Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: This conversation going now with Rob are Not. He is
Speaker 2: chairman and founder at Research Affiliates, joining us on set.
Speaker 2: Great to see you in person, Rob, Yeah, thank.
Speaker 3: You both very very much for wearing green to celebrate
Speaker 3: the launch of our new ETF in the crowded space
Speaker 3: of cap weighted indexing.
Speaker 2: Well, you made my transition for me, so I thank
Speaker 2: you for that. Let's talk about this ETF that you
Speaker 2: launched last week, the Research Affiliates cap Weighted US ETF.
Speaker 2: This tracks the Research Affiliates cap Weighted index and Rob,
Speaker 2: you made the bold claim that this could represent a
Speaker 2: new future for passive investing. Tell us about this product.
Speaker 3: It's actually very straightforward. Cap Weighted indexing has an enormous
Speaker 3: achilles heel. People think active versus passive. Cap weighted indexes
Speaker 3: are passive. Yeah they are, but no they're not. There's
Speaker 3: four or five percent turnover per anum on average, So
Speaker 3: ninety five percent of the portfolio is blissfully uncaring about
Speaker 3: whether the stocks are going up or down, whether the
Speaker 3: businesses are flourishing or floundering, and four to five percent
Speaker 3: is traded. That four five percent is active and boy
Speaker 3: is it wild active. It would make Kathy Wood blush.
Speaker 3: It buys stocks at an average of twice the market multiple.
Speaker 3: It sells stocks that are deeply out of favor, unloved,
Speaker 3: and typically half the market multiple. It chases a frothy
Speaker 3: emerging growth strategy. All we're doing is saying, wait a minute.
Speaker 3: This leads to flip flops. For every new tesla and
Speaker 3: video that gets found and added to the index, there's
Speaker 3: a dozen companies that come along that look super promising,
Speaker 3: that turn out to fall short of lofty expectations and
Speaker 3: crash right back out of the index in five to
Speaker 3: ten years. We call these flip flops. They do enormous damage.
Speaker 3: What if you just add a little bit of patience.
Speaker 3: You add stocks to the index when the business is
Speaker 3: big enough to matter. Not that the five hundred largest
Speaker 3: market cap stocks the five hundred largest businesses, and you
Speaker 3: sell stocks when their business is no longer large enough
Speaker 3: to matter. Now, if you do that, you slow down
Speaker 3: the trading, you have lower turnover. It's more passive than
Speaker 3: conventional cap weighted indexes. And when you go back over
Speaker 3: the last thirty four years, you find this really simple
Speaker 3: change boost returns by sixty nine basis points per annum
Speaker 3: with about one percent tracking error.
Speaker 4: Yeah no, so okay, this is our aus at ETF
Speaker 4: that tracks the index that would do this correct. And
Speaker 4: it is actively managed, so you're basically having a person
Speaker 4: time the market.
Speaker 3: Is that right? It is not actively managed. It is
Speaker 3: every bit as passive as the Russell one thousand. It's
Speaker 3: more passive than the S and P, which is managed
Speaker 3: by committee. It has turnover that's lower than the Russell
Speaker 3: one thousand. It has turnover that's almost identical to the
Speaker 3: S and P five hundred, and the turnover doesn't chase
Speaker 3: fads and bubbles and doesn't bail out of a stock
Speaker 3: when it's wildly out of favor. That's where the value
Speaker 3: added comes. It is a passive strategy.
Speaker 1: Looking at the holdings here, it looks a lot like
Speaker 1: the S and P. I mean, you've gotten a video Microsoft, Apple,
Speaker 1: They're all there. Let's talk about strategy, right, This is
Speaker 1: a case for the S and P. We qualified, but
Speaker 1: the committee who knows who they are, decided no, we
Speaker 1: don't like it. It's also not in yours. So it's
Speaker 1: interesting there talk a little bit about what really is
Speaker 1: passive and what determines whether a thock gets in here,
Speaker 1: and maybe strategy is a good example. Why isn't in here?
Speaker 3: Well, I love your framing this. In terms of active
Speaker 3: versus passive, there is no such thing as a passive portfolio.
Speaker 3: Portfolio has turnover. That turnover can be based on rules
Speaker 3: as at Russell, it can be based on committee decisions
Speaker 3: as at SMP. Better to define passive as sitting placidly
Speaker 3: and going with the flow. Well, the sitting placidly and
Speaker 3: going with the flow applies to ninety five percent of
Speaker 3: the portfolio. It's also interesting that our strategy has ninety
Speaker 3: five percent overlap with the S and P. Five hundred
Speaker 3: percent of the holdings are identical. The difference is at
Speaker 3: the margins. There are companies that are not yet big
Speaker 3: businesses that don't make it onto our index. Pallanteer is
Speaker 3: the largest market cap stock that we don't own, but
Speaker 3: it's not a big business. Trades at one hundred times
Speaker 3: it's annual sales. And at the other end of the spectrum,
Speaker 3: there are companies that are big businesses that aren't in
Speaker 3: the S and P because they've never been popular or
Speaker 3: frothy enough to make it into there there's a wonderful
Speaker 3: example of flip flops a Dillard's department store. It's been
Speaker 3: a member of the S and P five hundred and
Speaker 3: five times in the last thirty years. It's been kicked
Speaker 3: out four times, it's come back in four times. Every
Speaker 3: time it's by high sell low. Now here's an astonishing fact.
Speaker 3: If you owned Dillards during the thirteen years in the
Speaker 3: last thirty five that it wasn't in the Russell one thousand,
Speaker 3: you would have made sixty seven times your money. If
Speaker 3: you owned it during the twenty three years that it
Speaker 3: was in the Russell one thousand, you would have made
Speaker 3: ninety nine percent negative loss. You would have a penny
Speaker 3: left of every dollar you started with. So a six
Speaker 3: thousand to one ratio of wealth owning it when it's
Speaker 3: not in the index versus owning it when it's not
Speaker 3: just absolutely mind blowing.
Speaker 2: Well, Rob, you bring a Dillards, which is an incredible
Speaker 2: example of this. But bringing it back to I mean
Speaker 2: this ETF you said it has ninety five percent overlap
Speaker 2: with the S and P five hundred. So we're talking
Speaker 2: about large cap names here. How does this effect look
Speaker 2: when you think about midcaps? When you think about small caps.
Speaker 2: Do you have the same sort of flip flopping that
Speaker 2: you might see when it comes to the S and
Speaker 2: P five hundred.
Speaker 3: You do, but it's more powerful at the large cap
Speaker 3: end of the spectrum. Think of it this way. When
Speaker 3: Dillard's is not in the Russell one thousand, it is
Speaker 3: in the Russell two thousand and So what we find
Speaker 3: is is that every time Dillard's is added, it's added
Speaker 3: after an average of a fifty percent outperformance year five
Speaker 3: thousand basis points. Then it underperforms by an average of
Speaker 3: six thousand basis points and gets kicked back out. Then
Speaker 3: it snaps back by an average of two hundred and
Speaker 3: ten percentage points of outperformance, fifty percent of that in
Speaker 3: the last year before it's added, and then it's kicked out.
Speaker 3: Leather rids repeat. It's wild rob.
Speaker 4: Before we let you go, we got to ask you
Speaker 4: about the president's proposal. It's not official, but this idea
Speaker 4: that companies report earnings every six months, then every three months.
Speaker 4: As an investor, what do you think of something like that.
Speaker 3: I'm a libertarian. I prefer to let people and businesses
Speaker 3: do what they want. I think a requirement of every
Speaker 3: three months fine. Lift the requirement. If a company wants
Speaker 3: to report every six months, every twelve months, that's fine.
Speaker 3: Publicly traded it out a report at least once in
Speaker 3: a while, but a requirement for quarterly reporting increases short termism.
Speaker 3: I've often said that I will never ever work for
Speaker 3: a publicly traded company. Again, I've been saying that for
Speaker 3: a quarter century, and the reason is regulatory distraction and
Speaker 3: short termism. I can think about business rouse the new ETFRUS.
Speaker 3: We're pricing it at zero for the first year. The
Speaker 3: beauty in that is scale. If we get in one
Speaker 3: hundred billion dollars, multiply that by a zero fee, and
Speaker 3: that's a lot more money than one hundred million dollars
Speaker 3: time zero, Right, I'm joking. We're able to do that
Speaker 3: because we look past the coming quarter. We want to
Speaker 3: create a revolution in indexing. And if we create a
Speaker 3: revolution in indexing and it succeeds, it'll be a big
Speaker 3: money maker in ten years. I don't care if it's
Speaker 3: a big money maker in five years. I certainly don't
Speaker 3: care about the first year.
Speaker 2: Yeah, and certainly not the first three months. Rob. Fantastic
Speaker 2: to get some time with you, as always, that is
Speaker 2: Rob or Not of Research Affiliates, talking about, of course,
Speaker 2: his new ETF ticker rus