker 1: a lot of folks took interest in what we were
Speaker 1: try iring to do at that time. So that was
Speaker 1: the that was the spirit for the launch. The idea
Speaker 1: and the opportunity was clearly there. Did it ever cross
Speaker 1: your mind to start a hedge fund or a private
Speaker 1: fund like other people were doing. I mean, you mentioned
Speaker 1: that you you've had success in other open ended mutual funds,
Speaker 1: so that was your expertise. But did you ever even
Speaker 1: think about it? Not just thought about it, attempted it
Speaker 1: in different derivations, especially since we had going into the
Speaker 1: financial I think two thousand seven rssets under management peaked
Speaker 1: at close to thirty one billion dollars, so we had
Speaker 1: a pretty broad client base. But those clients in two
Speaker 1: thousand eight were more interested in getting their money back
Speaker 1: than allocating capital, and so raising funds in a private format.
Speaker 1: And even though we had that kind of a u M,
Speaker 1: we were in a private fund what you call a
Speaker 1: first time fund man GERM, right, because most of our funds,
Speaker 1: in fact, all of our funds were in public format, right,
Speaker 1: and mutual funds or separately managed accounts. So when you
Speaker 1: launch a private fund, private fund investors like to see
Speaker 1: track records, and this is why you have many of
Speaker 1: the successful private equy firms out there launching Fund seventeen
Speaker 1: right now, because there they've got track records for the
Speaker 1: sixteen prior funds that investors make their decisions on. Unfortually,
Speaker 1: we are backward looking industry, right, So that was the
Speaker 1: challenge for us, and and it became really uh almost
Speaker 1: the only way we could get the money was to
Speaker 1: do it through this public format. Now, one of the
Speaker 1: concerns that was that we were already talking about and
Speaker 1: that was really spotlight in late is this idea of
Speaker 1: a sort of liquidity mismatch. People want daily liquidity, or
Speaker 1: if it's in an e t F form, they want
Speaker 1: a minute by minute liquidity, but just dressed assets, junk bonds,
Speaker 1: they don't just trade. You know, a minute by minute
Speaker 1: is easily is the same the same way as a
Speaker 1: stocks do. When you launched the fund, was this something
Speaker 1: that was on your mind as a concern, Yeah, of course,
Speaker 1: and and so the goal was to get to a
Speaker 1: critical mass so that you could have size and enable
Speaker 1: yourself to have a diversified portfolio, not have any heavily
Speaker 1: concentrated positions where liquidity constraints would mismatch investors needs or desires.
Speaker 1: Because investors in mutual funds have the right to redeem daily.
Speaker 1: Uh you know, there are certain redemption fee features that
Speaker 1: you can put on funds, but that's that's the nature
Speaker 1: of the vehicle. So of course we were very conscious
Speaker 1: of that, and we wanted to get the size that
Speaker 1: we did quite. I think my recollection is that the
Speaker 1: fund got to about seven million in a u M
Speaker 1: and within three or four months, which was sort of
Speaker 1: an unprecedented at the time raise, especially given the time
Speaker 1: framework in right, it's the fall winter of two thousand nine, right,
Speaker 1: still anount of time when people were thinking about getting
Speaker 1: back into the market. Right, we hadn't even had the
Speaker 1: green shoots conversations yet. So it was it was a
Speaker 1: very successful launch, if you will, and that helped create
Speaker 1: liquidity for investors if they chose. And there were points
Speaker 1: of time, especially as you think about what happened in
Speaker 1: two thousand eleven with the downgrade of US treasuries, right,
Speaker 1: you know, you had issues over time where markets were
Speaker 1: volatile and people wanted to take look, take capital off
Speaker 1: the table. So we have to be able to manage
Speaker 1: that through that period. The ultimate demise here was the
Speaker 1: fact that you know, you have I had a portfolio
Speaker 1: manager in charge of the fund who who made some
Speaker 1: bad investments. And at the end of the day, in
Speaker 1: any construct, whether it's a mutual fund or or a
Speaker 1: private fund, you have to be making good investments. That's
Speaker 1: what you're charged with doing. And and when you have
Speaker 1: investments that turn out to be non performers. That's what
Speaker 1: ultimately lead to the challenges with the fund. It wasn't
Speaker 1: the market issue as much as it was individual investments.
Speaker 1: So can I ask, if you were doing it all again,
Speaker 1: is there something that you would do differently or what's
Speaker 1: your biggest takeaway from that experience? Well? Yeah, I think
Speaker 1: if you're that the learning is twofold. Work harder to
Speaker 1: try and raise a private fund. That's a that's an
Speaker 1: easy one. And secondarily, if you're going to do something
Speaker 1: in a in a public format where investors can can
Speaker 1: access you daily and redeem you daily, then the only
Speaker 1: way to properly manage risk is to massively diversify the portfolio.
Speaker 1: So it's it's sort of what has ended up really
Speaker 1: transforming into the high yeld marketplace. You have. Most hield
Speaker 1: funds are basically benchmark trackers, right They own wildly diversified
Speaker 1: portfolios of securities that track the high heeled index. So basically,
Speaker 1: if you're going to have a daily vehicle or liquid
Speaker 1: vehicle for the public, your lesson now is there's almost
Speaker 1: no way to do it on a concentrated basis. It
Speaker 1: just has to roughly more or less everything. That's correct
Speaker 1: if investors are going to demand daily liquidity. Right when
Speaker 1: it comes to credit market liquidity in general, we hear
Speaker 1: so much noise about, you know, trading having become more difficult,
Speaker 1: the market any more liquid, more e t f s,
Speaker 1: more open ended funds that are investing in you know,
Speaker 1: high old bonds and things like that. Are those valid
Speaker 1: concerns in your opinion? Well, I haven't seen it manifest
Speaker 1: itself in any way that that would cause me to
Speaker 1: be concerned about it. I think you had a point
Speaker 1: a little less than a year ago, maybe in January
Speaker 1: of this year, where HYLD was almost trading at perfection,
Speaker 1: probably maybe unprecedented in terms of where it was from
Speaker 1: a from a yield basis, and and the spread as
Speaker 1: as thin as I think it's ever been, and you
Speaker 1: didn't really have any any issues, and we weathered through
Speaker 1: what was a pretty challenging energy market a couple of
Speaker 1: years ago that we're now seeing. I think there were
Speaker 1: articles about it today that energy is now maybe the
Speaker 1: largest percentage of the High Heeled index right now, and
Speaker 1: you're seeing a sort of a robust demand for securities
Speaker 1: in that sector. So the market has seemed to evolve
Speaker 1: itself into a pretty stable place, notwithstanding all of these
Speaker 1: traditional metrics that might cause concern for folks, But it
Speaker 1: hasn't done anything to um to spook the market from
Speaker 1: what I can see. So the going back to a
Speaker 1: couple of years ago when we had the energy crash
Speaker 1: and a lot of high old dead tied to energy,
Speaker 1: that was obviously when people were most worried. In your view,
Speaker 1: the fact that we got through that period that it
Speaker 1: was pretty smooth, that none of the concerns really turned
Speaker 1: out too much, it's pretty good evidence that the market
Speaker 1: structure roughly works. Yeah, And if you had asked how
Speaker 1: old investors what their biggest concerns where maybe a year
Speaker 1: ago that's a healthcare was going to be the next
Speaker 1: energy sector and where what happened? Right, We haven't read
Speaker 1: or heard much about that sector getting disrupted in a
Speaker 1: in any kind of material way. So I I just
Speaker 1: think people keep trying to look for problems. It's just
Speaker 1: for the sake of looking for problems, and and the
Speaker 1: market seems to have worked itself out pretty efficiently, which
Speaker 1: tends to happen. So David, let's talk about your new venture.
Speaker 1: I alluded to it in the intro. But it's kind
Speaker 1: of an interesting take on investing. And I guess the
Speaker 1: clue is in the name. You know, you're now principal
Speaker 1: and co founder at outvest Capital. Can you tell us
Speaker 1: quickly what exactly it does, what the what the mandate is? Yeah?
Speaker 1: So out test is is really an intuitive, simple, scalable
Speaker 1: idea for how to do two things. One take advantage
Speaker 1: of what we think is the most forward facing risk
Speaker 1: for all investors, which is the rate of technological change
Speaker 1: and how tech is disrupting all industries. And secondarily, the
Speaker 1: wave of flows into the passive index investing marketplace, which
Speaker 1: I personally witnessed in my prior role, and as something
Speaker 1: that I think is going to continue infinitum. And so
Speaker 1: what simply one should think about is it may be important,
Speaker 1: more important what you leave out of your portfolio than
Speaker 1: what you put in. And thus the name and branding
Speaker 1: of our enterprise called outvest Capital. So this is really interesting.
Speaker 1: We typically think of funds as trying to select the
Speaker 1: very best assets within some sort of broader family, whether
Speaker 1: it's large caps or small caps, whatever. Your view is
Speaker 1: that perhaps the best way to go is to more
Speaker 1: or less by the index, but try to avoid the
Speaker 1: losers of the index so that you can gain from that.
Speaker 1: What is the Is there an academic research or backward
Speaker 1: looking data that suggests that that may be a better approach,
Speaker 1: So there isn't that we could identify. We wrote our
Speaker 1: own white paper which talks to this concept because if
Speaker 1: you really think about what you when you go to
Speaker 1: business school, you're given Harry Markowitz's book on modern portfolio theory,
Speaker 1: and it is pick concentrated portfolios of best ideas and
Speaker 1: over time you will beat the market. Right, that's the
Speaker 1: basis for the way most people are educated today, and
Speaker 1: still today we take issue with that and actually say
Speaker 1: that really flip the investment process and it's more important
Speaker 1: what you leave out than with you put in. Because
Speaker 1: the market has evolved, index funds are the market today.
Speaker 1: They are continuing to grasp more and more of what's
Speaker 1: happening where flows are going. And we decided to launch
Speaker 1: this concept after simulating back testing it for a little while.
Speaker 1: But we have chosen the SMP five hundred, the most
Speaker 1: broadest based domestic US market where more flows are going
Speaker 1: than in any other index, and simply by excluding as
Speaker 1: you call them the losers. We look at it as
Speaker 1: we're trying to eliminate from the portfolio those companies that
Speaker 1: are or likely will be disrupted by technology. And again
Speaker 1: technology disruption being a forward facing risk. And there's no
Speaker 1: better example for me to to share, and I think
Speaker 1: you you guys have talked about this in the past,
Speaker 1: is General Electric. General Electric was the top five i've
Speaker 1: company in the SMP from a market cap weighted basis,
Speaker 1: and now it's market cap is close to a hundred billions,
Speaker 1: and now I'll blow a hundred billions, Okay, So look,
Speaker 1: and that's happened in such a short period of time.
Speaker 1: And I think in May of two thousand seventeen, the
Speaker 1: Wall Street Journal wrote an article about how Jeff Emo
Speaker 1: was one of the great technology innovators in the way
Speaker 1: in which he'd you know, taken and transformed g GE. Well,
Speaker 1: that clearly hasn't happened. So it's it's think about that
Speaker 1: if you own the SMP, you were buying that stock
Speaker 1: at its weight, and if you've simply eliminated what kind
Speaker 1: of outperformance just from one security? Now we do this.
Speaker 1: We ended up out vesting through our process about a
Speaker 1: hundred and fifty close to of the market cap, and
Speaker 1: we have been able in eighteen months of live performance
Speaker 1: outperform the SMP by clist of five hundred basis points.
Speaker 1: So we're just trying to prove move this out. But
Speaker 1: that's where we're that's what we're doing. So how do
Speaker 1: you go about identifying those hundred fifty companies or how
Speaker 1: do you identify the next g e? And is the
Speaker 1: process for identifying something that you want to take out
Speaker 1: of your portfolio any different to identifying something you know
Speaker 1: under a traditional investment strategy that you would want to
Speaker 1: put in. So yes it is. And and the number
Speaker 1: of folks who we've talked about to say, why aren't
Speaker 1: you just doing a long short portfolio, because really the
Speaker 1: short selling mentality is to is to do that, to
Speaker 1: fundamentally select a security you think is going to not
Speaker 1: perform or under perform. But we're we're really trying to
Speaker 1: make this a scalable business, and short selling by definition
Speaker 1: has been non scalable. You have I think only one
Speaker 1: fund in the marketplace that's over a billion and a
Speaker 1: u M. So what our process entails is it's really
Speaker 1: two prong The for is simply dividing the index into
Speaker 1: industry groups through a technology taxonomy. In other words, we're
Speaker 1: not using the global industry classification codes to divide the index.
Speaker 1: We're using our own industry group determinations. And we we've
Speaker 1: divided the SMP into thirty four industry groups, and that
Speaker 1: may change depending upon how the SMP evolves over time,
Speaker 1: because there are new entrants and companies that leave the
Speaker 1: SMP from time to time. So we look at industry
Speaker 1: groups through our own lens and then we make a
Speaker 1: simple determination as that industry advantaged or disadvantaged by technology,
Speaker 1: and if it's advantaged, by default, that industry group and
Speaker 1: the securities in it will be in the portfolio. And
Speaker 1: if it's disadvantaged, that secure those securities and industry groups
Speaker 1: will be out vested from the portfolio or eliminated. So
Speaker 1: that's step one. It's a qualitative determination. It's an active approach,
Speaker 1: but it's merely making industry decisions, not company specific decisions.
Speaker 1: We then apply a quantitative model that we built to
Speaker 1: take that advantage group and make a decision whether to
Speaker 1: own it or not own it. So if it meets
Speaker 1: the quant screens, and the quant screens are are a
Speaker 1: lower bar for advantaged industries than they are for disadvantage.
Speaker 1: And similarly, if a company is in a disadvantaged industry,
Speaker 1: the quant screen will either keep it out or kick
Speaker 1: it back into the portfolio. So you can avoid situations
Speaker 1: where there are certain companies within an industry group. And
Speaker 1: I'll give you an example of that. Retail would clearly
Speaker 1: be a industry group that is likely to be disadvantaged
Speaker 1: by technology. I don't think many people would debate me
Speaker 1: on that, but there are companies within that industry group,
Speaker 1: like home depot, that we view as through our quant
Speaker 1: screen as having certain advantages and therefore it got kicked
Speaker 1: back in. And this is a fundamental quantz quant screen fund.
Speaker 1: This is looking at financial data of the company and
Speaker 1: something in that suggests that it's different than other retail.
Speaker 1: That's right now. You mentioned the advantage and investor could
Speaker 1: have by say, investing in the sp and not being
Speaker 1: exposed to G like even that would have been pretty good.
Speaker 1: Is there something that your screening would have picked up
Speaker 1: three years ago or two years ago or five years
Speaker 1: ago and never g E started to enter a tail
Speaker 1: spin that would have prevented that from getting into the portfolio.
Speaker 1: And can you identify what that is. Yeah, And indeed,
Speaker 1: in the case of G was our model that kicked
Speaker 1: the company out because we actually view industrials, which is
Speaker 1: this the industry group that G falls into, as an
Speaker 1: advantage sector. I mean that's industrials are clearly looking to technology,
Speaker 1: whether it's through robotics or otherwise to improve efficiencies and
Speaker 1: what they do. So long term, we we see that
Speaker 1: as an advantaged industry group. But the model kick G out,
Speaker 1: and primarily the the one particular signal for for for
Speaker 1: that company was was revenue growth rate. And so you
Speaker 1: had a situation where it's declining revenue growth and it's
Speaker 1: very hard for companies and publicly reported financials to fudge revenue.
Speaker 1: They can make all kinds of adjustments to EBITDA and
Speaker 1: other earnings metrics, but in the case of revenue, it's
Speaker 1: pretty tough two the fudget. So they triggered the model
Speaker 1: and got kicked out of the portfolio. Not long after
Speaker 1: we launched our fund, you mentioned that you had thought
Speaker 1: a lot about passive investing, the rise of passive investing.
Speaker 1: I assume that means that you've also thought a lot
Speaker 1: about the benchmark in disease and how those are constructed,
Speaker 1: and in fact, you know what you're talking about. It
Speaker 1: outvest is basically tweaking the SMP five hundred, which is
Speaker 1: itself a benchmark index. What do you think about the
Speaker 1: decisions that go into making the indusseries as as they
Speaker 1: currently stand. Yeah, look, we were having we're in the
Speaker 1: moment right now right where you have probably the most
Speaker 1: significant change to the SMP in terms of get classification. Right.
Speaker 1: You have a single person, David Blitzer, CEO of the SMP,
Speaker 1: who has the ability to make these changes in and
Speaker 1: now all of a sudden, we have something called communication
Speaker 1: services because Telecom had only two of the index when
Speaker 1: in two as we started this thing, I think Telecom
Speaker 1: was a significant percentage of the SMP, right so certainly
Speaker 1: was even ten years ago as compared to today. So
Speaker 1: they had to make adjustments two maintain the broad diversification
Speaker 1: of the index from a sector standpoint. That to us
Speaker 1: is sort of a statement of support for what we're
Speaker 1: trying to do because we we look at the SMP
Speaker 1: as a diversified portfolio where people if they want to
Speaker 1: diversified exposure the market, and we think all investors they've
Speaker 1: shown us that they want to have a diversified exposure
Speaker 1: to the general market, and in fact, institutional investors really
Speaker 1: need to have it, as most of their investment policy
Speaker 1: statements require them to have exposure. If if they can
Speaker 1: get that exposure in the same diversified way like our
Speaker 1: beta is is is almost one point oh even though
Speaker 1: we we excluded a hundred and fifty names, if they
Speaker 1: can get that and outperformed by the kind of margin
Speaker 1: that we've been able to generate in a very short
Speaker 1: period of time, and we think we can consistently do
Speaker 1: that over time, and consistency is a is a keyword
Speaker 1: in the asset management industry. Uh, they have to pay
Speaker 1: attention to that. So how the the indices change and
Speaker 1: evolve over time is going to be a significant impact,
Speaker 1: I think on the overall market. But there is no
Speaker 1: one that we've seen who's approached it as we have
Speaker 1: that is flipping this process to think about what to
Speaker 1: leave out as opposed to what to put in. Can
Speaker 1: you tell us sort of what if, if in what
Speaker 1: anything in your experience at Third Avenue or even with
Speaker 1: the collapse of the concentrated credit fund sort of led
Speaker 1: to you seeing this opportunity. Yeah, look, I I was
Speaker 1: a a student for a long period of time of
Speaker 1: my mentor and the founder off Third Have and being
Speaker 1: taught about concepts like diversification as a surrogate and a
Speaker 1: very poor surrogate for knowledge and and investing right, because
Speaker 1: you should know more about research, what you can fundamentally
Speaker 1: learn about a business, invest in that business, and over
Speaker 1: long time you'll be rewarded for that patience and and
Speaker 1: work right research. Yet consistently from the financial crisis forward,
Speaker 1: we were able to outperform indices. And so what asset
Speaker 1: managers like us did was we change the benchmark that
Speaker 1: we ended up getting compared to because we looked better
Speaker 1: against another benchmark than the original benchmark. We chose right.
Speaker 1: We were a SMP five hundred originally measured fund and
Speaker 1: we changed right. So what I was informed about there
Speaker 1: is you cannot I think you cannot beat the market.
Speaker 1: And if you can, then you're going to be in
Speaker 1: a hedge fund charging two percent management fees and the
Speaker 1: profits because you're a special individual who has skills that
Speaker 1: are more extraordinary, or you're a quantitative, purely quantitative manager
Speaker 1: who has come up with some concept that can beat
Speaker 1: the market. And we're seeing more and more asset flows
Speaker 1: into those types of vehicles as well. So the the
Speaker 1: informed judgment that I made was I now believe fully
Speaker 1: that these the market is going to evolve with more
Speaker 1: and more flows going into these types of entities, if
Speaker 1: just for fees, right, just just because fees are are
Speaker 1: much less, So if we can, if we can participate
Speaker 1: in capturing some of that flow, because we've come up
Speaker 1: with this intuitive concept and we're thinking about a forward risk.
Speaker 1: This is about technology disruption, which nobody's talking about. You
Speaker 1: guys will spend all day talking yesterday about what what's
Speaker 1: going to happen with the FED, and people study it
Speaker 1: up upwards and downwards. But how much time do you
Speaker 1: spend focusing on Moore's law and how that's impacting decision
Speaker 1: making and people's rate of change? Right? I was just
Speaker 1: I'll push back a little bit. I mean, I would say,
Speaker 1: we we do talk about this stuff, and we talk
Speaker 1: about vulnerable industries, and we talk about, say the clash
Speaker 1: between Amazon and physical retail. The thing that intrigues me
Speaker 1: most as a theory here is the idea of being
Speaker 1: able to quantify the disruption risk and the you know,
Speaker 1: we could talk you know one of the best performing
Speaker 1: sectors this year has been the department stores. And so
Speaker 1: this idea of actually being able to identify in a
Speaker 1: systematic manner and not just sort of your gut feel
Speaker 1: of these guys are in trouble is the part that
Speaker 1: I find to be I'm most interested in trying to understand. Yeah,
Speaker 1: and I would tell you that the fund and the
Speaker 1: concept is really about long term secular decline, but it
Speaker 1: will be technology that will be the the triggering for
Speaker 1: that long term secular decline. So maybe department stores are
Speaker 1: out performing because they were so under performing, but that's
Speaker 1: a I'd argue that that's a temporary a temporary blip,
Speaker 1: and that over time you'll continue to see deterioration in
Speaker 1: cycular decline unless they're able to transform themselves. And there
Speaker 1: are businesses that have been able to adjust, and it's
Speaker 1: those companies that adjust that I think will be the
Speaker 1: long term all Right, Well, David Bars, co founder and
Speaker 1: principle at Outvest, thank you so much for joining us.
Speaker 1: Thank you, Joe, Tracy really appreciate thank you. That was great. So, Joe,
Speaker 1: I found that conversation really fascinating, not just to hear
Speaker 1: the thoughts about what happened at Third Avenue, but also
Speaker 1: to hear his thoughts about diversification and the rise and
Speaker 1: passive investing, which is something that you and I have
Speaker 1: talked about quite a bit at this point. Yeah. Absolutely.
Speaker 1: I was going into the conversation thinking, oh, definitely the
Speaker 1: sort of Third Avenue fun collapse would be the most
Speaker 1: interesting part. But now I'm really intrigued sort of by
Speaker 1: the second half. And Okay, accepting this reality that we
Speaker 1: have now of mass of flows into passive or passive
Speaker 1: issue vehicles, what are the approaches that makes sense for now?
Speaker 1: Because as David said, it's pretty obvious it's just the
Speaker 1: sort of concentrated fund management strategy, particularly on the equity side.
Speaker 1: It's just not working for anyone. It looks like, right,
Speaker 1: and there's actually a link with um, you know what
Speaker 1: you said about Third Avenue, this notion that you know,
Speaker 1: if you're going to have a public facing fund, and
Speaker 1: especially an open ended one, you better make sure that
Speaker 1: it's diversified because otherwise people tend to get angry very
Speaker 1: quickly and tend to pull their money out very quickly,
Speaker 1: Whereas if you're investing, you know, in a broad index,
Speaker 1: it's kind of like that old maxim, that business maximum.
Speaker 1: You know, no one ever got fired for buying IBM,
Speaker 1: No one ever got fired for buying the SMP five
Speaker 1: hundred and making you know, little tweaks to it right absolutely,
Speaker 1: And this idea that maybe you could basically get the
Speaker 1: exact same beta, the exact same diversification with three fifty
Speaker 1: or four hundred of the SP stocks is pretty interesting.
Speaker 1: And you're probably not going to get fired for missing
Speaker 1: out on one of those hundred stocks they've got kicked out.
Speaker 1: And I like the idea that if they did turn
Speaker 1: themselves around, so maybe like some department store really does
Speaker 1: figure out the magic sauce to save retail, then maybe
Speaker 1: you could get back into the fund. On fundamental reasons,
Speaker 1: I am rooting for Sears. I have a soft spot
Speaker 1: for Sears. I hope they they are one of the
Speaker 1: ones that can redeem themselves. Who knows, I'm rooting for
Speaker 1: them to it. Okay, all right, Well this has been
Speaker 1: another episode of the Odd Lots podcast. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway, and
Speaker 1: I'm Joe Wisa though. You can follow me on Twitter
Speaker 1: at the Stalwart and you should follow our producer on
Speaker 1: Twitter He's told for Foreheads. His handle is at for
Speaker 1: headst and followed the Bloomberg head of podcast Francesco leaving
Speaker 1: at Francesca Today. Thanks for listening.