Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: the processes, challenges, and philosophies and security selection. I'm David Cohne,
Speaker 1: i lead mutual fund and active research at Bloomger Intelligence.
Speaker 1: Today my co host is Christopher kine Us, quantitative strategist
Speaker 1: at Bloomberg Intelligence. Chris, thank you for joining me today.
Speaker 2: Thank you for having me, David.
Speaker 1: So, you did a recent note about the traditional equity factors.
Speaker 1: How have they performed so far this year? You know
Speaker 1: which ones are performing the best?
Speaker 2: Sure, it's been certainly a strong gear for equity factors
Speaker 2: so far. You know, we have our four main equity
Speaker 2: factor families I would call them, which is low volatility, value, momentum,
Speaker 2: and quality. Three of the four are this year. They're
Speaker 2: all up double digits actually on a long short basis.
Speaker 2: The only laggard is value, which is only down moderately.
Speaker 2: We have our low volatility factor long short as actually
Speaker 2: the best on the year. Now, one little wrinkle with
Speaker 2: that is that you know we have a beta neutralized
Speaker 2: long between the long and short legs. So what that
Speaker 2: really means is a little bit more, you know, a
Speaker 2: little bit more money in the low ball and a
Speaker 2: little bit less money in the high ball. When you
Speaker 2: do the long short factor that's the best performing on
Speaker 2: the year momentum and quality. I've also performed very well.
Speaker 2: Like I said, value is down. But the one thing
Speaker 2: I'll say about value is when you do long short
Speaker 2: on equal weight basis, it's just down moderately. It's just
Speaker 2: that market cap weighted long short value is really getting harmed.
Speaker 2: And that's because of the FASTAUP performance of the largest
Speaker 2: most expensive stocks on the year. Interesting.
Speaker 1: So I think it'd be a great time to introduce
Speaker 1: our guest, Andrew Slimon, managing director at Morgan Stanley Investment Manager,
Speaker 1: where he's the lead senior portfolio manager on all long
Speaker 1: equity strategies for applied equity Advisors. So, Andrew, welcome to
Speaker 1: the podcast.
Speaker 3: Hey, thanks for having me on. Very exciting.
Speaker 1: So, you know, before we dig in, you know you're
Speaker 1: no stranger to factor models. You know, I'd like to
Speaker 1: kind of get your thoughts on what Chris just said.
Speaker 1: And you know, are you seeing you know, higher returns
Speaker 1: for momentum and quality? Is that kind of helping you
Speaker 1: identify market drivers.
Speaker 3: Well, I think, you know, I would begin by saying
Speaker 3: this year hasn't really been that different, to the extent
Speaker 3: that if you look very very long term, what factors
Speaker 3: work over time? The best performing factors are momentum and profitability,
Speaker 3: which are is a form of quality. So you know,
Speaker 3: I don't think this is very different. I do think,
Speaker 3: you know a lot of people predicted that Value would
Speaker 3: have a better year. It's done, as Chris said, it's
Speaker 3: done okay, but it hasn't been spectacular. But overall, I
Speaker 3: look at you know, what works long term, quality and
Speaker 3: sticking with winners. Usually there's some fundamental backdrop behind it,
Speaker 3: and this year hasn't been really different.
Speaker 1: No, it's great, So I'd like to stick I guess
Speaker 1: step take the step back. You know, I think we'd
Speaker 1: really love to hear how you got your start in
Speaker 1: the investment business.
Speaker 3: Sure, I mean it's a great question because in many
Speaker 3: ways it's a great way to frame the global concentrated
Speaker 3: product that we run. And my experience in the business
Speaker 3: really led up to really starting this strategy. So if
Speaker 3: I could just wind the clock back for you a
Speaker 3: little bit, I started my caravan in a very long time.
Speaker 3: I think One of the things I love about this
Speaker 3: business is, you know, I played college sports and competed
Speaker 3: as a junior, and I love the investment business because
Speaker 3: there's you know, there's a you know, there's score at
Speaker 3: the end of the day, and you can't make up
Speaker 3: you know, there's no room for commentary on the scoreboard.
Speaker 3: And I think that's true of sports also. But I started,
Speaker 3: you know, my career at a at a private bank
Speaker 3: in New York out of college that had a you know,
Speaker 3: an investment management arm and I never you know, they
Speaker 3: had about thirty research analysts that cover all these different industries,
Speaker 3: and you know, I was right out of college and
Speaker 3: I was in the research department, and they all seemed
Speaker 3: very very bright. And they had an investment committee that
Speaker 3: met once a week and they would debate the investments
Speaker 3: and then they put the investments into the fund based
Speaker 3: on you know, what the research analysts would recommend. And
Speaker 3: they all seem very very bright. Except I noticed after
Speaker 3: being there a couple of years that the performance was, yeah,
Speaker 3: it wasn't it wasn't terrible, but it was never really
Speaker 3: really that good. And our outperformance and I think, now,
Speaker 3: you know, what we've learned since the eighties. Is well,
Speaker 3: when you have an investment committee that meets once a week. Uh,
Speaker 3: you know, the market is more you know, kind of
Speaker 3: reflexive than that. Uh, management by committee hasn't done as
Speaker 3: well as managed by kind of uh lead or or
Speaker 3: closely Philip Kim and I run the strategies. I think
Speaker 3: that's That's another thing. And then most importantly, we've learned
Speaker 3: that when you own you know, one hundred plus securities
Speaker 3: in your benchmarks to the S and P, it's really
Speaker 3: hard to perform over time. So that was the first
Speaker 3: experiences that led me to believe huh, okay, uh, when
Speaker 3: I start this, you know, I started the group. Those
Speaker 3: experiences didn't work, you know very well. Maybe I won't,
Speaker 3: I won't mimic that. Then I went to the Universe
Speaker 3: Chicago Business School because I wanted to you know, kind
Speaker 3: of hardcore finance experience, and I took Gene Foma's course
Speaker 3: and Ken French's course, and I learned that, you know,
Speaker 3: kind of there's a quantitative side to investing, and that
Speaker 3: buying cheap stocks outformed buy expensive stocks. Uh. And uh,
Speaker 3: you know, things like momentum actually work. And that had
Speaker 3: nothing to do with fundamental research it had to do
Speaker 3: for the quantitative side. And I think since that time
Speaker 3: in business school and even morning Star has come out
Speaker 3: and proven studies that you know, kind of two thirds
Speaker 3: of it in manager's return comes from its factor exposure.
Speaker 3: You know, Chris is loving what I'm saying now, But
Speaker 3: the reality is is that think about the year twenty
Speaker 3: twenty one. Growth in twenty twenty twenty one got so
Speaker 3: expensive that going into twenty twenty two, it didn't really
Speaker 3: matter what growth manager you chose. It really didn't matter
Speaker 3: what growth stocked your own. You went down a lot.
Speaker 3: So it really the decision was not which growth stock owner,
Speaker 3: which growth manager invested in, is should I own growth stocks?
Speaker 3: And so that led me to HM, before we get
Speaker 3: to the fundamental research of analyzing a stock, maybe we
Speaker 3: should understand what factor exposure we're getting when we buy
Speaker 3: a sock. And look at the last month and a half,
Speaker 3: did it really matter what financials you own? They've all
Speaker 3: done great now, maybe some have done better than the other,
Speaker 3: but they've done a hacker a lot better than they've
Speaker 3: done recently. So it was a factor shift. And so
Speaker 3: I think that's the second experience, and then third coming
Speaker 3: out of business school, I wanted to stay in Chicago.
Speaker 3: My wife got a very good job in Chicago, and
Speaker 3: I wanted to really be start my career on as
Speaker 3: a research you know, going back to the buyside. But
Speaker 3: I couldn't really get a job. That was in nineteen
Speaker 3: ninety one. We're in the depths of a bear market,
Speaker 3: and I started my career at Morgan Stanley in their
Speaker 3: prior wealth management office area. At the time, we didn't
Speaker 3: have a you know, a broad distribution of wealth management
Speaker 3: financial advisors, so we had this small group that kind
Speaker 3: of cover family offices, smaller institutions and show them, you know,
Speaker 3: investment ideas. And what I observed was a couple things
Speaker 3: from that experience. Number one is clients generally don't care
Speaker 3: whether they own growth, their value or large cap mid cap.
Speaker 3: They want to make money and it doesn't really matter
Speaker 3: where it comes. And the problem with that is that
Speaker 3: their patients duration of investing in a style of investing
Speaker 3: is not consistent with the duration which a style can
Speaker 3: go out of favor. So inevitably, you know, after about
Speaker 3: two years of your value manager underperforming the S and P,
Speaker 3: the client starts to go with me. You know, maybe
Speaker 3: we should get rid of them, and so eventually say
Speaker 3: oh yeah, yeah, wah, we should definitely get rid of
Speaker 3: that manager. And it always has happens right before that
Speaker 3: style comes back into favor. So the point of this
Speaker 3: was is that Okay, the style box driven managers, they
Speaker 3: get all their money after they've done well because the
Speaker 3: tear sheet, your tear sheet only tells you what they've
Speaker 3: done in the past. It doesn't tell you what will
Speaker 3: happen in the future. So the combination of the tear
Speaker 3: sheet plus the emotional biases to buy things that are
Speaker 3: working that are priced up in the equity market, which
Speaker 3: is crazy. I don't know of any other market in
Speaker 3: the world where when things go down prices are marked down,
Speaker 3: people more willing to sell, and when we're marked up,
Speaker 3: they're more willing to buy, except for this market. But
Speaker 3: that's the reality. So when things have done poorly, clients
Speaker 3: didn't want to buy, they wanted to sell it, and
Speaker 3: so it led me to believe let's see, let's put
Speaker 3: all those experiences together. We know we need a small team.
Speaker 3: We know we need a portfolio that has a limited
Speaker 3: number of socks. We know we need to focus on
Speaker 3: a quantitative approach first, but quant doesn't explain everything, just
Speaker 3: a portion. And thirdly, we can't be stylebox driven because
Speaker 3: at the end of the day, clients really they're not
Speaker 3: clientbox driven. Hey I did great, I lost you less
Speaker 3: money than the growth index. Yeah, but you want to
Speaker 3: perform the SMP, so let's move to something that's performed
Speaker 3: the S and P. So by the very nature of
Speaker 3: all these style boxing we're kind of setting people up
Speaker 3: to fail. And so that was really, you know, kind
Speaker 3: of the experiences led me to believe. In two thousand
Speaker 3: and three, I raised my hands said I don't want
Speaker 3: to cover these clients anymore. I want to start this
Speaker 3: group that will be at the at the you know,
Speaker 3: at the at the base of what we do is
Speaker 3: factor analysis, quantitative analysis. But it won't be just that.
Speaker 3: We're going to have a fundamental group that focuses on
Speaker 3: fundamental research so that we once we get the factors right,
Speaker 3: we can overlay it with what's the best you know,
Speaker 3: value socks oone, what's the best financialist to own? And that,
Speaker 3: you know, that's what we started. Uh and I started
Speaker 3: oh four Philip Kim, who had a much deeper quantitative
Speaker 3: background than I did join me late oh four, and
Speaker 3: you know we've been off to the running ever since.
Speaker 1: So I think that's a great segue into you know,
Speaker 1: the strategy we're going to talk about today, the Global
Speaker 1: Concentrated portfolio fund ticker mL and i X. Can you
Speaker 1: go into just with the processes of how this all
Speaker 1: works when you're making selections for the fund.
Speaker 3: Sarah, So, first and foremost, we try to limit the
Speaker 3: number of sacks of twenty sacks. Occasionally it goes a
Speaker 3: little over if we're kind of transitioning into out of
Speaker 3: one sock into But the purpose of twenty stocks is
Speaker 3: it is it's a global strategy. It's benchmark to the
Speaker 3: MSCI world, which I don't know has fifteen hundred stocks
Speaker 3: in it. So if we own twenty stocks and there
Speaker 3: are fifteen hundred in the index, well that means our
Speaker 3: active share is really high. And remember what I said before,
Speaker 3: What studies have shown is that managers that have higher
Speaker 3: active share ten not all. It was ten to outperform
Speaker 3: managers that are benchmark huggers. Because at the end of
Speaker 3: the day, if you have high active share, you differ
Speaker 3: from the index, and therefore your people are going to
Speaker 3: find out pretty quickly. You're either doing a good job
Speaker 3: or you're not. You're not going to gradually underperform. So
Speaker 3: we by having twenty stocks, it keeps our active very high. Now,
Speaker 3: to be clear, you could have high active share because
Speaker 3: you own lots and lots of socks, none of which
Speaker 3: are in the index. But there's another measure that's very
Speaker 3: very important to us, and it's called your tracking air,
Speaker 3: and your tracking air measures how volatile your fund is
Speaker 3: relative to the benchmark. Now it's not your beta because
Speaker 3: that just measure is relative to the index. But so
Speaker 3: in other words, if I had lots and lots of
Speaker 3: stocks that weren't in the index, so I owned a
Speaker 3: hundred socks none of which were in the index, well
Speaker 3: then I wouldn't move with the index much, and so
Speaker 3: my tracking air would be very very high. But if
Speaker 3: I could own twenty stocks, all of which are in
Speaker 3: the index, but they're not all you know, kind of
Speaker 3: focused on one theme or one bet, then I could
Speaker 3: keep my tracking air down and all Again, the academic
Speaker 3: studies show high active share and only moderate tracking air,
Speaker 3: you know, leads to success. So that's where we start.
Speaker 3: We start with. Every time we look at a stock.
Speaker 3: We say, well, if we add a stock, you know,
Speaker 3: we got to take one away because we want to
Speaker 3: keep it at twenty. But if we add that stock,
Speaker 3: will that increase our tracking air which we don't want
Speaker 3: to do, or lowers our tracking. So broadly speaking, if
Speaker 3: we liked, say value, and we own only financials, well,
Speaker 3: adding another financial would increase our value exposure, but it
Speaker 3: would also increase our tracking. So we think in large
Speaker 3: a lot about how to add or change stocks that
Speaker 3: give us the factor exposures that we want but don't
Speaker 3: necessarily they're not correlated to other stocks in the portfolio.
Speaker 3: And that's how we you know, we start the the
Speaker 3: process and then we begin with okay, well, what factors
Speaker 3: are working? We want to stay in the game. We
Speaker 3: don't want to be you know, all in value where
Speaker 3: I'm sitting there and saying value work long term, and
Speaker 3: you're you know, you're mister, mister or missus client, you're saying, yeah,
Speaker 3: but value hasn't worked for three years. Right. We're looking
Speaker 3: at what factors are working from a price performance basis
Speaker 3: and then making an assessment and it continue to work
Speaker 3: in the future. And that assessments based on is the
Speaker 3: factor expensive or cheap. So we're looking at valuation and
Speaker 3: momentum of the factor and assessing can it work in
Speaker 3: the future. And if you look around the world, I've
Speaker 3: heard a lot of people tell say, you got to
Speaker 3: buy you know, especially in Europe, value is really cheap. Well,
Speaker 3: it's really cheap, but it had to work for a
Speaker 3: very very long time, so it hasn't pay just because
Speaker 3: value is very very cheap, it hasn't worked. And so
Speaker 3: again we're thinking about how to bias the portfolio from
Speaker 3: a quantitative standpoint first in each part of the world US, Europe, Japan, Asia,
Speaker 3: extrapan from a factor standpoint, and then and only then
Speaker 3: picking stocks that give us that appropriate factor exposure that
Speaker 3: we like for a fundamental, pure fundamental reasoning. So they
Speaker 3: call us a quantinmental team quantinental philosophy. I just know
Speaker 3: that pure quants try to diversify away the fundamental side,
Speaker 3: and my roots started with a fundament. I know there's
Speaker 3: value added good stock picking, but I'm also well aware
Speaker 3: that at the end of the day, you got to
Speaker 3: get your factors right first, and that's the most important.
Speaker 3: That's the core of what we do.
Speaker 2: Man Andrew, I love so many things you said, I
Speaker 2: don't know where to start, just two quick comments. You know,
Speaker 2: I joked that the momentum windows one year, but investors
Speaker 2: windows like three to five for hiring and firing managers,
Speaker 2: which is more of a mean reversion window. So it
Speaker 2: kind of goes to what you're saying. When they fire you,
Speaker 2: you start out performing, and then you know, I think
Speaker 2: a concentrated factor portfolio makes so much sense because you know,
Speaker 2: what people don't really understand is, after so many assets,
Speaker 2: so many alphas, however you want to say it, you
Speaker 2: don't get very much diversification benefit.
Speaker 3: I mean, it's.
Speaker 2: Extremely marginal after let's say twenty stocks, extremely marginal. So
Speaker 2: the difference in diversification between twenty and one hundred is
Speaker 2: not nearly as dramatic as it kind of seems. So
Speaker 2: I just love all of that. So my question is
Speaker 2: maybe with value, you know, the much maligned value factor.
Speaker 2: You know, without giving away your secret sauce, you mentioned
Speaker 2: that you studied under the legend Professor Farma at Chicago.
Speaker 2: When I think of Professor Fama, I think book to
Speaker 2: market factor, you know, as a value factor. You know,
Speaker 2: what do you how do you think about constructing value?
Speaker 2: Is it a composite of a lot of different metrics.
Speaker 2: You don't have to like get into them. But or
Speaker 2: how do you broadly think about a constructing a value factor?
Speaker 3: Yeah, so so Chris, this is this is a very
Speaker 3: interesting question because you know, don't forget I had worked
Speaker 3: on Wall Street before gone to univer Chicago, and then
Speaker 3: I had studied under Fama, and he's, you know, in
Speaker 3: the classroom saying, look, price to book works great long term,
Speaker 3: and then you start to really decompose deep what I
Speaker 3: call price to book is a deep value metric, and
Speaker 3: you realize it rarely works, but when it works, it
Speaker 3: works huge. Right, So twenty twenty, in the midst of COVID,
Speaker 3: if you had just bought stocks, had just gotten cream
Speaker 3: because you know they were casinos or airlines or cruise ship.
Speaker 3: If you just bought those, you did great. But you
Speaker 3: know that's true of nine also two thousand and nine.
Speaker 3: But most of the time price book doesn't work. So
Speaker 3: on a calendar your basis. So it's great in academia
Speaker 3: to talk about deep value as a factor, but in
Speaker 3: the reality of what we're trying to apply, Oh, we
Speaker 3: can't just look at deep value because most of the time,
Speaker 3: it doesn't work, and I can't keep saying, hey, don't worry, well,
Speaker 3: there will be a time when it'll work again. Clients
Speaker 3: don't They're gone, They are gone. How many clients we're
Speaker 3: buying into deep value strategies in you know, you know,
Speaker 3: in twenty twenty into covid u, They how about it?
Speaker 3: In eight? No way, but that's when they work. So
Speaker 3: it's it doesn't it does, It's not practical to the
Speaker 3: emotional biases of this business. So you move to earnings yield,
Speaker 3: which doesn't do long term as well, but it has
Speaker 3: a more consistent time frame. So we look at price
Speaker 3: to book, but I think over time, we you know,
Speaker 3: we look at things like earnings yel more closely. But
Speaker 3: we so we have a deep value factor, we have
Speaker 3: a stable value. We've looked at a gazillion different kind
Speaker 3: of metrics quality, growth, value, but we've learned to try
Speaker 3: to keep it simple and don't make it too complicated
Speaker 3: because you're never going to kind of find only stocks
Speaker 3: that fall into into one bucket. But I would say,
Speaker 3: you know, practicality, it's it's very, very hard to run
Speaker 3: a deep value book when clients can movement any in
Speaker 3: and out of your fund or strategy on a you know,
Speaker 3: on a daily basis. If I if I ran a
Speaker 3: fund that was locked up for ten years, I just
Speaker 3: go buy a lot of really really cheap stocks.
Speaker 2: But that's that's not realistic. Sure sure, so interesting. Yeah,
Speaker 2: I have to ask you about combining multiple factors. I mean,
Speaker 2: this is something that I get to question a lot.
Speaker 2: So I guess kind of a two part question. Number one,
Speaker 2: Like you know, you said your your global fund, your
Speaker 2: your benchmark to the MSCI. So when you look at
Speaker 2: these factors, I mean, do you normalize them for like
Speaker 2: the country they're in or the geographic region they're in,
Speaker 2: like like similar to like what we call sector neutralization
Speaker 2: in the United States. And then the bigger question is
Speaker 2: is around the kind of much maligned topic of factor timing.
Speaker 2: You know, you mentioned factor timing. I think you did,
Speaker 2: you know, I think you were hinting at that and
Speaker 2: using momentum to time factors. You know, I'm informed by
Speaker 2: the paper from aq R factor Momentum Everywhere, which basically
Speaker 2: shows that factors themselves have momentum. So you know, I
Speaker 2: would love to know is you know, is that your
Speaker 2: main input in how much tactically, are we switching between
Speaker 2: these factors or are you uh, you know, as Cliff says,
Speaker 2: sitting a little.
Speaker 3: So first of all, in terms of geographic we have
Speaker 3: a factor timing model for factor models for US Europe,
Speaker 3: so we look at that one group at Japan and
Speaker 3: Asia ex Japan, which captures most of MSCI world, and
Speaker 3: different factor models send different clues about how much we
Speaker 3: want to allocate to a country. For instance, when a
Speaker 3: factor model is saying, hey, you should buy high dividend
Speaker 3: yielding quality stocks, that's usually a sign of a risk
Speaker 3: off market versus a mark versus word that says hey
Speaker 3: buy growth or buy value, that's usually a risk on market.
Speaker 3: So we will allocate and buyas the portfolio from a
Speaker 3: regional standpoint where we see the factor models are setting
Speaker 3: the strongest, strongest system signal. Now stay within the the
Speaker 3: guidelines of you know, kind of requirements. We never can
Speaker 3: go more than seventy percent in the US or seventy
Speaker 3: percent outside of the US, so we will all there
Speaker 3: are certain guidelines, but broadly speaking, it has paid to
Speaker 3: have a higher allocation to the US within a global strategy,
Speaker 3: and that's one of the reason why we started global
Speaker 3: strategies was simply kind of my kind of picture advertisement,
Speaker 3: which is, hey, international manager can only buy non US
Speaker 3: A global manager can buy if it happens to be
Speaker 3: the best the best era. But look, I'm you know,
Speaker 3: like I like to say, I'm agnostic towards regional allocation.
Speaker 3: I'm agnostic towards styles. I'm not here to convince you
Speaker 3: to buy any sales. I just want to stay in
Speaker 3: the game in terms of factor timing. Very interesting, Chris.
Speaker 3: So when I started these strategies, especially on the institution side,
Speaker 3: So I started going on and I you know, I'd
Speaker 3: be taking around the world these very large institutions and
Speaker 3: I'd say, well, you know, we're starting these you know
Speaker 3: these we run these factor models and there's a factor
Speaker 3: component to them. And I would get a lot of
Speaker 3: pushback because at the time, it was kind of ten
Speaker 3: years ago, people just started about factor modeling, and they
Speaker 3: a lot of times I say, oh, well, we just
Speaker 3: hired you know, ten PhDs that are going to build
Speaker 3: these factor models, and you know, I thought, well, I've
Speaker 3: been doing this a long time, and would you ever
Speaker 3: hire someone, you know, right out of business school who's
Speaker 3: going to run a a long you know, strategy that's
Speaker 3: fundamentally based. But on the quantitative side, the belief was
Speaker 3: that you could just hire a bunch of math whizzes
Speaker 3: and you'd be really, really successful. So I remember walking
Speaker 3: out of these meetings going, this is crazy. You know,
Speaker 3: I have been watching factors for a very very over
Speaker 3: twenty years. I've been watching factors. My knowledge is no
Speaker 3: different than the knowledge you get from following company on
Speaker 3: a fundamental side. And so I think what happened is
Speaker 3: a lot of a lot of these big institutions. They
Speaker 3: really fail at factor timing because you know, there is
Speaker 3: you know, as we like to say it frames our viewpoint.
Speaker 3: We are not a black box. And I know certain
Speaker 3: things about what happens. For instance, I know that momentum
Speaker 3: tends to fizzle out in the second half of December,
Speaker 3: right because people are done tax loss harvesting and they
Speaker 3: they they poured into the winners, and you know, momentum
Speaker 3: kind of reverses in the late December. So you know,
Speaker 3: that's just that's this knowledge of So we do run
Speaker 3: factor timing models. I can tell you that, yes, we're
Speaker 3: talking about the global concentratet, but we run a strategy
Speaker 3: that just looks at our factor timing model, and it's
Speaker 3: an enhanced index, and it's been running for a long time.
Speaker 3: It's done very very well with a much lower tracking
Speaker 3: error that's attracted kind of enhanced index product. So our
Speaker 3: factor model models have added value from it, and therefore
Speaker 3: timing has worked, but it hasn't done as well as
Speaker 3: our more concentrated strategy like global contract simply because there
Speaker 3: is value to fundamental research.
Speaker 2: Absolutely, you know, I totally agree with you. I mean,
Speaker 2: I think there's more craftsmanship in art in this than
Speaker 2: some people give credit for it, Like it's not just
Speaker 2: crunch to numbers. So I completely you know, I love
Speaker 2: what you said that.
Speaker 3: So can I just add one thing about that? At least, Chris,
Speaker 3: you'll be interested. So what Philo Kim, who is the
Speaker 3: co portfolio was on. He would tell say to right now, look,
Speaker 3: so many quants have given up on factor timing, they've
Speaker 3: thrown the towel, they are factor neutral. That this is
Speaker 3: a big opportunity for us because the space is not
Speaker 3: crowded anymore.
Speaker 2: I totally agree with that. So one kind of broad
Speaker 2: question I wanted to ask you, and this is a
Speaker 2: question I get a lot. I kind of disagree with it, So,
Speaker 2: you know, I would love to know your answers. Like
Speaker 2: some people that aren't nearly as sophisticated as you come
Speaker 2: to me and say, well, isn't quality as a factor,
Speaker 2: which is typically some culmination of like you said, profitability
Speaker 2: and then things like low leverage, stability of earnings, et cetera.
Speaker 2: Isn't that like growth? Isn't it the same thing?
Speaker 3: Right?
Speaker 2: Why do we need a quality factor? Why don't we
Speaker 2: just do a growth factor? Isn't this exactly the same thing?
Speaker 2: I don't think it is. What's your response to that question?
Speaker 3: The answer is, it depends what's in your quality factor,
Speaker 3: because are if it's just Roe and r O I C.
Speaker 3: We know that, you know, with you know, exception of two,
Speaker 3: the mag seven have the highest Roe horst ir C.
Speaker 3: So if that's your quality framework, yeah, then it is.
Speaker 3: But we look at things beyond just that, like earning stability.
Speaker 3: I think that's a wonderful factor. So earning stability measures
Speaker 3: you know that the earning stream of companies and looks
Speaker 3: at how stable their earnings are. Now that does not
Speaker 3: necessarily mean they're you know, gross stocks. They could be
Speaker 3: very defensive consumer staples type stocks. One of the reasons
Speaker 3: why I still believe we're in the early stages or
Speaker 3: you know, kind of you know, kind of not real early,
Speaker 3: but we're we're not the tail end of this bull
Speaker 3: market is yes, consumer state, peoples and healthcare stocks have underperformed,
Speaker 3: but there are a lot of stocks that are perceived
Speaker 3: as very earning stable that are still very very expensive
Speaker 3: because they the investors perceived downside risk. So earning stability
Speaker 3: is not necessarily just you know, tech growth. Another one
Speaker 3: would be dividend yield, right, high dividend yield, It can
Speaker 3: be a quality metric well, that tends to work in
Speaker 3: bear markets. So you know, certainly tech is not our
Speaker 3: gross stocks are not necessarily high dividend yields. So I
Speaker 3: think there's different ways to dissect the quality factor. We
Speaker 3: look at in terms of profitability as one, so that
Speaker 3: does capture those gross stocks, but we look at bond
Speaker 3: proxies as one, so those are higher dividend yields, And
Speaker 3: we look at earning stability, which is in my opinion,
Speaker 3: the ultimate risk off factor. That's what works into bear markets.
Speaker 1: So you mentioned in terms of exposure, you talked about
Speaker 1: you know more us you know, and that's really a
Speaker 1: factor that's driven by factors. I also, you know, the
Speaker 1: last time I looked at the portfolio, it looked like
Speaker 1: you were a bit underweight tech and overweight financials compared
Speaker 1: to your benchmark. Is that also a result of factors
Speaker 1: or is that driven more by the fundamentals?
Speaker 3: Uh? Yeah, I mean so, yes, we're underweight tech, but
Speaker 3: not necessarily in the US. Okay, so you know you've
Speaker 3: got to remember that we're looking around the world and financials. Yes,
Speaker 3: but you know this is you know, Chris is going
Speaker 3: to love when I say this, but you have to
Speaker 3: be very careful on financials because on the surface, you say, oh, okay,
Speaker 3: so financials they're all value stocks, right, and so therefore
Speaker 3: you have a huge financial bet. But wait a minute,
Speaker 3: insurance stocks traded very high multiples. They do not move
Speaker 3: with money center banks, right, They've done much better than
Speaker 3: money center bents. They're actually a much more defensive group
Speaker 3: than money center banks. So yes, on the surface, you'd say, well,
Speaker 3: we're making a financial bet because we're making a value bet,
Speaker 3: but be careful that because some of those insurance type
Speaker 3: stocks they actually fall into the You know that our defensive,
Speaker 3: defensive bucket. So I guess when I boil it all down,
Speaker 3: where we are and you know, obviously having a big
Speaker 3: financial weight has helped in the last month. But what
Speaker 3: we're achieving, at least in the US, is an overweight
Speaker 3: to growth, an overweight to value, and an underweight to defensive.
Speaker 3: So yes, we own insurance company, which fall into defensive bucket,
Speaker 3: but we're underweight staples, healthcare and things like that that
Speaker 3: also fall in to that as well. And so I
Speaker 3: think if I think about performance here today, it's come
Speaker 3: not it's you know, yes, we a great performance here today,
Speaker 3: but and what And that's come from what we're overweight,
Speaker 3: but it's also come from the factors that we've been underweight,
Speaker 3: which are the defensive factors. And it's behavioral. I go
Speaker 3: back to all this works. Quantitative investing works because of
Speaker 3: behavioral investment. There is we know that people sell value
Speaker 3: into recessions because during recessions people go, oh my god,
Speaker 3: every bank's going to fail, well, every industrial it's going
Speaker 3: down the tube, And so they sell value sucks and
Speaker 3: they run into defensive because they're worried about risk mitigation. Downside.
Speaker 3: I don't want to lose as much, right, so defensive
Speaker 3: strategies get very expensive in bear markets, and value and
Speaker 3: growth tends to get cheap. And as you come out
Speaker 3: and people realize, huh, not every bank's going to fail,
Speaker 3: you know, not every gross stocks going down. The two
Speaker 3: growth and value outperform. And as a bear market proceeds,
Speaker 3: people say, I don't want downside protection, I don't want
Speaker 3: dividend yield, I don't want earning stability. I want to
Speaker 3: make money, and they jettison defensive strategies and they move
Speaker 3: more into growth and value. And this is what we
Speaker 3: are just on the cusp of because early in bear market,
Speaker 3: you know, bull market, you know, bull markets are born
Speaker 3: on pessim. Let's buy a lot of defensive stocks. It
Speaker 3: grows on skepticism, which is last year in matures on optism.
Speaker 3: It's the optimism phase where people go, I don't care
Speaker 3: about don doowntime protection anymore. And this is you know,
Speaker 3: I started my career at Morgan Stali in ninety one,
Speaker 3: and this is exactly what I saw, you know, in
Speaker 3: ninety seven ninety eight, and I see it happening again.
Speaker 3: Early in the early nineties. People wanted downside protection, they
Speaker 3: wanted dividend yields in the late nineties, they had no
Speaker 3: interest in dividend. So I just it's a quantitative investing
Speaker 3: works because of the consistency of human behavior and the
Speaker 3: you know what I would call, you know, kind of
Speaker 3: the the the consistent fear to greed behaviors that I
Speaker 3: see in this business.
Speaker 1: So actually, you know, that kind of brings up another
Speaker 1: question I had. You know, you mentioned, you know the
Speaker 1: factor analysis is quantitative. Is when you're actually applying the
Speaker 1: fundamental analysis, is there a quantitative component there as well?
Speaker 3: So if we take you.
Speaker 1: Know, dividend yield, which you just mentioned, you know, if
Speaker 1: you looking at the dibdend yield factor and you know
Speaker 1: you think it's the right time to go into stocks,
Speaker 1: do you have a quantitative filter to you know, look
Speaker 1: at the stocks themselves, you know, based on yield.
Speaker 3: Yeah. I like to say it's a good question. I
Speaker 3: like to tell people all the time, Look, no one's
Speaker 3: going to walk in our door, and you know, obviously
Speaker 3: we have a lot of people that are trying to
Speaker 3: convince us to buy certain stocks. No one's going to
Speaker 3: come into our office and say, hey, I got a
Speaker 3: great investment idea for you. And then proceed to tell
Speaker 3: us a fundamental store. All our investments begin with what
Speaker 3: are the exposures? From a quantitative standpoint, each and every
Speaker 3: stock gives us. So when we look at every stock,
Speaker 3: we know what exposures are they do they do they
Speaker 3: move with earnings yield or PE low P? Do they
Speaker 3: move with growth? Do they move with earning stability? Quality? What?
Speaker 3: What are we getting if we buy the stock? So
Speaker 3: even before our fundamental re search, guys and gals start,
Speaker 3: they always start. They have to show us that because
Speaker 3: we're making if we add a stock to the portfolio,
Speaker 3: we're making a factor adjustment. So first and foremost we
Speaker 3: start with that, and then we drill down into the stocks.
Speaker 3: But even before we do that, we look at the Okay,
Speaker 3: so we're thinking of adding a stock, let's say in
Speaker 3: the value are well, okay, we start with it has
Speaker 3: exposure to earning yield? Check the box. Okay, we like that. Well,
Speaker 3: what's the correlation to the other stocks in the earnings
Speaker 3: yield low pe bucket? Because we want to have companies
Speaker 3: that will not increase What I remember why I said
Speaker 3: in isually our tracking error. I want to have exposure
Speaker 3: earnings yield, but I don't want to make a what
Speaker 3: I call a big bet on something that's outside our
Speaker 3: you know, quantitative models. So in other words, if I
Speaker 3: just keep adding banks, I'm making a bank exposure, right,
Speaker 3: So that then and only then do we call down
Speaker 3: the list to Okay, now, let's let's look at the
Speaker 3: following stocks. And so a great example, we added a
Speaker 3: real estate company recently to the portfolio because we wanted
Speaker 3: to increase our value exposure. And we have quite a
Speaker 3: bit of financials as you mentioned, we have industrials, and
Speaker 3: we didn't have a uh, you know, a real state
Speaker 3: a stock that moves with the value exposure, at least
Speaker 3: in the States.
Speaker 2: Interesting, you know, I would love to ask you about
Speaker 2: position sizing generally, you know, without getting into into specifics.
Speaker 2: I mean, how do you think about that? I mean,
Speaker 2: all the major industries are market cap weighted. You know,
Speaker 2: you could kind of naively do it equal weighted, which
Speaker 2: gets you a lot of the way there, or you
Speaker 2: could do some kind of optimization or I've seen a
Speaker 2: lot of people do things like have their position size
Speaker 2: be congruent with you know, how good do they think
Speaker 2: the investment is, or what their estimation of the alpha
Speaker 2: of this certain investment is. So, how do you think
Speaker 2: about position sizing within your portfolio?
Speaker 3: Sure, well, so, first of all, I don't think about
Speaker 3: it in terms of an absolute basis. I think about
Speaker 3: it in terms of relative because at the end of
Speaker 3: the day, you could go and buy the NSCI world
Speaker 3: ETF right. And I to be clear, I'm an active manager.
Speaker 3: I got nothing against passive investing. I really don't. I
Speaker 3: think people should have passive exposure to these to these markets.
Speaker 3: What I you know, I roundly against is managers that
Speaker 3: have you know, they're broadly diversified, and then they're scratching ahead.
Speaker 3: Why you know, why they haven't outperformed, why they're losing
Speaker 3: au M and so I think I think passive strategies
Speaker 3: are bring are doing what's right for the the industry,
Speaker 3: which is forcing manages to be truly active twenty stock
Speaker 3: people say, oh my god, that's really concerted. Yeah, it's
Speaker 3: really concentrated. We try to control the risk by not
Speaker 3: having all stocks correlated to a theme. But that's what
Speaker 3: we're Brian and chieve and certainly the performance over time
Speaker 3: has proven so. So I think in terms of relative exposure.
Speaker 3: You know, if you go to our fact sheet it's
Speaker 3: to shows I'm required to show our top ten. It
Speaker 3: looks like you look at top ten. Oh it looks
Speaker 3: like you got big positions in some tech names, but
Speaker 3: actually on a relative basis, we have much bigger relative
Speaker 3: position to value names. So that's you know, that's the
Speaker 3: first place we saw start in terms of position side size.
Speaker 3: You know, again, I've been in this business a long time.
Speaker 3: I've got a lot of tattoos on my back figuratively
Speaker 3: that of you know, kind of bad decisions. And I've
Speaker 3: learned that. You know, we're making educated bets, but we
Speaker 3: don't know everything, and so therefore I don't I want
Speaker 3: to make sure if something ha happens, it's not going
Speaker 3: to take them, you know, kind of the fun And
Speaker 3: so how does that happen is I got to make
Speaker 3: sure we don't let the relative weight and anyone stock
Speaker 3: get too big. So when the relative weight gets to
Speaker 3: kind of ten percent of the portfolio, I start to
Speaker 3: switch a little. But the other way we look at
Speaker 3: it is in terms of we look at each stock's
Speaker 3: contribution to risk. And we know that if you know,
Speaker 3: stocks that are very very big in the index, if
Speaker 3: we bring those down, that will lower our overall risks
Speaker 3: of our portfolio. So we it's not a you know,
Speaker 3: there's not any one kind of magical line we do.
Speaker 3: Tram Wind stocks have done extremely well, and we think
Speaker 3: there's you know, there's a risk of underperformance on a
Speaker 3: short term basis regardless of what our factor modeling says.
Speaker 3: And certainly we've been forced to trim some big winners
Speaker 3: this year, but it's really in terms of relative weights.
Speaker 3: And again, when it gets over ten percent, I start
Speaker 3: to get nervous that one stock's going to determine the
Speaker 3: outcome of the portfolio.
Speaker 2: Gotcha.
Speaker 3: Yeah.
Speaker 2: My last question is really kind of going along with
Speaker 2: that theme, I mean, just risk management as a theme.
Speaker 2: I mean, it seems like most of the risk management
Speaker 2: is based on position sizing, you know, making sure your
Speaker 2: correlations are relatively not negative, but you're not adding just
Speaker 2: the same risk to the portfolio over and over again.
Speaker 2: Is that where most of the risk management comes from
Speaker 2: from your from your side or is there any kind
Speaker 2: of like I mean, I know you're tactical with the
Speaker 2: factors and such, but is there any kind of like,
Speaker 2: you know, tactical overlay. Maybe the market's going down and
Speaker 2: we sell some futures or go to some cash or
Speaker 2: something like that. Is there anything like that in the portfolio?
Speaker 3: Yeah, So let me start with the last question, which
Speaker 3: is you know again. And I used to sit and
Speaker 3: listen to people come and pitch their strategies and and
Speaker 3: to me when I was first startup more insali and
Speaker 3: I hated when people would say things like, well, I'm
Speaker 3: a long acquity manager, but if I don't like the market,
Speaker 3: I'll go to cash, Because at the end of the day,
Speaker 3: I think that's a bunch of I mean, I just
Speaker 3: don't think that's being honest. Like, are you a manager
Speaker 3: that's in the business of competing on a relative basis
Speaker 3: and an active manager or you a you know, a
Speaker 3: long short you know, kind of neutral where your return
Speaker 3: is your relative returns cash. You can't be both, right,
Speaker 3: And so someone says I don't like you know, I'll
Speaker 3: go to cash. What they're suggesting to you is I'm
Speaker 3: going to give you a good relative performance on the upside.
Speaker 3: I'm not going to lose your money on the downside.
Speaker 3: I think that is that's just being that's just not honest.
Speaker 3: I hope in all the data shows that our downside
Speaker 3: capture is less than the market and our upside is
Speaker 3: more you know, since we started the strategy, so it
Speaker 3: has worked in terms of how we shift. Now how
Speaker 3: we do that Again, what I told you before is
Speaker 3: when I look at say in Europe, right, you know,
Speaker 3: over the last a decade, it really it's it's screened
Speaker 3: own safe stocks, own quality stocks, and that means focus
Speaker 3: on the amount of beta risks you have, right, and
Speaker 3: so we've been very cautious on stepping into deep value
Speaker 3: or very low value stocks because they tend to have
Speaker 3: higher valuation. So the factor model very much guide how
Speaker 3: we think in terms of how you know, that's the
Speaker 3: first you know kind of risk management, uh that we do.
Speaker 3: And then the other thing that we watch is the
Speaker 3: correlation of a stock to the factor. Okay, so what
Speaker 3: there's something called residual volatility. I'm really getting quantity here,
Speaker 3: but volatility. Residual volatility is kind of the unexplained volatility,
Speaker 3: which is basically the uh, the volatility that comes from
Speaker 3: at the company level. So a biotech company has a
Speaker 3: lot of residual volatility because you know, they you know,
Speaker 3: it's not it's not correlated to growth, it's correlated to
Speaker 3: drug success. Stock goes up, drug failure stock goes down,
Speaker 3: so that has high residual voltilay. I don't want high
Speaker 3: residual volatility. I want stocks that are correlated to their factors,
Speaker 3: because what I desperately don't want to have happened is
Speaker 3: where I get the factor right, but something happens fundamentally
Speaker 3: that I didn't know about, and then stock goes down
Speaker 3: even though I'm you know, in my quantitative side, guys
Speaker 3: are dancing say yeah, we got the we got the
Speaker 3: factors right, oh oh yeah, but this company didn't move
Speaker 3: in the fact So we watched the changes in the
Speaker 3: correlation to the fact there's and that can set off
Speaker 3: what we call a warning bell that oh my gosh,
Speaker 3: there's a problem here, because you know, for instance, if
Speaker 3: and our financials did very well, but we know that
Speaker 3: value in financials did have done very well last month.
Speaker 3: If we have a stock in financials that hasn't done well,
Speaker 3: then we're all over fundamental guys going okay, there's a
Speaker 3: problem there. There's a problem here, and we need it.
Speaker 3: So that's that's a big part of the risk management.
Speaker 3: And then the other the last part is and we
Speaker 3: kid we have something called correlation Thursday, where we look
Speaker 3: at the portfolio and address each relationship of the stocks
Speaker 3: as the correlations come together, and that will cause turnover
Speaker 3: if you know position as you mentioned position sizing, if
Speaker 3: boil boy, you know, we've got a couple of AI
Speaker 3: stocks and gone through the roof and they are moving
Speaker 3: one for one. You know, that's going to cause us
Speaker 3: from a risk management standpoint, to take down the exposures
Speaker 3: as well.
Speaker 2: Yeah, it's great us as an industry. Just just one
Speaker 2: quick comment, David, I just think US as an industry,
Speaker 2: like you know. I that's one of my big things
Speaker 2: is to measure the volatility of or portfolio from the
Speaker 2: factors as well as from your videosyncratic or residual volatilities
Speaker 2: as well, because you want to know where that's coming from.
Speaker 2: I think a lot of people don't do that, and
Speaker 2: it's a very important step in the process. And I'm
Speaker 2: really glad that you mentioned that.
Speaker 1: Well, Andrew wanted to thank you for your time. I
Speaker 1: definitely learned a lot.
Speaker 3: This is great, Well, thank you, it's great. It's it's
Speaker 3: fun to be able look at in the weeds, and
Speaker 3: I really appreciate David, especially Chris and understanding what we do.
Speaker 3: It's a it's a complicate in some ways. It's complicated,
Speaker 3: but what we like to tell people, look, we're just
Speaker 3: we just want to stay in the game. We just
Speaker 3: want to stay in the game and not convince you
Speaker 3: to buy some style it's you know, out of favor
Speaker 3: if it could last for you know, multiple multiple years. Now,
Speaker 3: how we do that is is is a little bit
Speaker 3: more complicated, so it's fun to actually talk about it.
Speaker 1: Thank you, Thank you, Chris, thank you again for serving
Speaker 1: as my co host.
Speaker 2: Thank you.
Speaker 1: Until our next episode, this is David Cone with Inside Act.