Speaker 1: Look New Trillions. I'm Joel Webber and I'm Eric bell Chierness.
Speaker 1: So Eric on the show, most of the time we've
Speaker 1: talked to people in E t F advisors around E
Speaker 1: t F. We're gonna shake it up a little bit today. Yeah,
Speaker 1: we're going to talk to somebody who is somewhat of
Speaker 1: a legend from the mutual fund industry and somebody who's
Speaker 1: got a new venture and it's related to something a
Speaker 1: word that comes up probably on every single episode. Can
Speaker 1: you guess what that word is? Active? Close? Alright? Yes,
Speaker 1: I think all three? Yeah, you're right. His name is
Speaker 1: Peter Krauss. He's starting a venture called Aperture Investors. He's
Speaker 1: formerly of Goldman Sachs and most recently he was the
Speaker 1: CEO of Alliance princetein or Yeah. So I mean this
Speaker 1: is a major league person here who knows the mutual
Speaker 1: fund industry. He's very well aware of the rise of
Speaker 1: passive and the cost obsession going on now in the
Speaker 1: end history, and so he has a solution for the
Speaker 1: mutual fund side. So this is a little bit about
Speaker 1: can they get it back together, can they stop this
Speaker 1: sort of migration over to low cost passive and we'll
Speaker 1: try to break it down to how this would practically
Speaker 1: work for an investor as well. We're also joined by
Speaker 1: Shannai Basik, who covers finance or finance, depending on how
Speaker 1: you want to say, for Bloomberg News, this time on Trillians.
Speaker 1: The man who hates e t s. Okay, so, Peter,
Speaker 1: you're you've been called the man who hates e T s.
Speaker 1: Why do you hate et F so much? Well, I
Speaker 1: didn't really say I hated ets the New York New
Speaker 1: York Times. They're trying to get clicks. Yeah, exactly. I
Speaker 1: think e t s are a useful vehicle. But in
Speaker 1: all things, in the securities market, there's a lot more
Speaker 1: than what there appears on the front cover. E t
Speaker 1: s are actually rather sophisticated security. They are actually derivatives.
Speaker 1: They aren't really just a package of indie ugual stocks
Speaker 1: or bonds. They're actually a set of promises to buy
Speaker 1: and sell those securities, will hold those securities over time.
Speaker 1: There are major participants in the marketplace that support that.
Speaker 1: Some of the e t f s are quite liquid,
Speaker 1: Some of the e t f s are not very liquid.
Speaker 1: Some e t f s have trillions of dollars attached
Speaker 1: to them, and some ETFs have tens of millions of
Speaker 1: dollars attached to them, and there's thousands of eats if
Speaker 1: that exactly My concern with e t s at the
Speaker 1: time and still is that investors don't really understand their
Speaker 1: construct and they don't really understand the potential risks the
Speaker 1: e t F itself, the liquidity e t F itself
Speaker 1: relies on market participants who actually trade them. But the
Speaker 1: market participants get paid by having a spread between what
Speaker 1: they buy it at what they sell it at. If
Speaker 1: that spread collapses or that spreads not available, where the
Speaker 1: market participants somehow feels that they need a bigger spread
Speaker 1: while the investor is subject to that cost. And we've
Speaker 1: actually had some experience in the market about three years
Speaker 1: ago in August when the SPX or the or the
Speaker 1: standard and Poors ETF separated from the cash market for
Speaker 1: about thirty minutes by a significant amount, something that people
Speaker 1: did not think was going to happen. Having been in
Speaker 1: the markets for a long time, probably now going on
Speaker 1: forty years, things like that just don't happen out of
Speaker 1: thin air. They actually have a rationale, there's actually a
Speaker 1: reason for that, and it's hard to fix because at
Speaker 1: the end of the day, it again relies that liquidity
Speaker 1: relies on market participants, meaning institutional participants, actually having confidence
Speaker 1: to trade those markets at that point in time in
Speaker 1: a very tight bit as spread. If that spread extends
Speaker 1: or goes away, or it gets larger, the cost becomes
Speaker 1: very significant. I don't think investors actually understand that risk. Now,
Speaker 1: for the highly liquid large cap equity markets, that risk
Speaker 1: is less and it's actually reasonably modest. But for bond markets,
Speaker 1: it's actually quite significant, and there's lots and lots of
Speaker 1: money follow high yield e t s for example, and
Speaker 1: the high yield e t F S tracking error, which
Speaker 1: is a measure of the cost of that bit as spread,
Speaker 1: its actually quite large. It's sometimes seventy eight basis points,
Speaker 1: almost one percentage point. Well, you wouldn't give up one
Speaker 1: percentage point. That's a lot of money in a you know,
Speaker 1: yield environment of call it five percent for a high
Speaker 1: yield security, that's the yield. So I think investors need
Speaker 1: to understand that better. My whole point was understand the
Speaker 1: e t F better, understand the risks of the ETF better,
Speaker 1: which is a big part of the show, and I
Speaker 1: can literally I can feel Eric wanting to pounds right now.
Speaker 1: So let's just let him ask a question. Well, what
Speaker 1: you're saying about the reliance on the middleman is true.
Speaker 1: You are relying on a lot of these people connected
Speaker 1: to the system market makers to make markets. If they
Speaker 1: don't have all the inputs from the stocks and bonds.
Speaker 1: Like that day on August where some of the stocks
Speaker 1: were halted, they widen their spreads and that's what caused
Speaker 1: the dislocation of the e t F. Now since then
Speaker 1: they've tried to make it to the et F, the
Speaker 1: stocks are not going to have different halting times. So
Speaker 1: I think the e t f s are just downstream
Speaker 1: sometimes from like a rule in the exchange or the
Speaker 1: plumbing as I call it. So that has like can
Speaker 1: when breggsit happened, that did not happen. However, it is
Speaker 1: true you have to trade the e t F. In
Speaker 1: the high yield case, I think that most of the
Speaker 1: money and high yields still goes for mutual funds because
Speaker 1: active mutual funds that's where they really kick butt. In
Speaker 1: the high yield area or bonds in general, I think
Speaker 1: beat h y G So the high yield e t
Speaker 1: F I think is more used as like quick beta
Speaker 1: for traders. Maybe there's some long term money, but for
Speaker 1: the most part, I think investors have figured out that
Speaker 1: you can do better going active in a mutual fund.
Speaker 1: UM But so just two caveats on that, but I
Speaker 1: think both points are very valid. Something interesting, UM, you know,
Speaker 1: in your own research and aperture, you've been in the
Speaker 1: mutual fund industry for so long, but you still see
Speaker 1: something wrong with the mutual fund industry. You've said there
Speaker 1: are too many of them. Can you explain your thinking
Speaker 1: here and what's the idea with aperture, what's the what's
Speaker 1: where did this big idea come from? So um I
Speaker 1: have been operating in the mutual fund industry for a
Speaker 1: very long time, and of course any portfolio manager in
Speaker 1: the mutual fund industry, any portfolio managing the industry, will
Speaker 1: say that their objective is to actually perform. That's what
Speaker 1: they would say every day. The problem is the incentive
Speaker 1: structure is actually not set up that way. The incentive
Speaker 1: structure is you're paid based on your asset levels, not
Speaker 1: based on your performance. And that's a fundamental disconnect. And
Speaker 1: over many years, thirty forty years. It led to companies
Speaker 1: being focused on the growth of their assets. I have
Speaker 1: to before you go any farther, I want to ask
Speaker 1: if you said this at any of your prior jobs
Speaker 1: with the table has been flipped over. I did say
Speaker 1: this that many of my prior jobs at the tables over.
Speaker 1: In many cases they did. Now I have been saying
Speaker 1: this for really literally the past three years, um and
Speaker 1: I think what happened is is that we got to
Speaker 1: a tipping point, which was sometime before this, where the
Speaker 1: size of assets under management was so large it became
Speaker 1: difficult to perform. And I spent a lot of time
Speaker 1: investigating long term performance of managers of different types of managers,
Speaker 1: concentrated managers, diversified managers, managers and large cap managers and
Speaker 1: small cap managers outside the United States, and unfortunately, the
Speaker 1: data that's available, which is you know, publicly available to anybody,
Speaker 1: really proves the point that there's no easy way to
Speaker 1: identify a manager that will persistently perform, and on average,
Speaker 1: managers do not perform in access of their fees. And
Speaker 1: that's a really troubling problem. And of course the investor
Speaker 1: in the world has figured that out and in fact,
Speaker 1: they've moved their money from you know, mutual fund assets
Speaker 1: and active management to E t S and passive. And
Speaker 1: I actually think we need et S and passive because
Speaker 1: basic hypothesis is there's too much money being managed actively
Speaker 1: to actually perform. So can you explain your fee structure
Speaker 1: that what does the future look like when so many
Speaker 1: people are going to zero? So if you take the
Speaker 1: prospect that I'm assuming I'm right for the minute, that
Speaker 1: there's too much money being managed actively, you need to
Speaker 1: change the incentive structure. Because if you don't change the
Speaker 1: incentive structure, then people will just keep managing the assets
Speaker 1: because they're paid to manage the assets and they're paid
Speaker 1: to gather the assets. But if you go back to
Speaker 1: basic principles, which is why is the PM there and
Speaker 1: BYM portfolio manager, yes, I'm sorry, I'm sorry. The portfolio
Speaker 1: manager exists because they want to perform. And if you
Speaker 1: ask a portfolio manager that that is what they would say,
Speaker 1: I'm here to create performance for my clients. If that's
Speaker 1: the basic concept, guess what, let's pay you based on
Speaker 1: that concept. If you don't perform, you don't get paid.
Speaker 1: If you do perform, you do get paid. It seems
Speaker 1: like a fair deal. There's a cap to how much
Speaker 1: you can get paid. Still, there is a cap in
Speaker 1: the US under the the Act rules. There. The the
Speaker 1: SEC view is that we should have performance linked fees,
Speaker 1: and there's performance linked fees include a fulcrum structure which
Speaker 1: creates a cap. But the cap is reasonable and so
Speaker 1: if managers hit that cap, they're still possible out performance
Speaker 1: over the cap and the managers performance uh fee. Then
Speaker 1: it's just declined by the certain pro rata amount by
Speaker 1: which the actual excess return exceeds the cap. But just
Speaker 1: a question on this performance fees. This has been something
Speaker 1: been hearing a lot about and on Twitter where a
Speaker 1: lot of I called the gladiator pit of debate with ideas.
Speaker 1: A lot of people will push back on performance fees
Speaker 1: and say, well, the problem with them is it it
Speaker 1: inspires really outrageous bets, reckless behavior, because now you're really
Speaker 1: looking to get as much money as possible, and couldn't
Speaker 1: that really turn out bad for the investor? Right, So
Speaker 1: that's a very good point. And so you need an
Speaker 1: ecosystem in which the performance fee exists. So there's both
Speaker 1: a structure for the performance fee. So point one is
Speaker 1: Our proposition is that there's too much money being managed actively,
Speaker 1: And the reason why there's too much money is there
Speaker 1: too many managers who are paid based on the amount
Speaker 1: of assets they have rather than the performance. If they
Speaker 1: were paid on performance, given their historical performance, they wouldn't
Speaker 1: exist and therefore be less managers and less capacity. More
Speaker 1: money would be impassive, but the managers that did exist
Speaker 1: would perform and produce performance for clients that we're saying
Speaker 1: there's a dinosaur die off that needs to happen. There
Speaker 1: is a dinosaur die off. And people have asked me
Speaker 1: many many times, wouldn't that happen by consolidation, And I've
Speaker 1: said to people, you know, and consolidation in the manufacturing business,
Speaker 1: for example, generally leads to more efficiencies. Consolidation in the
Speaker 1: asset management business, however, is the opposite. When one firm
Speaker 1: buys another, they don't expect the portfolio managers in the
Speaker 1: acquired firm to go out of business. They actually expect
Speaker 1: the portfolio managers to grow. There's no reduction in the capacity.
Speaker 1: In fact, there's a there's an expectation that will it
Speaker 1: will grow. So consolidation is not the answer. The only
Speaker 1: answer I've said sort of uh uh with gallows humor
Speaker 1: is death. You know, then the portfolio manager out of business.
Speaker 1: But another answer would be to change the revenue structure.
Speaker 1: And if you change the revenue structure, then those managers
Speaker 1: who can't perform will be out of business and they
Speaker 1: won't carry any money. So put that's point one. Point
Speaker 1: to to go back to Eric's point if I if
Speaker 1: I'm a longer answer, sorry, Point two is all right,
Speaker 1: how do we deal with if you pay people in performance?
Speaker 1: How do we deal with risk taking? Because on the
Speaker 1: one hand, people say, well, I don't like the fact
Speaker 1: that I pay you a fee to try to perform
Speaker 1: and you get it whether you do or you don't.
Speaker 1: I don't like that, But I also don't want to
Speaker 1: pay you a performance fe because I'm worried you'll take
Speaker 1: too much risk. Now, look, you sort of can't have
Speaker 1: your cake and eat it too, But just for the moment,
Speaker 1: let's assume that that's the position. When so what we've
Speaker 1: said at apertures, look, that's a fair point. So number one,
Speaker 1: in the forty act vehicles, the fees are capped, and
Speaker 1: so excessive risk taking that is attempting to produce a
Speaker 1: return and excess of the cap doesn't actually pay the manager,
Speaker 1: so they really don't have any real reason to do that.
Speaker 1: But the way we set up the compensation structure is
Speaker 1: quite interesting. So we've said two managers, look, we're going
Speaker 1: to pay you on performance, but half of your compensation
Speaker 1: is deferred. You receive that compensation if in the succeeding
Speaker 1: two years you actually produce zero or positive returns for
Speaker 1: your client. If you actually produce negative returns for your client,
Speaker 1: you reduce that deferred compensation or potentially lose all of it.
Speaker 1: So that is a very significant impact on how the
Speaker 1: manager takes risk. Now there's a further interesting element in
Speaker 1: the ecosystem. You've heard of high water marks. In the
Speaker 1: head fund industry, firms use high water marks. I don't
Speaker 1: like high water marks they do in gender risk taking
Speaker 1: because what happens in a high water mark is if
Speaker 1: you're down five you have to earn the five percent
Speaker 1: back before you earn any money. That actually makes you
Speaker 1: a risk taker. It take makes you take too much risk,
Speaker 1: And if you actually don't earn the five percent in
Speaker 1: the second year, then you're really swinging for the fences
Speaker 1: because you're gonna be you won't have earned any money
Speaker 1: for two years. So we we set the performance every
Speaker 1: year and we use this three year averaging, and that
Speaker 1: deferred compensation is a way to control risk. So it's
Speaker 1: a complicated ecosystem, yes, but I think we've actually addressed
Speaker 1: your concern. You were talking about consolidation being a bad thing.
Speaker 1: It's funny you say that because earlier this year we
Speaker 1: broke that JP Morgan was among um large banks that
Speaker 1: we're looking to buy et F companies. So you know,
Speaker 1: with JP Morgan, with Goldman's Acts becoming massive et F players, now,
Speaker 1: is this a good thing or a bad thing for
Speaker 1: their business models? Well, my proposition is is that we
Speaker 1: need more passive investing vehicles essentially, or more passive providers.
Speaker 1: I don't like the fact, although I think it's gonna
Speaker 1: be hard to change because passive is so benefited by
Speaker 1: scale that between you know, the two large players, three
Speaker 1: large players, State Street, Van Guarden and black Rock, you
Speaker 1: have you know, enormous concentration, and so you have operational
Speaker 1: risk in inside of those firms, which the market completely discounts,
Speaker 1: but there is real risk there. Having said that, investors
Speaker 1: will need to continue to have passive vehicles to allocate
Speaker 1: capital too. And everybody's portfolio should include a substantial amount
Speaker 1: of passive and managers who are paid for performance, who
Speaker 1: actually produce performance. And then over the whole portfolio managers
Speaker 1: clients will actually get performance, which today they're not getting. UM.
Speaker 1: And so I think that JP Morgan, Goldman Sachs getting
Speaker 1: into the t F business just provides for a more
Speaker 1: diversification of the passive vehicles. And that's a good thing. Um.
Speaker 1: And let's talk about this. There needs to be more passive.
Speaker 1: So let me give you the numbers here right now,
Speaker 1: I think the fund industry is about sixteen trillion dollars
Speaker 1: that is passively managed. The rest is active. Obviously that
Speaker 1: swing from a pendulum twenty years ago where it was active.
Speaker 1: Where is that pendulum going to stop, in your opinion,
Speaker 1: where they'll have a nice new equilibrium were active will
Speaker 1: be right sized fifty passive. Great question. I don't know
Speaker 1: the answer, as you would you would expect that that's
Speaker 1: a guess. But um, look we know. One of the
Speaker 1: reasons why I pushed very hard to try to change
Speaker 1: the revenue structure in the industry is that the existential
Speaker 1: question is that if managers were paid fixed fees I eat,
Speaker 1: paid to try as opposed to pay to perform. Over time,
Speaker 1: more and more money would leave the active industry and
Speaker 1: go into the passive industry. And what I was concerned
Speaker 1: about is that you didn't have a level playing field
Speaker 1: between active and passive. Fee structures inactive were just materially
Speaker 1: higher than fee structures in passive and ets. So investors
Speaker 1: were saying, look, I don't get I don't get returns
Speaker 1: net of fees in the active space. I might as
Speaker 1: well just pay less fees and get the market return
Speaker 1: minus the fee. And if you if you looked out
Speaker 1: over a long period of time and said, well, philosophically,
Speaker 1: that means that people would just move from active to
Speaker 1: passive because they're not getting paid anything to be an
Speaker 1: active in fact, their returns are less than what they
Speaker 1: would get in passive. Then you end up with a
Speaker 1: market that's pent passive. And that, of course, theoretically is
Speaker 1: a disaster because now you don't have a capital market
Speaker 1: that actually prices. So I I went down to Washington
Speaker 1: to talk to the SEC and I said and the
Speaker 1: tragicy Department, And I said to them, look, you have
Speaker 1: a philosophical or fiduciary problem. Nobody wants the markets to
Speaker 1: be passive because we will be able to price an
Speaker 1: ip L. That's a really bad thing. And this is
Speaker 1: the largest capital market in the world, and we need
Speaker 1: to be the most robust capital market in the world.
Speaker 1: So what you you're not going to say, as regulators,
Speaker 1: we're going to outlaw passive or you can't have more
Speaker 1: than ext percent passive. That's not going to happen. But
Speaker 1: what you can do is create a level playing field
Speaker 1: so that competition allows investors to actually move money into
Speaker 1: vehicles that makes sense to them, and that will create
Speaker 1: a balance in the market. And that was why I
Speaker 1: was pushing the regulators and treasury to think about a
Speaker 1: structure where the base fee was this et F like fee.
Speaker 1: Then investors could say, look, I could have either active
Speaker 1: or passive at the same cost, but I have an
Speaker 1: option on the active managers performing. So Derik's question, I
Speaker 1: think passive will continue to grow. It's at thirty today.
Speaker 1: I think it will easily get the fifty. Whether it
Speaker 1: goes beyond fifty or sixty, I don't know. My guess
Speaker 1: is that somewhere in the fifty to six level is
Speaker 1: kind of where it tops out. I think that, uh,
Speaker 1: if you thought about, well, of your sixteen trillion, could
Speaker 1: eight trillion be actively managed? You know, that's a question.
Speaker 1: I don't know, but I do think in ten to
Speaker 1: fifteen years there's going to be at least a trillion
Speaker 1: dollars managed by these performance structors. And you know, the
Speaker 1: old industry isn't going to go away tomorrow. The old
Speaker 1: industry is going to remain for a long period of time.
Speaker 1: By the way, there are managers in the old industry
Speaker 1: that do perform, that do cap their capacity, but they're
Speaker 1: very small number. Is it hard to recruit talent? You're
Speaker 1: pushing down fees across the board? Do people want defer
Speaker 1: and differing compensation? You're telling people they are going to
Speaker 1: get paid less, So what is it like to recruit
Speaker 1: money managers? Well, I'm actually not telling people they're gonna
Speaker 1: get paid less. I'm actually telling people if they perform,
Speaker 1: they're going to get paid substantially more, actually substantially more,
Speaker 1: And we pay the managers thirty of the that's a
Speaker 1: significant improvement in the percentage of the revenues that they
Speaker 1: earn relative to industry standards. Let's focus on appertuers, I
Speaker 1: can what products are you selling and how much are
Speaker 1: they going to cost? So I can't focus on specific
Speaker 1: products because as you know, there's a registration process, but
Speaker 1: we do expect to have all of our products available
Speaker 1: in both registered investment vehicles, both in the US and
Speaker 1: in Europe and perhaps in Asia over time, as well
Speaker 1: as separate accounts for institutions. So what we are our
Speaker 1: thesis is that we want these investing vehicles and these
Speaker 1: fees available to anybody who wants to be able to
Speaker 1: participate them, anybody meaning retail investor all the way to
Speaker 1: institutional investors. So does that mean mutual fund Yes, that
Speaker 1: would mean mutual funds. Act Advisor of funds UH and
Speaker 1: use its funds which are mutual funds in Europe. And
Speaker 1: of course they could be in different vehicles if we
Speaker 1: were in Asia, but for the time being, I think
Speaker 1: the U S and Europe's a very big market. Now
Speaker 1: there's a couple, there's I think at least one e
Speaker 1: t F that has a folk groum fee. Why not
Speaker 1: do this in the e t F structure is because
Speaker 1: you don't want to show your holdings every day, or
Speaker 1: specifically because of what you talked about earlier, not like
Speaker 1: the trading aspect. Why a mutual fund because clearly, you know,
Speaker 1: people are all kind of thinking et F right now.
Speaker 1: I wouldn't want to be where the money is going.
Speaker 1: So it's a very interesting question, Eric, very interesting question.
Speaker 1: I hope you're ready for the response embracing Okay, well
Speaker 1: we'll see so. Um. Along with the idea that I
Speaker 1: wanted to change the revenue structure of the market, I
Speaker 1: also think that the structure of the mutual fund and
Speaker 1: the pricing of the mutual fund meaning NAV at the
Speaker 1: end of the day, is an anachronism. I mean, we
Speaker 1: have that structure because it's seventy years old, not because
Speaker 1: we would design it that way. Today, we can price
Speaker 1: a mutual fund all day long. What stops a mutual
Speaker 1: fund from being priced all day long like a security answer? Nothing,
Speaker 1: just the rules. So one of the things that I
Speaker 1: think the industry needs to do is to recognize that
Speaker 1: continuous pricing for mutual funds is actually very healthy for
Speaker 1: invest sters. If you continuously priced mutual funds, what's the
Speaker 1: difference shereet of mutual fund and in e t F
Speaker 1: Exactly nothing excepted in the mutual fund case, we actually
Speaker 1: are not disclosing the positions to the street and allowing
Speaker 1: the street potentially to disrupt the pricing value that the
Speaker 1: investor keeps because the securities are known only to the investor.
Speaker 1: So I think one of the things that has to
Speaker 1: happen in the next year or so is the sec
Speaker 1: needs to examine continue to examine the possibility for continuously
Speaker 1: trading mutual funds. If you continuously traded mutual funds as
Speaker 1: a security that was listed in the New York Stock
Speaker 1: Et Change, you could tomorrow take sixteen trillion dollars and
Speaker 1: turn them into e t s, the only difference being
Speaker 1: the tax treatment, which is a biggie for a lot
Speaker 1: of people. It's about the tax treat of capital gains.
Speaker 1: Let's talk about the tax treaming. There is no reason
Speaker 1: on Earth why e t f s should have deferred
Speaker 1: taxes and mutual fund should pay taxes every year. The
Speaker 1: only reason why it exists is that e t f
Speaker 1: s were dreamt up a long time after Earth the
Speaker 1: I R S built the code. The fact that inside
Speaker 1: and E t F every transaction is treated is a
Speaker 1: light kind exchange is kind of a silly thing. You're
Speaker 1: shooting so many arrows at your fort right now. Mutual
Speaker 1: funds should not pay tax eating now you're you're gonna
Speaker 1: be You're gonna be dead by the time i'm Mutual
Speaker 1: funds should not pay taxes, and E t F s
Speaker 1: it should avoid paying taxes. There should not be a
Speaker 1: subsidy running between mutual funds and ets. They both should
Speaker 1: be treated the same. Right In other words, eat Mutual
Speaker 1: funds are kind of double taxed. When you sell it,
Speaker 1: you get taxed, and you also get taxed for doing nothing.
Speaker 1: You're saying, kill one of the taxes in the mutual
Speaker 1: fund to make it even with the E t F.
Speaker 1: To be precise, mutual funds are not double tax Mutual
Speaker 1: funds are taxed in two ways. You're not double taxed.
Speaker 1: You're taxed as gains and losses occurred during the course
Speaker 1: of the year and distributions occur in the year, and
Speaker 1: then you are taxed with your adjusted basis relative to
Speaker 1: your sale value. The E t F the same thing happens,
Speaker 1: but it's all deferred, so there is it's a timing difference.
Speaker 1: It's actually not a permanent difference. It's a timing difference
Speaker 1: between when you pay the tax. But there's no earthly
Speaker 1: reason why the e t F should not pay that tax.
Speaker 1: If the I R S wants to increase its revenues,
Speaker 1: which I would think they do, given that the government's
Speaker 1: going to post i think latest reading eight billion dollar deficit,
Speaker 1: they ought to tax et S and there's no reason
Speaker 1: why they shouldn't other than the sort of silly rule
Speaker 1: that existed well before you created an e TF for
Speaker 1: just fell down. Well, no, I actually completely understand that
Speaker 1: point of view. From the mutual fund side, it's not fair.
Speaker 1: In fact, the tax efficiency of an et F was
Speaker 1: a happy accident, as Kathleen Mori already told, didn't mean
Speaker 1: to do that. It was just a nice byproduct. And
Speaker 1: it turns out that for some people that's the number
Speaker 1: one benefit. For others it's maybe two or three. But
Speaker 1: it certainly adds to this whole like basket of advantages
Speaker 1: that has helped the ETF. So so I agree with you.
Speaker 1: I've actually analyzed this in great detail because I'm actually
Speaker 1: intellectually interested in it. So the e t F is
Speaker 1: the greatest to state vehicle in the world. If you
Speaker 1: buy the e t F and die with it, it's
Speaker 1: a step up in basis you never pay the tax.
Speaker 1: That's a terrific opportunity. The number of people to take
Speaker 1: advantage of that is less than point one percent. E
Speaker 1: t F holding periods, you know, are within one to
Speaker 1: two years, maybe three years max. The benefit that that
Speaker 1: holder is getting is the net present value of the
Speaker 1: tax payments over that time period at today's interest rates.
Speaker 1: It's the minimus. People think it's an attractive thing. It
Speaker 1: really doesn't pay that much, but it is a marketing
Speaker 1: pitch that e t F organizations use a happy accident.
Speaker 1: It's nice to say to somebody, why don't you take
Speaker 1: advantage of the happy accident? The fact that mutual funds
Speaker 1: pay taxes. That's just the facts. That's fine. There's another
Speaker 1: interesting issue. If you force the e t F to
Speaker 1: actually pay taxes, their costs would actually go up because
Speaker 1: they'd actually have to account for the ten forty to
Speaker 1: get sold that gets sent to you each year, So
Speaker 1: there's also a cost differential. That's actually the thing that
Speaker 1: bothers me the most. It's not so much a act
Speaker 1: is because the net present value is a small number.
Speaker 1: It's the fact that the mutual fund structure has to
Speaker 1: actually account for that taxation every year, send out information
Speaker 1: to their constituents, their mutual fund holders. They pay attacks,
Speaker 1: the e t F doesn't pay that, and then the
Speaker 1: e t F says, my fees are lower. But that's
Speaker 1: that's what really bothers me. Yeah, and Mike Tyson's punch out.
Speaker 1: You're the guy who's like days in the corner right now. No,
Speaker 1: I mean this is something wrong with the t F. Yeah.
Speaker 1: I just think this is an inequality in the system
Speaker 1: that needs to be addressed. Listen, I call this the
Speaker 1: fighting spirit on Twitter. I'm amazed that how few people
Speaker 1: are out there pushing back on this sort of raw,
Speaker 1: rob passive thing. I like it. This is good debate.
Speaker 1: This is what people need. It's there. There aren't that
Speaker 1: many people on the active side who are fired up
Speaker 1: like this. It's it's odd. But I have one quick
Speaker 1: question though, in terms of your funds, right, you have
Speaker 1: equity Right, let's say we talk about an equity fund.
Speaker 1: One thing that's coming up a lot lately is active share.
Speaker 1: So the amount of the portfolio that say, isn't in
Speaker 1: the benchmark. How much you need exposure are you getting?
Speaker 1: Do you plan to have a high active share, which
Speaker 1: I assume you would if you're on a performance fee,
Speaker 1: and thus, how would you use it in a portfolio
Speaker 1: as like a ten percent add on to a low
Speaker 1: cost passive core or you look into sell funds that
Speaker 1: would have smaller active share that would be used as
Speaker 1: your complete core position. Yeah, great question. So what I
Speaker 1: love about this fee structure is the portfolio manager is emancipated. Literally,
Speaker 1: I'm paying them to perform. And so what you find
Speaker 1: with portfolio managers, and look, I've interviewed the hundred portfolio
Speaker 1: managers over the last nine months and and probably had
Speaker 1: three meetings each with them, So that's three interviews. Which
Speaker 1: you find with portfolio managers is they all have styles.
Speaker 1: They all have I don't mean styles like value growth,
Speaker 1: I mean investing styles. They have ways in which they
Speaker 1: take risk, ways in which they're comfortable taking risk. And
Speaker 1: you never before in a mutual fund could actually do
Speaker 1: what you said, which is have a small active position
Speaker 1: that was really all of your alpha and then the
Speaker 1: rest of your port folio was just an index. And
Speaker 1: the reason why you couldn't is because you were charging
Speaker 1: sixty five basis points to the client. The client would say,
Speaker 1: how can you have you know your portfolio index, I
Speaker 1: could pay you know, ten basis for that. We're changing
Speaker 1: that model entirely. You're paying us ten basis points in
Speaker 1: a US large cap portfolio. If we chose, if the
Speaker 1: portfolio manager chose to have a portion of that in
Speaker 1: an index, actually an index, or just replicate the index
Speaker 1: in a swap, you wouldn't be upset because you're not
Speaker 1: actually charging more getting charged more for that than you
Speaker 1: would if you bought it outside the mutual fund. So
Speaker 1: portfolio managers are going to construct these portfolios and ways
Speaker 1: in which they're comfortable taking risk, which I think increases
Speaker 1: the probability that they actually create a return. Because you
Speaker 1: want portfolio managers to be able to manage portfolios in
Speaker 1: with the least amount of constraints as possible. You lower
Speaker 1: the constraints, you increase the probability for performance. The people
Speaker 1: that are going to come and be portfolio managers are aperture,
Speaker 1: are people that actually believe they can perform. And I've
Speaker 1: I've had a couple of debates with folks that are
Speaker 1: in the traditional industry and they say, listen, some years
Speaker 1: people don't perform. You know, you can't hold the talent,
Speaker 1: and I said, look, I don't want the talent that's
Speaker 1: in your company, because the talent in your company is
Speaker 1: happy to get paid whether or not they perform. I
Speaker 1: actually want talent that wants to get paid when they perform.
Speaker 1: I'll pay them more. They'll be more focused on performance,
Speaker 1: and they're aligned with the client. And this one last thing,
Speaker 1: it's critical, which we haven't talked about this whole active
Speaker 1: passive debate, is focused on capacity because you know that
Speaker 1: when you manage more and more dollars, it becomes more
Speaker 1: and more difficult to produce returns. If I pay you
Speaker 1: on performance, you will cap your own capacity. That is
Speaker 1: a huge benefit, huge benefits, the biggest benefit that aperture offers,
Speaker 1: because if you don't have that, then the owner of
Speaker 1: the company, of the asset manager, and the portfolio manager
Speaker 1: are always fighting over you know, who's got you know,
Speaker 1: how much capacity is there really available in the industry.
Speaker 1: The portfolio manager will always say they can manage more money,
Speaker 1: and unfortunately the asset manager themselves, the shareholders of those
Speaker 1: of those companies, they're incentivized to grow the assets too.
Speaker 1: So this is the only company that I've seen so
Speaker 1: far with the owner the equity, meaning me and generally
Speaker 1: that both of us are incentivized to actually cap the
Speaker 1: capacity because we make money when the clients make money,
Speaker 1: and the same thing for the for the portfolio manager.
Speaker 1: That's a key difference. So, speaking of which, what do
Speaker 1: you view as going to be your your ideal size?
Speaker 1: So I think the ideal size of the company. First
Speaker 1: of all, this is a company that I believe will
Speaker 1: take eight to ten years to get to, you know,
Speaker 1: the ideal size. I don't think you can build asset managers.
Speaker 1: You know, over a short period of time. We're committed
Speaker 1: to this business. We generally and I are committed to
Speaker 1: this business over the long run. I've I've been lucky
Speaker 1: enough to head two asset managed organizations and both basis
Speaker 1: it took eight plus years to either stabilize them or
Speaker 1: grow them to scale. I don't really think this will
Speaker 1: be any different. Um, I think that we will have
Speaker 1: ten to fifteen managers over long periods of time. So
Speaker 1: over ten years, you know, if we're lucky enough to
Speaker 1: have three to five billion dollars per manager, you know,
Speaker 1: you can do the math, call it, you know, billion.
Speaker 1: We don't need to be a hundred billion dollar or
Speaker 1: two hundred or five hundred or trillion dollar company. In fact,
Speaker 1: I think that you probably can't produce the alpha at
Speaker 1: that basis. I think what the industry needs is lots
Speaker 1: of apertures out there, and in that way, I think
Speaker 1: that people can control their capacity. They can be specific
Speaker 1: alpha generating engines, and they can produce for the investor
Speaker 1: a much better environment over time. Your investor is interesting.
Speaker 1: You have a large one of the largest, you know,
Speaker 1: insurers in the world, Generalize, one of the largest Italian
Speaker 1: insure that's also been looking to expand their asset management base.
Speaker 1: Why an insurance company to build an asset manager need
Speaker 1: two things. One is far more important than the other.
Speaker 1: You need a little bit of capital to run the business.
Speaker 1: So this company has about forty million dollars of initial
Speaker 1: capitalization between myself and generally. That's interesting, but not very
Speaker 1: Which really interesting is the seed capital because what drives
Speaker 1: portfolio managers to actually come to a company is I
Speaker 1: can start you off with a sizeable amount of capital,
Speaker 1: and that means if you perform, you actually can get
Speaker 1: paid a reasonable amount of money. What does an insurance
Speaker 1: company have that most other entities don't have? They have
Speaker 1: very long duration liabilities. You know, people live for long
Speaker 1: periods of time, their insurance premiums are paid over long
Speaker 1: periods of time. Insurance company balance sheets have these very
Speaker 1: long duration liabilities, which means that they can invest over
Speaker 1: long periods of time. So an insurance company is the
Speaker 1: perfect balance sheet to actually provide seed capital. And what
Speaker 1: you need is an innovative insurance company who's willing to
Speaker 1: understand that building the asset manager might in fact be
Speaker 1: cheaper and more attractive over time than buying it. Most
Speaker 1: have bought them. I have bought lots of asset managers.
Speaker 1: I've sold lots of asset managers. Is very difficult to
Speaker 1: buy an asset manager. All kinds of issues plague you,
Speaker 1: and you have to pay for the fair value of
Speaker 1: the asset, which means that in order to get your
Speaker 1: money back, it has to grow faster than it's currently growing,
Speaker 1: and that's not an easy thing to do, particularly in
Speaker 1: today's market. So I think what Generality's insight was that, well,
Speaker 1: this is an innovative, disruptive model. We are an innovative
Speaker 1: and disruptive company. Fits with what we want to do,
Speaker 1: and we have the long duration liability that actually could
Speaker 1: fund it. So that's how it came together. When we
Speaker 1: talk active like your funds and the managers are hiring.
Speaker 1: A huge trend right now is quantitative active, which is
Speaker 1: actually not a human making decisions per se, but a
Speaker 1: system that humans used converted into an index. We call
Speaker 1: it smart beta. Are you going to use any of
Speaker 1: that or you're gonna have are going to be more
Speaker 1: quote like old school where you're discretionary active, you can
Speaker 1: decide what to do on any given day. Is that
Speaker 1: the kind of active you're gonna sell? Are you're gonna
Speaker 1: maybe have a murder of two? Very good Questionnaeric, you
Speaker 1: have very good questions. Really really, I'm way steep in
Speaker 1: this stuff. No, No, you're very good. Um. So I've
Speaker 1: managed quantitative managers over time, M built quantitative systems. Which
Speaker 1: interesting about quantitative systems, and you alluded to this is
Speaker 1: that they are actually just um disciplined and um mechanized
Speaker 1: human research processes, and so they aren't that different than
Speaker 1: what a human does. They're just routinized and they presumably
Speaker 1: exclude human biases in making decisions. I say presumably, because
Speaker 1: that's actually not true, because the research factors that actually
Speaker 1: drive them haven't bedded in them some bias. To begin with.
Speaker 1: The challenge with UH with the quantitative system is they
Speaker 1: have a very hard time seeing inflection points. And so
Speaker 1: if you actually run a quantitative model, the quantitative model
Speaker 1: will say, even though it lost money yesterday, that today
Speaker 1: it's going to make money, and it continues to actually
Speaker 1: execute the way it was the past day. It's hard
Speaker 1: for that quantitative model to actually see an inflection point
Speaker 1: and change and that's the biggest risk in quant models
Speaker 1: in the world. Then they're all basically the same one
Speaker 1: form or another. So sometimes some of the engineers of
Speaker 1: the quant models actually can see the inflection points and
Speaker 1: change the model, and so effectively they inject into the
Speaker 1: process a human element that wasn't really supposed to be there.
Speaker 1: And often and oftentimes they don't get it right, but
Speaker 1: sometimes they get it. They do get it right, and
Speaker 1: that's what makes some of these you know, unique quantitative
Speaker 1: models more successful versus others. I think that's interesting, But
Speaker 1: my own view of the world is that um the
Speaker 1: quantitative models are more likely to not see the inflat
Speaker 1: action point and take on too much money over time
Speaker 1: because the quantitative model also doesn't have a capacity, you know, instinct,
Speaker 1: it's just a it's just a machine. It just keeps trading.
Speaker 1: So I've concluded that I think the human actually, on balance,
Speaker 1: has more to offer than the machine. Wow, that is controversial.
Speaker 1: I like him. He's going after passive and quants. I
Speaker 1: like it. So this is you're taking on two huge trends.
Speaker 1: There's a whole discussion about artificial intelligence that AI, you know,
Speaker 1: effectively will trump human thinking. And look, that may be
Speaker 1: true fifty years from now, it is not true today.
Speaker 1: And so if you wanted to build a investment management
Speaker 1: company on AI driven quantitative investing, I don't think that
Speaker 1: that's in the cards right now. It's funny, how you know,
Speaker 1: all this movement into passive and quant and the news flow,
Speaker 1: how original saying a human being human being? Fun It's like, Wow,
Speaker 1: how novel? SELLI Bazak, Peter Krause, Your church is called
Speaker 1: Aperture Investors. Thanks for joining Sun Trillions. Thank you so much.
Speaker 1: Thanks for listening to Tricks Until next time. You can
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