Speaker 1: Hello, and welcome to What Goes Up, a weekly markets podcast.
Speaker 1: My name is Mike Reagan and I'm a senior editor
Speaker 1: at Bloomberg. This week on the show, has all this
Speaker 1: rotation made you see sick? Yet? Earlier this year was
Speaker 1: the massive rotation out of big tech and other growth
Speaker 1: stocks and into more cyclical and value oriented stocks. But
Speaker 1: a whip of hawkishness from the Federal Reserve has caused
Speaker 1: everyone to sort of jumped back to the other side
Speaker 1: of the boat again and growth is outperforming once again,
Speaker 1: at least for now. Now some people are saying the
Speaker 1: market is falling for a head fake from the Fed.
Speaker 1: But we want to get into it with the head
Speaker 1: strategist at a major pioneering quantitative fund manager. But first
Speaker 1: I want to bring in our co host. And sorry
Speaker 1: to all the Charlie Pellet fans out there, but no
Speaker 1: Charlie Pellet intro this this week. And that's because as
Speaker 1: this co host is, there's no mystery about her. She's
Speaker 1: been on the show before and gotten to Charlie Pellet treatment.
Speaker 1: Her name is vill Donna hi Rich. She is a
Speaker 1: cross asset reporter at Bloomberg. Vill Donna, what do you
Speaker 1: have to say for yourself, well, I wouldn't be opposed
Speaker 1: if we had another Charlie Pellet treatment. Here you are.
Speaker 1: You're disappointed, aren't you? Everyone loves the Charlie Charlie. All right,
Speaker 1: I'm sorry. I apologize next time, but I will put
Speaker 1: out Vill Donna, as many of you know, is what
Speaker 1: I consider the chief crazy things correspondent for what goes up.
Speaker 1: Many of the crazy things I've brought to the show
Speaker 1: have been courtesy of Bill Donna. You're actually very sane
Speaker 1: and level headed for someone who is such an expert
Speaker 1: in crazy things. Though, I gotta say they're just really
Speaker 1: interesting to read. And I have what I think is
Speaker 1: a pretty good one you know today. Okay, good, I
Speaker 1: got a good one. So hopefully we don't have the
Speaker 1: same one that that would be awkward, and by all means,
Speaker 1: if you see something crazy, a reminder that we have
Speaker 1: a podcast hotline that's just sitting here waiting for you
Speaker 1: to leave us a voicemail. Vil Donna, our our old
Speaker 1: friends Sarah promised she would call the hotline and leave
Speaker 1: us some crazy things. But um alas so far, I'm
Speaker 1: like a kid on Christmas checking the voicemail and I'm
Speaker 1: nothing in my stocking. But I'm thinking maybe she's just
Speaker 1: forgotten the numbers, so I'll give the number. It's uh
Speaker 1: six four or six three two four three four nine.
Speaker 1: Oh so, please don't give us a call, leave us
Speaker 1: a voicemail and maybe we'll play it on the show.
Speaker 1: But let's get to that. Guest, as I said, he
Speaker 1: is the head of investment strategists at a big fund manager,
Speaker 1: uh that manages about six d and thirty seven billion
Speaker 1: dollars in assets. His name is West Krill, head strategist
Speaker 1: at Dimensional Fund Advisors. West, Welcome to the show, excited
Speaker 1: to be here, Thanks for having me today. Absolutely absolutely, West,
Speaker 1: I've got good news. I'm gonna start off with what
Speaker 1: we call in the industry, a softball question for you,
Speaker 1: uh so, so that's my gift to you today. But
Speaker 1: I'm just want to talk a little bit from your
Speaker 1: perspective about the approach Dimensional takes to investing. Now. Obviously,
Speaker 1: Dement sal as I said in the intro, considered a
Speaker 1: very pioneering firm that was sort of one of the
Speaker 1: first to be at the intersection of kind of the
Speaker 1: academic thinking about markets and actually managing money using those
Speaker 1: types of approaches. In the real world. For example, the
Speaker 1: founders studied under Eugene Fama and Kenneth's French Um. But
Speaker 1: I'm curious just for you to explain to us what
Speaker 1: is dimensionals approach to investing. Yeah, of course, So you know,
Speaker 1: we're founded in nineteen eighty one and we've always been
Speaker 1: built on implementing the great ideas in finance, and to
Speaker 1: your point, you know, a lot of that is cultivating
Speaker 1: these deep connections with some of the luminaries in the
Speaker 1: academic world Fama and French, like you mentioned, Robert Merton,
Speaker 1: Robert Novi, Mars. So that's been really instrumental in the
Speaker 1: way that we've built our firm. And then a central
Speaker 1: tenant to our investment philosophy is our deep seated belief
Speaker 1: in markets. So what that means is when we go
Speaker 1: to UH seek to outperform markets, we do so not
Speaker 1: by trying to outguess market prices and figure out where
Speaker 1: they've gone wrong, but by emphasizing certain groups of securities
Speaker 1: with higher expected returns based on research, very rigorous research
Speaker 1: from the academic community. And of course you know, we
Speaker 1: have a fanatical emphasis on the role of implementation. We
Speaker 1: feel that's a really critical level of expertise to have
Speaker 1: when you're trying to translate these ideas from the academic
Speaker 1: world into real world value add investments for our clients.
Speaker 1: I know you guys recently converted a bunch of your
Speaker 1: mutual funds into e t s and it was a
Speaker 1: really big deal in the world of ets, and I'd
Speaker 1: love to chat about that in a second, but maybe
Speaker 1: you can tell us a little bit about what types
Speaker 1: of things your clients and people who've been having conversations
Speaker 1: with recently have been asking you about them what's been
Speaker 1: on their minds? And I asked, because I'm thinking of
Speaker 1: all of the fund manager surveys and all these different
Speaker 1: surveys that we tend to see from from week to week,
Speaker 1: where some of the topics recently, I feel like have
Speaker 1: been changing. Where the virus used to be at the
Speaker 1: top of of mind for a lot of people and
Speaker 1: it's sort of fallen off and now it's more fed
Speaker 1: and questions around inflation, yes, certainly, I mean those come
Speaker 1: up in conversations. I would say the foremost conversation topic
Speaker 1: for us, and this has been the case really for years,
Speaker 1: is the performance of small cat value versus large cap growth,
Speaker 1: And you know, it's been interesting as you've sort of
Speaker 1: seen a cee saw in terms of the sentiment behind
Speaker 1: those questions. For a while, it was, you know, small
Speaker 1: cap value underperforming large growth concerns around that, and then
Speaker 1: when you had small cat value coming roaring back and
Speaker 1: people would start to ask how much longer can this last?
Speaker 1: And then you know, now you see that at least
Speaker 1: in this past quarter as small value has been underperforming
Speaker 1: large growth again. So you know, I think it reinforces
Speaker 1: a couple of different billion points for investors investors to
Speaker 1: keep in mind. The first is just the uncertainty around
Speaker 1: these premiums. So you know, the premise behind the small
Speaker 1: cat value stocks having higher expectory turns in the market
Speaker 1: is a very simple one. It's the idea that you're
Speaker 1: paying less for a stream of future cash flows, and
Speaker 1: that's a very evergreen concept. But we also know that
Speaker 1: stock returns are volatile, and these premiums can be negative
Speaker 1: for sustained periods of time, but they can also show
Speaker 1: up in really large magnitudes really quickly. The return difference
Speaker 1: between small value and large growth in the US as
Speaker 1: of March thirty one over the trailing six month period
Speaker 1: was sixty two percentage points. That's one of the largest
Speaker 1: return deltas over such a short period of time ever.
Speaker 1: But it's not uncommon for these premiums to show up
Speaker 1: in a hurry, and this has obvious implications for investors.
Speaker 1: It means that you need to be disciplined in terms
Speaker 1: of your approach to capturing these and it also means
Speaker 1: from an investment management standpoint, we need to be continuously
Speaker 1: pursuing these groups of stocks and a very accurate way,
Speaker 1: so that our investors know what they can expect from
Speaker 1: our investment approach, you know. So I want to talk
Speaker 1: about that what Vildana mentioned, the conversion of of some
Speaker 1: of your funds into et apps. I mean, you're still
Speaker 1: cominently a mutual fund manager, but you've you know, began
Speaker 1: the process of converting some into e t f s,
Speaker 1: And to me, I wonder, you know, in the bigger
Speaker 1: scheme of things, that seems to me like perhaps part
Speaker 1: of the natural evolution of quant investing. You know, I
Speaker 1: think back to one when you were founded, but I
Speaker 1: can't imagine the man hours and the labor required to
Speaker 1: do just a simple regression study. Say, going back you know,
Speaker 1: a few decades. It must have been, you know, and
Speaker 1: an army of of people with visors and calculators. There's
Speaker 1: all Texas instrument calculators. However, it was done. But is
Speaker 1: that part of it? Just that you know, uh, the
Speaker 1: computing power and the brain power on Wall Street is
Speaker 1: kind of caught up with the quant uh sort of strategies,
Speaker 1: and you know, it's now a lot you're able to
Speaker 1: do it a lot cheaper, able to put it in
Speaker 1: an ETF rapper, and and do it at a much
Speaker 1: less cost basis than than you would say, years ago
Speaker 1: in the equal fund space. Is does that sound right?
Speaker 1: Is it? Is it kind of part of that evolution? Well,
Speaker 1: I think that, you know, the E t F conversion
Speaker 1: was was a very exciting thing for us because that conversion,
Speaker 1: that type of event had not happened at that scale before.
Speaker 1: And those particular strategies that were converted are managed with
Speaker 1: an eye towards minimizing the tax impact for investors, and
Speaker 1: the et F rapper gives you another tool in the toolkit,
Speaker 1: uh to mitigate or to increase the tax efficiency of
Speaker 1: those strategies. And so that was a very important thing
Speaker 1: for us. But we like to say we're wrapper agnostic.
Speaker 1: You know, we believe both the mutual fund and et
Speaker 1: f rappers those type of vehicles do have a place
Speaker 1: depending on an investor's objectives. But I think one of
Speaker 1: the things you're kind of hinting at with this what
Speaker 1: i'll call the rise and systematic investing. You know, that's
Speaker 1: something that we have noticed, even going back further again
Speaker 1: to your point. You know, you mentioned how the ability
Speaker 1: to identify factors within the investment data, uh is a
Speaker 1: lot easier now that it used to be. You know,
Speaker 1: We're used to have computers the size of entire rooms
Speaker 1: like the and I'm sitting in that you needed to
Speaker 1: run regressions to identify these kind of parameters. Uh. Yeah,
Speaker 1: Now it's much timplt. You could probably do it on
Speaker 1: a smartphone. At this point. There is actually an academic
Speaker 1: by the name of Campbell Harvey who keeps track of
Speaker 1: all of the factors that have been identified in the
Speaker 1: academic literature, and last time I checked, it was up
Speaker 1: over five hundred. Uh And in fact, another academic named
Speaker 1: John Cochrane refers to this as the factors zoo Um. Now,
Speaker 1: this is not to say that there's that many, maybe
Speaker 1: hundreds of different distinct sources of expected returns. A lot
Speaker 1: of these are probably variations of the same economic concept
Speaker 1: that are repackaged, but I think it does bring the
Speaker 1: conversation back to the importance of implementation. It's one thing
Speaker 1: to identify a group of securities that, based on historical
Speaker 1: data while outperform in a simulation. Bringing that to a
Speaker 1: real world investment solution where you deliver the outperformance net
Speaker 1: of implementation costs is a different story altogether. And I'll
Speaker 1: give you one really simple example. The Russell two thousand,
Speaker 1: a small cap index we know from the research as
Speaker 1: small cap secure. These have higher expected returns than large caps. Well,
Speaker 1: the small cap Russell two thousand index has historically underperformed
Speaker 1: the Russell one thousand index going back to seventy nine.
Speaker 1: So that's one example. We're just identifying a group of
Speaker 1: stocks you expect to have higher returns. Doesn't always pan
Speaker 1: out an investment vehicle. You really need this level of
Speaker 1: expertise and the research, design, management, and last but not least,
Speaker 1: trading of a strategy to capture these sources of higher
Speaker 1: expector returns for investors. I want to ask you and
Speaker 1: Mike and I were chatting about this right before our conversation.
Speaker 1: But when it comes to some of those factors, does
Speaker 1: it feel like all of the good ones have already
Speaker 1: been sort of discovered and exploited and repackages, you say,
Speaker 1: or is there something else out there that you you're
Speaker 1: finding really exciting? I think that's certainly a challenge, you know,
Speaker 1: especially let's say you're a finance student these days compared
Speaker 1: to one thirty years ago, to find something that hasn't
Speaker 1: already been discovered. There's certainly the incentive to try and
Speaker 1: look for something that's new. Um, But I think that,
Speaker 1: you know, just because some of these core kind of
Speaker 1: acid allocation determining building blocks like size, value or profitability,
Speaker 1: you know, even if you can't add on to those necessarily,
Speaker 1: there's a lot of other inputs into a strategy that
Speaker 1: need to be taken into account. And that's where you know,
Speaker 1: some of the really exciting research has been done, uh,
Speaker 1: you know, internally with our research team, where we look
Speaker 1: at things like this, where you find shorter term drivers
Speaker 1: of expected returns that are really tradeoffs that you have
Speaker 1: to balance against things like size, value or profitability. You know,
Speaker 1: if you think about a value strategy, how to stocks
Speaker 1: often become value stocks while it's following a period of
Speaker 1: relative underperformance versus their peers. What do we know from
Speaker 1: the phenomenon of momentum within the cross section of stocks. Well,
Speaker 1: stocks that have had relatively poor returns uh in previous
Speaker 1: periods tend to continue to have relatively poor returns in
Speaker 1: the short run. And so addition, all sources of information
Speaker 1: about expector returns like that are really crucial to Again,
Speaker 1: even for these well established factors like size, value, and profitability,
Speaker 1: making sure that we capture our fair share of those
Speaker 1: still a very important part of implementation. Uh, what's I'm
Speaker 1: great glad you brought up Cam Harvey. We've had him
Speaker 1: on the show a few times. Not in a while, though,
Speaker 1: But listeners, if you wanna hear more of the thoughts
Speaker 1: of Camp, scroll back on the on the phone a
Speaker 1: few a year or two and we had a couple
Speaker 1: of good episodes with Cam. I getting back on. But
Speaker 1: wes I wanna talk about what I What I mentioned
Speaker 1: at the top of the show is basically what appears
Speaker 1: to be kind of a reversal in the rotation back
Speaker 1: to growth and tech leadership. Now, Uh, maybe the thinking
Speaker 1: is the FED took a little bit of the wind
Speaker 1: out of the sales of the reflation trade that was
Speaker 1: boosting Uh, you know, the banks, the energy companies, the
Speaker 1: real cyclical and value sectors of the market. How are
Speaker 1: you thinking about that? Is uh, you know, and Bildad
Speaker 1: has written about this and some others that a lot
Speaker 1: of people think this is kind of a wrong react
Speaker 1: and from the market to rotate this aggressively back into growth,
Speaker 1: that there's still some jewice left to be squeezed out
Speaker 1: of the value and cyclical trade. How are you thinking
Speaker 1: about it? Well, we can start with first principles when
Speaker 1: it comes to why we would believe any value premium
Speaker 1: or size premium or profitability premium in the first place.
Speaker 1: And it's based on the fact that there are differences
Speaker 1: and discount rates across stocks. Right, Investors are going to
Speaker 1: require different rates of return to hold different stocks. Just
Speaker 1: like if you had a whole population of people went
Speaker 1: to the bank for alone, they're likely to get different
Speaker 1: interest rates from the bank, and so it's similar that
Speaker 1: we would expect something like that to be true for
Speaker 1: first stock discount rates, size, value, and profitability are just
Speaker 1: based on using price combined with fundamentals to identify these
Speaker 1: differences and expect to returns, which means that every single day,
Speaker 1: based on the information known to market participants, there's some
Speaker 1: stocks with higher expected returns than others. And that's what
Speaker 1: we're talking about with these expected premiums, such as the
Speaker 1: value premium. So we expect this premium every day, and
Speaker 1: I know from the data that these premiums can be volatile.
Speaker 1: If you just look on a rolling you know, one
Speaker 1: year basis about of twelve month periods going back to
Speaker 1: the nineteen twenties, and the US growth is outperformed value,
Speaker 1: and I think that really hints at this notion of
Speaker 1: the difference between realized returns and expector returns. So many
Speaker 1: people had attributed the strong performance of growth stocks versus
Speaker 1: value and you know, kind of that decade leading up
Speaker 1: to the big turnaround for value recently, and they kind
Speaker 1: of laid that at the feet of the FED. But
Speaker 1: when you look at the performance of those growth stocks
Speaker 1: over that period where they were churning out twenty per
Speaker 1: year in terms of returns, you have to ask yourself
Speaker 1: as an investor, do I believe the expected return for
Speaker 1: this asset classes that seems awfully high and I think
Speaker 1: we would look at that and say a good portion
Speaker 1: of that was an unexpected component of the return that
Speaker 1: might have been based on great success for some of
Speaker 1: these companies, that could have been unexpected to a certain extent.
Speaker 1: Certainly when you look at their valuation as they were
Speaker 1: creeping up, they were still are very very high. Um. So,
Speaker 1: when I think about is the question of is there
Speaker 1: any juice left exqueeze from this limon? My question would be, well,
Speaker 1: what's changed about your expectation for the value premium? As
Speaker 1: long as you believe that low prices associated with higher
Speaker 1: expector returns, there's plenty of juice left to squeeze because
Speaker 1: we still expect a value premium every single day, you
Speaker 1: know us. I'm curious how your approach fits in with
Speaker 1: the year like this, Uh, you know, and I know,
Speaker 1: being anchored in sort of the academic approach of investing
Speaker 1: and very much anchored to the efficient market hypothesis at dimensional.
Speaker 1: Then boy, we enter a year like one, right, and
Speaker 1: we've got all of a sudden, all the discount brokerages
Speaker 1: just completely get rid of commissions. You've got all these
Speaker 1: people stuck at home. Uh, they can't go out. They
Speaker 1: can't bet on sports. You know, they've got a lot
Speaker 1: of spare cash, whether it be because of that or
Speaker 1: because of the stimulus from the government and whatnot. And
Speaker 1: we have this phenomenon like the at its stocks just
Speaker 1: going going absolutely nuts. And it's hard to for me
Speaker 1: to sort of wrap my head around how a student
Speaker 1: of sort of efficient market theory can can kind of
Speaker 1: operate in that environment. I mean, Um, does it change
Speaker 1: your approach at all to see this type of behavior?
Speaker 1: And half jokingly, I asque is there perhaps a Reddit
Speaker 1: factor that can be exploited? You know, is there a
Speaker 1: Wall Street bets factor that you could somehow quantify and
Speaker 1: and try to play with and and feel free to
Speaker 1: tell me I'm crazy for thinking that. I've I've heard
Speaker 1: it before, but I'm just curious how you think about
Speaker 1: a year like this, Um, with that academic background, that
Speaker 1: efficient markets theory background, Uh, with the market that's a
Speaker 1: lot of times just being driven by day traders, you know,
Speaker 1: place some trades based on what they read on Reddit
Speaker 1: and what they think the crowd, where they think the
Speaker 1: crowd is going to go next. Well, I think it
Speaker 1: reinforces the need for flexibility within your investment approach and
Speaker 1: having a daily process. So you know, when we look
Speaker 1: at the price change for a visual securities, I mean
Speaker 1: we know it can happen because of maybe a change
Speaker 1: in the expectation for the future for the cash flows
Speaker 1: of the firm. It could reflect a change in the
Speaker 1: discount rate that's assigned to those expected future cash flows.
Speaker 1: Very difficult, if not impossible, to disentangle those two effects.
Speaker 1: But what we do know is that when price is higher,
Speaker 1: expect to returns are lower. So where that's relevant is
Speaker 1: if you have a strategy, like say one that's focused
Speaker 1: on small cat value stocks. Well, if you have a
Speaker 1: company like one of the ones you're mentioning that started
Speaker 1: off a small cat value and all of a sudden
Speaker 1: it's prices now making it one of the largest two
Speaker 1: or three companies in the US, well, then at that
Speaker 1: point it's not really fitting the definition of higher expected
Speaker 1: returns in accordance with a small cat value portfolio. So
Speaker 1: if I have a daily process, then I can make
Speaker 1: the determination to sell that out of the portfolio at
Speaker 1: that time. It's funny when you look at, uh, you know,
Speaker 1: some of the index approaches. You can use the Rustle
Speaker 1: two thousand value as an example, where as of May
Speaker 1: thirty one, you've got game Stop and AMC still within
Speaker 1: the index, and at that time they were accounting for
Speaker 1: about one and a half percentage point of the index. Uh.
Speaker 1: And you know, you might even think of that is
Speaker 1: a almost a Yao Ming like outlier, like if you
Speaker 1: had Yamming visiting a kindergarten class in the size of screpancy.
Speaker 1: Kind of the picture you would get if you think
Speaker 1: about those two companies in a small value index. But
Speaker 1: they weren't alone. In fact, you had about fifteen percent
Speaker 1: of the Russell two thousand values holdings were actually in
Speaker 1: the top one thousand largest in the US, which is
Speaker 1: obviously the domain of the Russell and thousand indusicries. So
Speaker 1: you know, again that's kind of a function of the
Speaker 1: way that indusseries do their rebalancing in the case of
Speaker 1: the Russell in disease once per year. We believe in
Speaker 1: having a daily process that we can reflect changes in
Speaker 1: market prices throughout the year and rebalance our portfolios incrementally,
Speaker 1: and you need flexibility to do that. You have to
Speaker 1: flex flexibility across names through time and individual names, so
Speaker 1: you're not beholding the one individual trade. In that way,
Speaker 1: you can dynamically react to the way prices changed to
Speaker 1: continuously pursue higher expector returns and manage risk at the
Speaker 1: same time. I gotta say, I would to see Yao
Speaker 1: Ming visited kindergarten class. I'd I'd pay, I'd pay cover
Speaker 1: charts for that, Dott, I'm sure you would. Most of
Speaker 1: my sports jokes go over my head. Sorry about that.
Speaker 1: But but to go back to what Mike was saying
Speaker 1: about this year, Um, you know, returns have been really great.
Speaker 1: I think we were checking the numbers just this morning.
Speaker 1: It's been the second best first half of the year
Speaker 1: in about two decades or so. And then at the
Speaker 1: same time you have all these naysayer's warning about bubble
Speaker 1: and pockets, bubbles and pockets of the markets that are
Speaker 1: sort of bubblicious, if I can use that word. But
Speaker 1: is that thanks is that a prevalent sense right now
Speaker 1: or is it just uh something that you here all
Speaker 1: the time anyway, or is there sort of this sense
Speaker 1: of paranoia that's just a bit more prevalent just because
Speaker 1: the market has been doing so well for the last year. Well,
Speaker 1: the danger with using the expectation or the fear of
Speaker 1: a bubble to influential asset allocation decisions is the possibility
Speaker 1: that you might be wrong in the enormous opportunity costs
Speaker 1: for doing so. And again, you know, I keep on.
Speaker 1: I think twenty was a great example of all the
Speaker 1: case studies that you can use where if you look
Speaker 1: at the flows that we're going into money market funds
Speaker 1: in Q one of I mean, it was close to
Speaker 1: seven billion of dollars presumably going out of equities into
Speaker 1: money market funds, and then what happens subsequent to the
Speaker 1: end of Q one that year, Will you had any
Speaker 1: enormous tear We had equities globally, you know, delivering thirty
Speaker 1: some percentage points worth of return over the next two quarters.
Speaker 1: So that's what's potentially on the table if you let
Speaker 1: expectations of when maybe these premiums are gonna show up
Speaker 1: in the future influence what you're gonna do. We don't
Speaker 1: know when these premiums we're going to show up. That's
Speaker 1: kind of the nature of you know, not just the
Speaker 1: equity premium, but size, value and profitability, you know, the
Speaker 1: value premium. Again, we keep one back to this one
Speaker 1: because it's been in the news so much lately one
Speaker 1: out of twenty months in the US historically. So this
Speaker 1: is data going back to value stocks outperform growth stocks
Speaker 1: by seven and a half percent inch points. That's fifteen
Speaker 1: times what their unconditional average was. Uh So, I think
Speaker 1: that just this notion that things can turn very quickly
Speaker 1: unless you know what the news that's going to influence
Speaker 1: expectations in the future is going to be. Then the
Speaker 1: most tried and true method of capturing your fair share
Speaker 1: of the market return and of these premiums is that
Speaker 1: stay consistently invested so when they do show up, you're
Speaker 1: there to capture them. At the same time, we do
Speaker 1: have this wrong cohort that's been consistently buying, which is
Speaker 1: which has been the retail investor. I read a note
Speaker 1: earlier this week that said last Friday was a record
Speaker 1: day for retail traders buying equities. I'm wondering how you
Speaker 1: guys are thinking about the retail investor and their involvement
Speaker 1: in the market, and how much of your conversion from
Speaker 1: of your mutual funds into e t s is aimed
Speaker 1: at attracting retail money potentially. Yeah, one of the benefits
Speaker 1: for us having different investment solutions in different rappers, whether
Speaker 1: it's open and mutual funds, ETF, separately managed accounts. We
Speaker 1: want our clients to have lots of different ways to
Speaker 1: use dimensionals investment solutions within the way they're building an
Speaker 1: asset allegation for their clients and you know, so we
Speaker 1: want at the end of the day to have all
Speaker 1: those choices on the table for them. But we still
Speaker 1: very much believe in the idea of having these financial intermediaries.
Speaker 1: And again, some of the lessons we've been talking about
Speaker 1: of the opportunity costs from deviating at the market at
Speaker 1: the wrong time or not being consistently exposed to these
Speaker 1: premiums can be greatly mitigated by you know, for example,
Speaker 1: an an investor having an advisor who helps helps them
Speaker 1: stay consistent with their investment approach. And we feel like
Speaker 1: it's a very big benefit for investors. And then all
Speaker 1: of our investment solutions are really tailored so that they
Speaker 1: can make the best decisions of how to peace these
Speaker 1: things together consistent with the goals of their you know,
Speaker 1: West says, regular listeners will know, Um, I think I'm
Speaker 1: contractually obligated to discuss inflation on the on the show,
Speaker 1: perhaps legally obligated. I think they passed a law somewhere
Speaker 1: all podcast hosts must discuss inflation. But I mean, obviously
Speaker 1: the big wild card, the big variable everyone's top of
Speaker 1: mind this year. Will it be transitory or not? How
Speaker 1: long does transitory really mean? How are you thinking about
Speaker 1: inflation and and is it affecting the way you're thinking
Speaker 1: about portfolios? You know, break it down to us about
Speaker 1: you know, you're you're sort of thirty view of inflation
Speaker 1: and what to do about it? Yeah? Absolutely, I mean
Speaker 1: depending on you talk to, you get lots of differing
Speaker 1: viewpoints in terms of their expectations for inflation. So it's
Speaker 1: helpful for us to just look what is the market
Speaker 1: in aggregate telling us about inflation expectations, And you know,
Speaker 1: we can see that from some indicators. For example, you
Speaker 1: can need to break even inflation, or the difference in
Speaker 1: yields between nominal and inflation protected treasuries at the same maturity.
Speaker 1: You can use the you know, the forward inflation expectations,
Speaker 1: something like the five year five years. So if I
Speaker 1: look at the five year break even inflation rate right now,
Speaker 1: or at least as of a few weeks ago, it
Speaker 1: was hovering around right around two point four percent. The
Speaker 1: five year five year forward inflation, which is telling you
Speaker 1: something about inflation expectations for the five year period after
Speaker 1: the next five years, so basically covering ten four years here,
Speaker 1: that number was around two point one percent. Both of
Speaker 1: those numbers are pretty well on line with historical trends,
Speaker 1: So looking at those indicators, it doesn't seem that the
Speaker 1: market in aggregate is expecting particularly high inflation. And expecting
Speaker 1: inflation is incorporating into security prices, whether you're buying you know,
Speaker 1: stocks or bonds or anything that's in nominal terms, you're
Speaker 1: getting compensation for expect and inflation. Now, some investors might
Speaker 1: be particularly sensitive to inflation, and that means they might
Speaker 1: be concerned with unexpected inflation. So, for example, if consumer
Speaker 1: prices rise more than the broad market is expecting, then
Speaker 1: they might want to seek additional protection for that. And
Speaker 1: there are options, and it's sort of like the COVID vaccines,
Speaker 1: where you have different ways to reach the same level
Speaker 1: of inoculation. You can use treasury inflation protected securities which
Speaker 1: will hedge on expected inflation. There's a consideration there, which
Speaker 1: is that the yields on those are very very low.
Speaker 1: The real interest rates for US treasuries are negative across
Speaker 1: the board, across all maturities. Um. Then there's also the
Speaker 1: possibility of having a fixed income solution which combines inflation
Speaker 1: swap overlays, so you're getting you're gonna get paid real inflator,
Speaker 1: actual inflation, and then it's overlaid. On corporate bond strategies,
Speaker 1: we can expand your opportunities set two different levels of
Speaker 1: credit and different currencies as well, so there are options
Speaker 1: for investors who do have concerns about unexpected inflation. But
Speaker 1: I think getting to this notion that expected inflation, which
Speaker 1: is whatever the market believes is going to come to pass,
Speaker 1: is being compensated in current security prices. And let's face it,
Speaker 1: the market, when they're producing prices like this, they were
Speaker 1: very difficult to out guests. We might all have our
Speaker 1: opinions on what's gonna happen in the future, but looking
Speaker 1: at the data around active fund managers outguessing market prices
Speaker 1: is very difficult for most folks, you know, West. Before
Speaker 1: we get to the crazy things, I just want to
Speaker 1: get your your sort of current of the moment thoughts
Speaker 1: on on asset allocation. If I can, And let's start,
Speaker 1: you know, with the hypothetical sixty forty. Now, obviously there's
Speaker 1: been a lot of debate recently of whether sixty is
Speaker 1: dead or you know, what should go into that bucket? Um,
Speaker 1: you know, should he be seventy thirty or whatever, whatever
Speaker 1: the case may be. There's there's kind of a lot
Speaker 1: of diversity of opinion on the whole notion of a
Speaker 1: diverse what a diversified portfolio should should look like right now?
Speaker 1: So I'm just kinda cure swear you stand on that idea. Um,
Speaker 1: you know, are you a sixty forty type of guy? Uh?
Speaker 1: And if so, what you know, what exactly are you
Speaker 1: putting in your sixty? What are you putting in your forty?
Speaker 1: You know a lot of people saying you've got to
Speaker 1: take a little more risk in the forty, get some
Speaker 1: credit in there, some corporate credit, maybe some em debt,
Speaker 1: that sort of thing. How are you thinking about it all?
Speaker 1: And how much bigcoin is part of that? We're dose
Speaker 1: coin for that matter. Well, I'll start with what the
Speaker 1: theory tells us, and it tells us that your asset allocation,
Speaker 1: especially that split between equities and fixed income, is going
Speaker 1: to be a function of really the relative amount of
Speaker 1: actual invested capital you have versus your human capital. So
Speaker 1: when you first start out working, where most of your
Speaker 1: assets on your quote unquote balance sheet, if you want
Speaker 1: to call it, that is your human capital, your ability
Speaker 1: to continue to work to save more money and contribute
Speaker 1: to your savings in the future. And as you transition
Speaker 1: through your working life, when you get closer to retirement,
Speaker 1: obviously you've exhausted more of your human capital, probably don't
Speaker 1: want to work forever, but hopefully you've been able to
Speaker 1: accumulate more in terms of invested assets. So when you
Speaker 1: think about the riskiness of each one of those components,
Speaker 1: your human capital is a much more stable and lower
Speaker 1: risk component than your investment capital. So when you're when
Speaker 1: you're young, when you're starting off in your working career,
Speaker 1: that means that most of your balance sheet is in
Speaker 1: quote unquote lower risk assets. You might take more risk
Speaker 1: in terms of your invested assets, so that's why you
Speaker 1: might see a higher allocation equities when you're at a
Speaker 1: younger investment age. Obviously, as you proceed through your investment lifetime,
Speaker 1: you start to transition or de risk your financial assets
Speaker 1: and you start to transition into more fixed income heavy allocation.
Speaker 1: So you know, that's something that I think is probably
Speaker 1: a good starting point when you're thinking about how much
Speaker 1: you know you how much do you want to continue
Speaker 1: to work, how much, how on target you are in
Speaker 1: terms of what you've been able to say for your
Speaker 1: financial goals, and you can make your equity fixed determination
Speaker 1: from there. Now, within each one of those sleeves, I
Speaker 1: start with the notion that you want it to be
Speaker 1: as diversified as possible. So when within the equity sleeve,
Speaker 1: maybe have a global allocation and two equities, does that
Speaker 1: mean you're gonna hold just an exact fac simile of
Speaker 1: the global market portfolio? Maybe not. You might have reasons
Speaker 1: to deviate. US based investors tend to have a home
Speaker 1: bias towards US stocks, you might have an overweight there.
Speaker 1: But I think broad diverse vacation is a very important
Speaker 1: component within the fixed income Some of that depends on
Speaker 1: what your ultimate goals are, and let's say your goals
Speaker 1: are to support consumption within retirement. That kind of sets
Speaker 1: up almost like a liability, Like if you were to
Speaker 1: think of a same insurance company that has cash flow
Speaker 1: needs at certain periods of time, those are liabilities that
Speaker 1: they're going to try and hedge with their fixed income.
Speaker 1: And this is where maybe a liability driven investment approach
Speaker 1: might work. Where you have fixed income that has a
Speaker 1: duration that's taylor or connected to whatever the liabilities are. Uh,
Speaker 1: those cash flow needs you have in retirement, they have
Speaker 1: a duration associated with them and it changes through time.
Speaker 1: So by having a dynamic allocation, you're fixing. Um, that's
Speaker 1: one example of how you would taylor that fixed income
Speaker 1: sleeve to whatever your needs are. Well, don I'm just
Speaker 1: glad West when he started talking about people getting further
Speaker 1: along into the workforce and closer to the retirement age
Speaker 1: that he didn't point right at me. I'm glad about that. Well, Well,
Speaker 1: listeners can't see, but he did. Actually everybody knows he
Speaker 1: did point at Mike fair enough, fair enough as he should,
Speaker 1: as he should stand clearer of the craziest things we
Speaker 1: saw in markets this week? Well, West, great conversation. I
Speaker 1: think that is our segue to the crazy things that
Speaker 1: I know you brought a good one for us. I'm
Speaker 1: gonna save yours for last. But West, how about you?
Speaker 1: Have you seen anything crazy in markets in the last week? Yeah,
Speaker 1: there was one that kind of caught my attention, and
Speaker 1: it happened right when there was a press conference for
Speaker 1: the Portugal soccer team, during which Christian Ano Ronaldo came
Speaker 1: up to the stage and as part of their promotional
Speaker 1: period for Coca Cola, there were, of course, to Coca
Speaker 1: Cola bottles sitting right next to his microphone, and of
Speaker 1: course his reaction was to remove those from the table
Speaker 1: and hold up a bottle of water, I guess, encouraging
Speaker 1: people to drink water. What was notable about this was
Speaker 1: that that day Coca Cola stock went down about four
Speaker 1: billion dollars, so, uh, you know, whether it's caused and effect,
Speaker 1: whether it's just a coincidence. Kind of interesting because Coca
Speaker 1: Cola actually owns some water distribution companies, so you know,
Speaker 1: they should be able to benefit from a widespread surge
Speaker 1: and water consumption. But that was certainly one that was notable.
Speaker 1: That was that's a great one. That's a perfect crazy thing.
Speaker 1: And I you know, interestingly, you would think the margins
Speaker 1: on water are probably a lot higher for Coke anyway,
Speaker 1: I guess maybe it wasn't the De Saunty brand or
Speaker 1: whatever Cokes brand is that, but that's that's a good one.
Speaker 1: That's a pretty good one. And then another guy pushed
Speaker 1: aside the Heineken I think too, they he didn't want
Speaker 1: to be associated with Heineken, so little uh, a little
Speaker 1: activism in the in the soccer world. And then they
Speaker 1: I think they were all told stop doing this, just
Speaker 1: leave the cokes and for the sponsor. That's right, that's right,
Speaker 1: all right, that's a good one. And I'm mine is
Speaker 1: very food oriented too. And you may argue with me
Speaker 1: that this is not exactly a market story, but I
Speaker 1: will push back on that because my crazy thing is
Speaker 1: about the avocado market uh Albana. And to prove it's
Speaker 1: a ballad topic, there is a ticker on the Bloomberg
Speaker 1: for avocado prices out of Mexico, so you know you
Speaker 1: can you can run a regression on it. The seasonality
Speaker 1: on it is interesting. I don't know if you want
Speaker 1: to get into the avocado trade West, but I encourage
Speaker 1: you check it out. But this is a really good
Speaker 1: story from the Wall Street Journal, one of their a
Speaker 1: head stories on page one, and it's about the fact
Speaker 1: that avocados have gotten so pricey that there are these
Speaker 1: organized gangs going in and trying to to basically rob
Speaker 1: avocado farms and what the farmers are doing to prevent it.
Speaker 1: They talk about one farmer in South Africa. He's got
Speaker 1: motion activated infrared cameras around the hundred seventy acre farm. Um,
Speaker 1: he's also got on stand by a rapid response team
Speaker 1: that's led by a next military guy, complete with tracker dogs,
Speaker 1: and they try to you know, immediately react to the
Speaker 1: avocado thiefs as they come in. Um. One of my
Speaker 1: favorite things in Mexico. The drug cartels are actually fighting
Speaker 1: over the avocado crop now because the prices prices have
Speaker 1: got so far. But they say, you know, these just
Speaker 1: aren't sort of smash and grab guys that they basically
Speaker 1: planned this to a t. And the general describes it
Speaker 1: as large career grapht raids on farms where they can
Speaker 1: basically steal about a ton of avocados in a very
Speaker 1: short time I think like a couple hours, and then
Speaker 1: they take it, they launder it onto the black avocado
Speaker 1: market and uh and make a fortunate it so fascinating stuff.
Speaker 1: I know. Our colleague Tracy Alloway loves to chart the
Speaker 1: correlation of avocado prices with bitcoin, so uh, another reason
Speaker 1: why this is I think a good candidate for our
Speaker 1: crazy things. Well, Dona, I don't know if you'll if
Speaker 1: you'll allow me this uh, this rare commodity trade to
Speaker 1: be a crazy thing. I'll allow it. And I'll even
Speaker 1: allow you to name it. You can name it the
Speaker 1: guacamole cartel. I'm open. I'm open to other names, other suggestions.
Speaker 1: Guack cartel. I like that, all right, not bad? All right?
Speaker 1: What do you have first, Fildanna. Mine is not food related,
Speaker 1: but I'm leaving the planet for for mine. Uh, and
Speaker 1: it's I read this story about Procter and Gamble saying
Speaker 1: that they've signed an agreement with NASA to test laundry
Speaker 1: solutions in the International Space Station, which I thought was
Speaker 1: really interesting because there are no washing machines in space,
Speaker 1: so basically what happens astronauts just wear the same clothes
Speaker 1: over and over until they're like totally disgusting. And so
Speaker 1: this is a way for them to try to make
Speaker 1: continuous space living actually a possibility, I suppose. So there.
Speaker 1: I guess they're not sure how Proctu and Gamble detergent
Speaker 1: behaves in space. Well, you can't, you can't. You can't
Speaker 1: wash clothes in space, and so they're trying to figure
Speaker 1: out a way to actually make that happen. Huh, that's
Speaker 1: a good one. I'm i gonna say, if they can
Speaker 1: make dry shampoo, maybe they can make dry detergent. That's right, right, right, Again,
Speaker 1: there's not a lot of dirt in space either, I
Speaker 1: imagine those uh International Space Station is a pretty sterile environment,
Speaker 1: so how much no, because astronauts have to exercise two
Speaker 1: hours a day. Oh gotcha, gotcha? So there you can
Speaker 1: get pretty gross. So they've got pit stains on their
Speaker 1: their space suits and stuff. I guess wow. All right,
Speaker 1: well that seems like I'm glad to hear that. I'm
Speaker 1: you know, if this whole space tourism thing kicks off further,
Speaker 1: that's that's gonna that's gonna come in handy. I don't know, West,
Speaker 1: I don't know how you trade that one is there.
Speaker 1: I don't know what the end market is for for
Speaker 1: detergent in space. Still wrapping my my head around the
Speaker 1: expectations there. All right, what the check back on that?
Speaker 1: We'll see how they did on that experiment. That's a
Speaker 1: good one, Bill Dona. I don't know if the share
Speaker 1: price moved or not, but no, but it was just
Speaker 1: a fun read. Yeah. Well, hopefully you know you won't
Speaker 1: see so match you're not in a press conference. Push
Speaker 1: the tide pods away from him anyway, that would be
Speaker 1: that would make the share person, that would make it
Speaker 1: share absolutely anyway, vel Data, Hirich uh West Krill. So
Speaker 1: happy to have you on the show. Really enjoyed the
Speaker 1: conversation and hopefully we can do it again sometime. Yeah,
Speaker 1: thanks for having me. It was great. What Goes Up.
Speaker 1: We'll be back next week. Until then, you can find
Speaker 1: us on the Bloomberg Terminal, website and app where wherever
Speaker 1: you get your podcasts. We'd love it if you took
Speaker 1: the time to rate and review the show on Apple
Speaker 1: Podcasts so more listeners can find us. And you can
Speaker 1: find us on Twitter, follow me at Reaganonymous, Bildonna is
Speaker 1: at Bildonna high Rich. You can also follow Bloomberg Podcasts
Speaker 1: at podcasts. I thank you to Charlie Pellet to Bloomberg
Speaker 1: Radio in the voice of the New York City Subway System.
Speaker 1: What Goes Up is produced by Topor forhez ahead of
Speaker 1: Bloomberg Podcasts is Francesco Levy. Thanks for listening. See you
Speaker 1: next time,